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Banks Are Not A Safe Place?

Adrian Ash - Tue 18 Sep, 2007

Don't want to put your money at risk? Then don't put your cash in the bank. The safest place that any financial advisor will ever recommend, High Street banks simply offer a way for you to lend out your money. Without ever meeting your borrower. And without collecting all the interest he pays. Yes, there are protections and thanks to the taxpayer, the upper limit just rose from 31,700 to however much you are owed. But retail bank customers will pay dearly for letting Alistair Darling step in to fix this mess.

Don't want to put your money at risk? Then don't put your cash in the bank.

The safest place that any financial advisor will ever recommend, High Street banks simply offer a way for you to lend out your money. Without ever meeting your borrower. And without collecting all the interest he pays.

Yes, there are protections — and thanks to the taxpayer, the upper limit just rose from £31,700 to however much you are owed. But retail bank customers will pay dearly for letting Alistair Darling step in to fix this mess.

Insuring your own money rarely comes cheap. Just imagine the banks themselves arranging that insurance for you!

Amongst the greasy nuts and fast-rusted bolts of deposits and lending, bank savers only get a portion of the interest paid on their money, of course. The bank takes the rest — and it's known as a ‘profit’. The bank earns it in return for defending your cash against fire, theft and floods, plus the not inconsiderable task of identifying worthy borrowers.

Sometimes the bank gets it wrong, sometimes it doesn't. Only 0.24% of Northern Rock's asset-base is exposed to the sub-prime US housing market. But it has gone for growth in UK buy-to-let...and even choosing the right debtor can sometimes get trumped by choosing the wrong sector.

That's the risk you take when you give your cash to a bank. It means your bank will lend it just as it sees fit. And you can't stop this happening, because you don't own your money anymore. That's what being a creditor actually means – from the Latin.

‘Creditor, n. – He or she who owns sweet f.a...’

Creditors merely believe that their bank has got their money to hand, ready to stump up when they ask for their money. For as long as everyone keeps believing this myth — and for as long as the bank doesn't require emergency support from the government — the system works fine. But it's worth remembering, gentle reader, that your property rights, as with all standard bank deposits, just don't apply.

Even under the Victorian model of dowdy banking, the banks will have lent out your money... or very nearly all of it... thanks to the magic of fractional lending. Come 1981, in fact, the UK government slashed the proportion of their liabilities that British banks had to keep ready-at-hand. These rock-solid homes for your cash only needed to keep just 0.5% in a zero-interest account at the Bank of England, plus a further 6% in short-term money market instruments, most commonly government gilts.

Then, "by the time the Bank of England Act was passed in June 1998," notes Tarek El Diwany for IslamicFinance.com, "the non-interest-bearing balance had been reduced to a ratio of 0.15% and the requirement for a minimum liquidity reserve had been abolished entirely."

The impact on Britain's stock of ready cash versus all the promises issued against it? By August this year, the total value of all notes and coins in the economy – including those stacked up at the Bank of England — stood just shy of £66 billion. The outstanding stock of what passes for money, however... adding together notes, coins, bank accounts, certificates of deposit, short-dated bonds and commercial paper plus bonds given to the Bank of England as collateral for cash loans... grew by more than that sum between April and July alone.

"When customers make their deposits, the promise is that the deposit is always available for withdrawal," notes Philip Bagus, a PhD economist writing for Mises.org. "However, the deposits, by the very definition of fractional reserve banking, are never completely available to all customers at one time. This is because banks will take a part of these deposits and loan them out to other customers."

"By issuing more property titles than property entrusted to them," Bagus goes on, "the banks violate the traditional property rights of their customers. [In fact] fractional reserve banking evolved as a perversion of deposit banking."

Flee the schoolroom as fast as creditors are fleeing Northern Rock, and here in the chilled glare of 2007's autumn sunshine the issue of bank account property rights has suddenly lurched out of nowhere. Nobody, not even your editors at The Daily Reckoning, saw a run on the banks looming ahead. But once the trouble in US sub-prime mortgages spilled into short-term interbank lending, maybe we should.

"Banks that infringe upon and abuse the property rights of their clients can make very good profits," our wised-up scholar goes on. "The temptation to expand credit is almost irresistible." Hence the mess at Northern Rock.

Northern Rock may have lost more than £3 billion since the run began on Thursday, but it still has £21 billion held on deposit by its trusting creditors. Now the government has stepped into promise that every last penny of those outstanding balances will be settled by the taxpayer — if need be. So the mortgage bank's stock has finally stopped plunging and turned higher at last.

By lunchtime on Tuesday, NRT had regained 20 pence of the £9.76 it's lost since February.

If that's all the fillip that raising taxpayers to the status of ‘payer of last resort’ can achieve, what price fixing a market-wide panic at the High Street bank desks? Bank savers haven't made headlines like this since Barings and BCIC went broke.

The government hasn't intervened like this since... oh... since ever before.

Regards

Adrian Ash
For The Daily Reckoning

Adrian Ash is head of research at BullionVault.com the world's fastest-growing and best-value gold ownership service.

http://www.bullionvault.com/from/dailyreckon

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