Is your money safe at the bank? An economist says ‘no’ and withdraws his
BY TERRY BURNHAM January 30, 2014 at 12:45 PM EST

Terry Burnham, former Harvard economics professor, author of “Mean Genes” and “Mean Markets and Lizard Brains,” provocative poster on this page and long-time critic of the Federal Reserve, argues that the Fed’s efforts to strengthen America’s banks have perversely weakened them. (See our 2005 segment with Burnham below about how “lizard brains” influence our economic decisions.)

Last week I had over $1,000,000 in a checking account at Bank of America. Next week, I will have $10,000.

Why am I getting in line to take my money out of Bank of America? Because of Ben Bernanke and Janet Yellen, who officially begins her term as chairwoman on Feb. 1.

Before I explain, let me disclose that I have been a stopped clock of criticism of the Federal Reserve for half a decade. That’s because I believe that when the Fed intervenes in markets, it has two effects — both negative. First, it decreases overall wealth by distorting markets and causing bad investment decisions. Second, the members of the Fed become reverse Robin Hoods as they take from the poor (and unsophisticated) investors and give to the rich (and politically connected). These effects have been noticed; a Gallup poll taken in the last few days reports that only the richest Americans support the Fed. (See the table.)

Gallup poll

Why do I risk starting a run on Bank of America by withdrawing my money and presuming that many fellow depositors will read this and rush to withdraw too? Because they pay me zero interest. Thus, even an infinitesimal chance Bank of America will not repay me in full, whenever I ask, switches the cost-benefit conclusion from stay to flee.

Let me explain: Currently, I receive zero dollars in interest on my $1,000,000. The reason I had the money in Bank of America was to keep it safe. However, the potential cost to keeping my money in Bank of America is that the bank may be unwilling or unable to return my money.

They will not be able to return my money if:

Customers wait in line at the Indymac Bank branch headquarters in Pasadena, Calif., in July 2008. Joshua Lott/Bloomberg News
Customers wait in line at the IndyMac Bank branch headquarters in Pasadena, Calif., in July 2008. Joshua Lott/Bloomberg News

Many other depositors like you get in line before me. Banks today promise everyone that they can have their money back instantaneously, but the bank does not actually have enough money to pay everyone at once because they have lent most of it out to other people — 90 percent or more. Thus, banks are always at risk for runs where the depositors at the front of the line get their money back, but the depositors at the back of the line do not. Consider this image from a fully insured U.S. bank, IndyMac in California, just five years ago.

Some of the investments of Bank of America go bust. Because Bank of America has loaned out the vast majority of depositors’ money, if even a small percentage of its loans go bust, the firm is at risk for bankruptcy. Leverage, combined with some bad investments, caused the failure of Lehman Brothers in 2008 and would have caused the failure of Bank of America, AIG, Goldman Sachs, Morgan Stanley, Merrill Lynch, Bear Stearns, and many more institutions in 2008 had the government not bailed them out.

In recent days, the chances for trouble at Bank of America have become more salient because of woes in the emerging markets, particularly Argentina, Turkey, Russia and China. The emerging market fears caused the Dow Jones Industrial Average to lose more than 500 points over the last week.

Returning to my money now entrusted to Bank of America, market turmoil reminded me that this particular trustee is simply not safe. Or not safe enough, given the fact that safety is the reason I put the money there at all. The market turmoil could threaten “BofA” with bankruptcy today as it did in 2008, and as banks have experienced again and again over time.

If the chance that Bank of America will not return my money is, say, a mere 1 percent, then the expected cost to me is 1 percent of my million, or $10,000. That far exceeds the interest I receive, which, I hardly need remind depositors out there, is a cool $0. Even a 0.1 percent chance of loss has an expected cost to me of $1,000. Bank of America pays me the zero interest rate because the Federal Reserve has set interest rates to zero. Thus my incentive to leave at the first whiff of instability.

Surely, you say, the federal government is going to keep its promises, at least on insured deposits. Yes, the Federal Government (via the FDIC) insures deposits in most institutions up to $250,000. But there is a problem with this insurance. The FDIC currently has far less money in its fund than it has insured deposits: as of Sept. 1, about $41 billion in reserve against $6 trillion in insured deposits. (There are over $9 trillion on deposit at U.S. banks, by the way, so more than $3 trillion in deposits is completely uninsured.)

It’s true, of course, that when the FDIC fund risks running dry, as it did in 2009, it can go back to other parts of the federal government for help. I expect those other parts will make the utmost efforts to oblige. But consider the possibility that they may be in crisis at the very same time, for the very same reasons, or that it might take some time to get approval. Remember that Congress voted against the TARP bailout in 2008 before it relented and finally voted for the bailout.

Thus, even insured depositors risk loss and/or delay in recovering their funds. In most time periods, these risks are balanced against the reward of getting interest. Not so long ago, Bank of America would have paid me $1,000 a week in interest on my million dollars. If I were getting $1,000 a week, I might bear the risks of delay and default. However, today I am receiving $0.

So my cash is leaving Bank of America.

But if Bank of America is not safe, you must be wondering, where can you and I put our money? No path is without risk, but here are a few options.

Keep some cash at home, though admittedly this runs the risk of loss or setting yourself up as a target for criminals.

Put some cash in a safety box. There is an urban myth that this is illegal; my understanding is that cash in a safety box is legal. However, I can imagine scenarios where capital controls are placed on safety deposit box withdrawals. And suppose the bank is shut down and you can’t get to the box?

Pay your debts. You don’t need to be Suze Orman to know that you need liquidity, so do not use all your cash to pay debts. However, you can use some surplus, should you have any.

Prepay your taxes and some other obligations. Subject to the same caveat about liquidity, pay ahead. Make sure you only pay safe entities. Your local government is not going away, even in a depression, so, for example, you can prepay property taxes. (I would check with a tax accountant on the implications, however.)

Find a safer bank. Some local, smaller banks are much safer than the “too-big-to-fail banks.” After its mistake of letting Lehman fail, the government has learned that it must try to save giant institutions. However, the government may not be able to save all failing institutions immediately and simultaneously in a crisis. Thus, depositors in big banks face delays and defaults in the event of a true crisis. (It is important to find the right small bank; I believe all big banks are fragile, while some small banks are robust.)

Someone should start a bank (or maybe someone has) that charges (rather than pays) interest and does not make loans. Such a bank would be a good example of how Fed actions create unintended outcomes that defeat their goals. The Fed wants to stimulate lending, but an anti-lending bank could be quite successful. I would be a customer.

(Interestingly, there was a famous anti-lending bank and it was also a “BofA” — the Bank of Amsterdam, founded in 1609. The Dutch BofA charged customers for safe-keeping, did not make loans and did not allow depositors to get their money out immediately. Adam Smith discusses this BofA favorably in his “Wealth of Nations,” published in 1776. Unfortunately — and unbeknownst to Smith — the Bank of Amsterdam had starting secretly making risky loans to ventures in the East Indies and other areas, just like any other bank. When these risky ventures failed, so did the BofA.)

My point is that the Federal Reserve’s actions have myriad, unanticipated, negative consequences. Over the last week, we saw the impact on the emerging markets. The Fed had created $3 trillion of new money in the last five-plus years — three times more than in its entire prior history. A big chunk of that $3 trillion found its way, via private investors and institutions, into risky, emerging markets.

Now that the Fed is reducing (“tapering”) its new money creation (now down to $65 billion a month, or $780 billion a year, as of Wednesday’s announcement), investments are flowing out of risky areas. Some of these countries are facing absolute crises, with Argentina’s currency plummeting by more than 20 percent in under one month. That means investments in Argentina are worth 20 percent less in dollar terms than they were a month ago, even if they held their price in Pesos.

The Fed did not plan to impoverish investors by inducing them to buy overpriced Argentinian investments, of course, but that is one of the costly consequences of its actions. If you lost money in emerging markets over the last week, at one level, it is your responsibility. However, it is not crazy for you to blame the Fed for creating volatile prices that made investing more difficult.

Similarly, if you bought gold at the peak of almost $2,000 per ounce, you have lost one-third of your money; you share the blame for your golden losses with Alan Greenspan, Ben Bernanke and Janet Yellen. They removed the opportunities for safe investments and forced those with liquid assets to scramble for what safety they thought they could find. Furthermore, the uncertainty caused by the Fed has caused many assets to swing wildly in value, creating winners and losers.

The Fed played a role in the recent emerging markets turmoil. Next week, they will cause another crisis somewhere else. Eventually, the absurd effort to create wealth through monetary policy will unravel in the U.S. as it has every other time it has been tried from Weimar Germany to Robert Mugabe’s Zimbabwe.

Even after the Fed created the housing problems, we would have been better of with a small 2009 depression rather than the larger depression that lies ahead. See my Making Sen$e posts “The Stockholm Syndrome and Printing Money” and “Ben Bernanke as Easter Bunny: Why the Fed Can’t Prevent the Coming Crash” for the details of my argument.

Ever since Alan Greenspan intervened to save the stock market on Oct. 20, 1987, the Fed has sought to cushion every financial blow by adding liquidity. The trouble with trying to make the world safe for stupidity is that it creates fragility.

Bank of America and other big banks are fragile — and vulnerable to bank runs — because the Fed has set interest rates to zero. If a run gathers momentum, the government will take steps to stem it. But I am convinced they have limited ammunition and unlimited problems.

What is the solution? For you, save yourself and your family. For the system, revamp the Federal Reserve. The simplest first step would be to end the dual mandate of price stability and full employment. Price stability is enough. I favor rules over intervention. We don’t need a maestro conducting monetary policy; we need a system that promotes stability and allows people (not printing presses) to make us richer.

To hear Terry explain how our lizard brains influence our economic decisions, watch the 2005 segment we did with him below.

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13 Responses to

  1. Sam Barber says:

    This is a great idea, I’ve been looking into underbanking myself and this fits in the the MW mindset as well. Good post, solid real world advice.

  2. Denise says:

    YAY! It’s crashing!

  3. Afterthought says:

    One quibble; fiat systems, and debt systems never were primarily economic solutions; they were political solutions.

    Keynes was explicit about why he advocated government intervention in the economy post-WWI, which was to preserve social peace. At that time communism was an active force, and revolution was a hair’s breadth away. In our time, folks are far less systematic thinkers (as they are less white), and don’t have a system as coherent as Jewish communism, but the threat to social peace is just as acute from the hordes of negroes, mestizos, and white trash.

    If “gibs me dat” isn’t placated we are right back to 1968 and riots in the streets. The powers that be do not share our longing for Ragnarok, and so will suffer a little economic inefficiency if it forestalls the reckoning.

    I

    • torgrim says:

      “If the ‘gibs me dat’ isn’t placated we are right back to 1968 and riots in the streets.”
      Those that remember the riots understand just what the shock and awe of whole sections of cities nationwide going up in flames and the government reaction of massive change in public expenditures. The three threats to social peace, negroes, mestizos and white trash must be placated, however, this is not the wealthy nation it was in 1968, as the middle class has been looted for years and this is the problem. Where are the social engineers going to get the revenue to continue the EBT cards, etc? I think there will be a slow and engineered retreat, the bean counters will quietly pull in spending for the poor and hope they will just go quietly….

  4. TabuLa Raza says:

    Do TPTB long for Ragnarok Danneskjöld?

  5. TabuLa Raza says:

    THE CRACK-UP BOOM

    “This first stage of the inflationary process may last for many years. While it lasts, the prices of many goods and services are not yet adjusted to the altered money relation. There are still people in the country who have not yet become aware of the fact that they are confronted with a price revolution which will finally result in a considerable rise of all prices, although the extent of this rise will not be the same in the various commodities and services. These people still believe that prices one day will drop. Waiting for this day, they restrict their purchases and concomitantly increase their cash holdings. As long as such ideas are still held by public opinion, it is not yet too late for the government to abandon its inflationary policy.” “But then, finally, the masses wake up. They become suddenly aware of the fact that inflation is a deliberate policy and will go on endlessly. A breakdown occurs. The Crack Up Boom appears. Everybody is anxious to swap their money against “real” goods, whether he needs them or not, no matter how much money he has to pay for them. Within a few weeks or even days, the things which were used as money are no longer used as media of exchange. They become scrap paper. Nobody wants to give away anything against them.”

    “This is what happened with the Continental Currencies in America in 1781, with the French Mandats Territoriaux in 1796 and with the German mark in 1923. It will happen again whenever the same conditions appear. If a thing has to be used as a medium of exchange, public opinion must not believe that the quantity of this thing will increase beyond all bounds. Inflation is a policy that cannot last.”

    via Ludwig von Mises, Human Action: A Treatise on Economics, 1949

  6. TabuLa Raza says:

    “. . .What is the solution? For you, save yourself and your family. For the system, revamp the Federal Reserve. The simplest first step would be to end the dual mandate of price stability and full employment. Price stability is enough. I favor rules over intervention. We don’t need a maestro conducting monetary policy; we need a system that promotes stability and allows people (not printing presses) to make us richer. . .”

    Absolute trash of the lowest order. Repair the joo counterfeiting monopoly? Fixing this is like fixing the devil, or fixing swej. Can’t be fixed, doesn’t want fixing anyway. All monopolies must go. We need NON-GOVERNMENTAL MONEY, WITH COMPETITION.

    [Sure, the Fed is private. Established by GOVERNMENT in 1923]

  7. TabuLa Raza says:

    1913, actually.

  8. JODAFO says:

    Thanks for this post. I was thinking about how our future countries should operate and reached the conclusion that banks should be like the one mentioned in Amsterdam. Didn’t know that style existed previously.

  9. Paladin Justice says:

    Credit unions are an alternative to banks. Be sure to look at the bank and credit union safety ratings online–wish I could remember the name of the website. Expect that when the Fed loses control, interest rates will skyrocket. I was earning 16 percent on my money back in the late 70s early 80s, which actually gave me a positive REAL rate of interest.

  10. zek says:

    It’s good advice, if incomplete. And it’s couched in language that maybe mainstreamers need in order to accept it. But I have to LOL @ the Harvard/MIT tool who has “been a stopped clock of criticism of the Federal Reserve for half a decade.” Really. What foresight and bravery, to come out and criticize the Fed AFTER it has just blown up the economy. Way to hang your balls out there, dude.

    He actually wants to “revamp” the Fed. “[The] price stability [mandate] is enough.” Oy vey, this guy is a real anti-establishment rebel, isn’t he? Joe Stiglitz wants his spotlight back!

    But I googled him and it turns out I have more in common with him than I thought. Apparently he has “studied wild chimpanzees in Africa.” I’ve studied wild chimpanzees right here in the upper midwest. There are over a million in the Chicago area alone.

  11. The funny thing is, this argument isn’t new, and it’s the traditional argument of Big Capital. Big Capital has long argued that the “full employment” part of the Fed’s dual mandate is inflationary, and have traditionally lobbied to have a single mandate of price stability.

    In other words, favoring creditors over debtors. Preservation of capital. Of course Big Capital would want that. It is a bit ironic to see middle class Ron Paul Libertarians arguing on the same side as the Rockefellers and Warburgs of the world.

    Thankfully, someone mentioned credit unions. This is a no-brainer. Credit Unions are better than banks, both for individuals as well as the community as whole.

    • Anon says:

      It favors people with dollar denominated assets over non-dollar denominated assets, and for better or worse that tends to describe the middle class.

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