Wavepacket Blog

Wavepacket Blog
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Mon Mar 24 21:00:00 2008
Seizing Up
Apparently our financial system can seize up.

The government is now trying to figure out how to respond to the mortgage crisis. In particular, the Federal Reserve is bailing out Bear Stearns in an effort to keep the "financial system from seizing up."

Gears all seized up.
Image courtesy of Jared C. Benedict (wiki)

That phrase has become very popular. Apparently, just like a big cranky engine without enough oil, the economy can suddenly grind to a halt with disastrous consequences. Most reporters and economists make comparisons with the Great Depression. It must be true, since so many reputable news providers use the phrase.

But what does it mean really?

In particular, what would have seized up? Would the nation's banks have stopped working? Millions would have pulled out their savings, leading to a nation-wide run on banks and financial meltdown?

Not likely. Consumers are so tightly leveraged that odds are they owe their banks a lot more than is owed back. In 1929, the savings rate was close to 15%. In 2008, the savings rate is close to -1%. That's right, negative 1%. Most Americans spend more than they earn.

Okay, so many people have no savings. But it is possible that a mass panic would have set in, and people with savings would have pulled them out. But how many? In 1929, we didn't have the FDIC, which now insures most Americans of up to $100K of their savings. I wouldn't run out and pull my insured money out. Would you? Where would you put it if you didn't trust the banks? And how much of your money is actually in banks versus stocks or properties?

(Incidentally, check out FDR's radio address in that FDIC link, even just the first few minutes. What a wild situation. His description of the banking system is better than any I heard in school. Check out the description of bankers around 11:40. And do they still make Presidents like that?)

So bank runs aren't a real risk. Is it the collapse of mortgages which could destroy bank funds to they point where they couldn't operate? Not at the national level. As bad as the mortgage problem is, it alone couldn't take down all the nation's banks. Again, the Federal Reserve is able to provide loans on assets if banks really needed it.

So what would seize up? It isn't clear at all. So I think that if reporters use the phrase, they should explain what is seizing up and why. Because at the moment it sounds like a loaded phrase used to justify the bailing out of incompetent bankers at the public's expense.

And I wonder if Bear Stearns should just be allowed to fail, as a warning to all other incompetent money managers. If taxpayer money should be involved, I'd say that should go towards the victims of bad lending practices and not the perpetrators.

[Update on 7 April 2008: if you read the FDIC documentation, you'll see that $100K is the minimum insured amount. You can be covered for more if the account qualifies. And certain retirement accounts are covered up to $250K. Nothing like this was available to banking customers in 1929!]

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