The Austrian Way: Why the Czechs actually caused the financial crisis

Since 2008 we’ve all heard explanations for why the Great Financial Crises (GFC) occurred and how to solve it. Most of the solutions from the talking heads are BS.

We think one of the main reasons we are in today’s financial straits is due to excessive meddling that caused some of the greatest enforcers of discipline in the financial system to fall asleep at the watch.

No, not the regulators!

There is a constituency in financial markets whose supervision, action and influence is essential to healthy banking and mitigating against financial crises.

We are talking about bank depositors.

We provide the foundations of the banking system

Bank depositors provide their savings as vital seed capital for the banking system to leverage and lend out. Your deposits are the keystone of banking and once lent to the bank cease to be your property. You become a creditor to the bank.

The alertness and judgement of depositors in the banking market is a crucial check on bad lending practises, excessive leverage and imprudent risk taking. We don’t put our money into risky banks, preferring to lend to better run institutions.

Since the 1970s depositors were guilty of falling asleep at the watch, because of something our wise central planners did to break our attention and focus.

The sacred cow of deposit insurance

The policy in our cross hairs is of course deposit insurance.

Deposit insurance schemes ostensibly aim to protect individual savers from devastating bank runs, by the state guaranteeing the first XYZ amount of cash in the bank. Deposit insurance is meant to make the banking system less prone to bank runs and thus safer and more stable.

These ideas were first tried in Czechoslovakia in the 1920s before finding their way into the United Socialist States of America in 1934. Now such schemes are visible in most Western nations, with the exception of New Zealand.

Unfortunately, deposit insurance doesn’t achieve what it sets out to do.

Deposit insurance is massively distortive in its effects on the efficient operation of the banking market. Depositors suddenly become far less considered in how they allocate their savings capital within the banking system.

Bankers in turn can take more risks, grow bank balance sheets and leverage up to the hilt in a mad dash for ever greater returns on equity. Bankers increasingly make the gamble that if they cock up, the state will mop up the mess.

A poisonous dynamic sets in.

What happens next?

The eventual results as predicted by a few Austrians from my school (the Austrian one by the way!) are years of bad lending practices, bigger bubbles, mega-banks that are too big to fail, and a culture of bank bail outs.

If this dynamic continues the growth of banks means we no longer have to worry about RBS, Lloyds etc being too big to fail, but too big to bail.

By trying to prevent bank runs, deposit insurance removes one of the essential features from a healthy, sustainable banking system – bank runs!

Here’s new hero to Bogpaper, Professor Kevin Dowd, waxing lyrical about why we need bank runs:

…runs perform a useful role in closing down insolvent institutions, and the threat of a bank run is a major factor serving to discourage a bank’s management from pursuing excessively risky policies. Remove these and insolvent banks will continue in operation possibly long after they should, and managements will be encouraged to take risks they would otherwise have avoided. Banks will therefore adopt policies more likely to lead to failure, and this will aggravate banking instability rather than reduce it. Bank runs are therefore best regarded as a symptom of banking instability rather than a major cause of it, and attempts to cure the symptom by discouraging runs are more likely than not to aggravate the underlying disease.

How deep is our slumber?

Very deep it turns out!

In today’s contemporary financial world, depositors exhibit a crazy lack of understanding and complacency about how banking works.

Here are a few choice statistics from an ICM/Cobden Centre poll of 2000 Brits in 2010:

  • 74% of depositors think they own their cash in the bank, when they do not
  • 66% answered “donʼt know” when asked what proportion of their current account was used in various ways by their bank
  • 33% oppose the fact that banks lend out some of the money as loans

UK depositors do not understand the loss of control of their money, do not bother to check out what banks are doing with their money and often don’t even agree with bank lending!

Apparently we don’t believe in the comfort blanket of deposit insurance anyway, with only 33% of the British depositors favouring government backed deposits.

Wake up depositors!

It’s your money that gives life-blood to the banking system. It’s your money they’re playing with.

You hold the trump card.

If you don’t like how banking works, say no thank you to Czech financial innovation (you can keep saying yes to Czech models and lager!) and put your money in a credit union with 100% reserve ratios. This way you cut out the banks, but still help lending in the economy.

Or better yet, bust the fiat money fraud in the same stroke and buy gold and silver bullion.

6 comments on “The Austrian Way: Why the Czechs actually caused the financial crisis

  1. Apparent bigot
    June 25, 2013 at 8:32 am #

    Superb article. You just need to read Jefferson, Lincoln and Washington’s thoughts re banking to get it. Today’s financial system is the most dangerous threat to global progress and security. It’s not small arms, suicide bombers or nukes we should worry about… It’s leverage, derivatives and other ticking time bombs. Proud to have my money in v low risk unions in Canada, NZ and UK. Gold too, but not telling anyone where.

  2. silverminer
    June 25, 2013 at 3:06 pm #

    Another symptom of the dependency culture that has been created. The public have outsourced the responsibility for checking out the financial institutions they do business with to the government. We’re all guilty of this to an extent I’m sure.

    But it’s worse than that because the government are in the pay of the institutions they’re meant to be regulating. We have a criminal cabal of bankers, politicians and bureaucrats running the world. Bankrupt nations backstopping insolvent banks and the mass of the public are totally clueless about it all.

    Nothing short of a complete collapse of the system is going to clean this out now. Then we can only hope the right people can seize the reins and bring back the principle of “caveat emptor” in all dealings.

    • theaustrianway
      June 26, 2013 at 7:47 am #

      Hi silverminer, I agree that some pretty big shocks need to shake the system for serious changes.

      If a few big banks were to fail, depositors more widely take some haircuts and savers start to really question whether deposit insurance is a good idea or even feasible, then we’ll start to see some vigilance from depositors. Banks will then begin to respond to a new form of market discipline, where they need to work to show why they are deserving of our money. Bring on the innovation, solutions to make it super easy to move accounts between banks and most crucially measures to straightforwardly show us how X,Y, Z banks work!

  3. David
    June 25, 2013 at 8:07 pm #

    Another great article Austrian I was just wondering how a layman can identify the reserve ratio of a credit union, are they required to publish it anywhere? I like the idea of localising things away from the big banks.

    • theaustrianway
      June 26, 2013 at 7:41 am #

      Hi David,

      Thanks for your kind comment and question.

      I personally just Google the hell out of this – thank F for the internet. Terms like ‘XXXX bank leverage’, ‘XXXX bank reserve ratio’, ‘XXXX bank risk’ etc. I then find results where financial analysts have put the numbers together on certain banks and financial institutions. An exercise in the wisdom of crowds and also standing on the shoulders of giants if you like. You might need to commit a few hours though. If I remember any good sites/results, I’ll drop them here later…

      Your question is pertinent because it shows that this information is not as easy to find as it should be for financial institutions today. In a better system, where banks have to work harder for deposit money and serve attentive, demanding savers, I believe banks would find ways to simply represent this information. Whether it was live ledgers, live reserve ratios, for customers to view online, with data provided to back up this. There would be innovation to show what the bank really held as assets, how its balance sheet was constructed and how it was really geared. Sunlight is the best disinfectant!

      Under such an improved system, I’d wager deposits would be attracted to more transparent institutions that made their balance sheets and business practices understandable, all being backed up with auditable data, comment and analysis. Bank balance sheets today are so complicated even analysts, accountants and the management struggle to know what’s going on… all because shareholders and depositors haven’t been exherting enough influence.

Trackbacks/Pingbacks

  1. The Austrian Way: Why we hate cash In the bank | Bogpaper.com - June 27, 2013

    […] the last article we looked at how depositors across the world have been falling asleep these last few decades, due […]

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