Dumb economic question

[fivemack]

It seems that the current Something To Do about the credit crunch is to provide Government backing of private bank deposits without limit - Ireland, Greece, and now Germany, and a punditry belief that once Germany has gone the insurance will be extended across the EU.

How does this help, when the immediate consequence of the credit crunch that keeps coming up is an inability of banks to issue short-term business loans, with a secondary concern about businesses losing float kept in their accounts with failing banks and being obliged to close.

It doesn't make the banks any more solvent, it just makes their insolvency less visible, and means that in the event of the bank running out of money I get repaid out of the National Debt, which I then presumably get to repay out of raised taxes over the next half-century.

Comments

[pseudomonas.livejournal.com]

I assume that the main way it helps is by deterring the situation in which private individuals all try to move their cash from their bank to their mattress before anyone else; it doesn't make the banks lessmore solvent but it might mean that there's not the activation energy for things to collapse before some more long-term solution is sorted out.

[fivemack.livejournal.com]

The relevant factor here is surely not 'private individuals', but 'private individuals with more than £35000 in a single bank'; there are at least three banks and most people with more than 35k in savings are reasonably risk-averse and financially competent, so you're dealing (in the context of a crisis caused by peoples' increased propensity to refrain from saving and live off credit - mortgage withdrawal rates only went negative this quarter, net saving is now tiny-but-positive rather than actually negative) with the relatively small set of people with more than £100k in savings in a bank.

I suppose there is a 'but what if Abbey go bust during the two-hour period that my house deposit is passing through them' worry, but insuring sums deposited for less than 7 days would handle that case.

You're creating a strong incentive to sell shares in anything that looks remotely risky and put the money into Halifax six-month bonds paying 7%, which is nice for Halifax until April but seems somehow sub-optimal for every other public company.

[arnhem.livejournal.com]

It's possible (I don't know, but I suspect) that most people with more than 35k in savings are retired. They've got them by having a pension. Admittedly, that probably filters out the really risk-seeking types, but I think it's unwise to assume that they'll all have done the most sensible/competent/risk-averse thing with any lump sums.

What I think I'm trying to say is that you may find that there's quite a lot of people with >35k who feel very vulnerable indeed (as they've got comparatively poor or no earning potential, and don't know how long they've got to make the lump sum last).

[cartesiandaemon.livejournal.com]

I also ought to know more about this, but off the top of my head (a) it is of course quite possible that a government adopts a counter-productive measure (b) to stop people withdrawing their money, which would immediately make worse an ailing bank?

[hairyears.livejournal.com]

Wot He Said. Which is to say: prevent a damaging 'run on the bank'... By small depositors, who are mosly voters. That's both gains, in a nutshell. It doesn't prevent the other type of run: a withdrawal of capital by the investors. It doesn't solve the problem of the asset-backed securities in the bank's regulatory capiital being valued at a market price a quarter of their face value, rendering the bank insolvent unless it can borrow from the Central Bank with these assets as collateral. It won't stope some unknown proportion of these assets being genuinely worthless - a small but unknown proportion that means banks won't lend to each other overnight and any of them could run out of cash... And be force to stop lending, leaving the non-voting commercial borrowers to fail and die, no matter how profitable they may be.

And if any bank can fail that way - or any rumour of it should arise - the depositors will 'run' anyway: their money may be guaranteed but it could take weeks or months to work through the bueaucracy.

[arnhem.livejournal.com]

Looking at history, I think that governments will be far more likely to bail themselves out of that situation by revaluing the currency than via National Debt (and who are they going to borrow from anyway?).

So you might get exactly the number of pounds back that you ought to, but they won't necessarily have the value that you expected them to.

[papersky.livejournal.com]

I have no idea.

I had an idea for something that would fix this -- set all mortgage rates by fiat to 5%. It doesn't reward any villains or the imprudent over the prudent, and it would actually work.

[arnhem.livejournal.com]

That'll make the arbitrageurs very happy; I'm not sure whether to characterise them as villains or not.