Friday, December 3, 2010

The Current Financial System is Too Big to Fail


Because the distinction between banks that keep your money (commercial banks) and banks that invest your money (investment banks) has been blurred even more.

A long long long time ago, the first banks were actually goldsmiths. These goldsmiths took your gold and held onto it for you because back then, gold was money. In exchange for your deposit they gave you a receipt. Eventually people found it was easier to trade these receipts for goods instead of going to the goldsmith, getting the gold out, and paying the dairy farmer to get your milk.

The goldsmiths used to charge a fee for this service of convenience and that's how they made their money.

Eventually some goldsmiths got the bright idea to loan out their vast stores of wealth, at interest. These were the investor goldsmiths. They did so without telling their customers that that's what they were doing with their money. A lot of money was made.

Investor goldsmiths took customers away from regular goldsmiths that weren't making loans because these investor goldsmiths were able to offer their services for free. They could make money loaning money out instead of charging the customers who gave them gold to keep. This angered the regular goldsmiths because people weren't keeping their money at the regular goldsmiths anymore. They had to copy Investor Goldsmith to just keep up.

One of these regular goldsmiths got the bright idea of paying people to keep their money for them. This Bankster Goldsmith would pay 3% interest to people who saved money with him and would charge people who needed money 6% interest. The Bankster Goldfish was able to make the 3% difference and did very well for himself for awhile.

Other goldsmiths caught on quickly and attempted to get bigger by offering more interest to savers and less interest to debtors. These banksterer goldsmiths took on a bigger risk and the goldsmith industry got extremely competitive.

Eventually, Conman Goldsmith got the bright idea to start a rumor about his Banksterer Goldsmith because he understood how the business worked. Rumors about how banksterer goldsmith was going out of business spread like wildfire. People wanted their money back from him but he couldn't give it back because he had loaned out their money. Upon hearing this the mob grew angrier and even more irrational and hung him from the tree on Main Street.

The mob then grew leery of all goldsmiths. They confronted each one and demanded their money back. Bankster Goldsmith was hung next to Banksterer Goldsmith. Investor Goldsmith also could not pay back his depositors and was hung next to Bankster Goldsmith.

Only Regular Goldsmith could pay back his depositors. Unfortunately, not many people had their money with him because everyone wanted free business checking and interest on their savings. The mob hung Regular Goldsmith anyways for their justice is anything but.

In the end, the only people with gold left were the mob's grandmothers who had kept their gold under their Sealy mattresses because the same thing happened to them many moons ago. Oh, there was also Conman Goldsmith who got away with all the gold because he started the first rumor that brought the whole system down and saw it coming.

The problem is that all banks loan out people's money so that when, not if, failure happens, nothing will be left. In the Great Depression, people's life savings were wiped out as banks failed left and right and there was no stable foundation to rebuild the economy.

The solution to the current financial crisis is to provide the stable foundation of regular goldsmiths, of banks that charge people money to store their money but do not lend it out. These "full-reserve banks" could coexist with risk-taking fractional-reserve banks. Both would provide a vital service to the economy and in the event that that an economic crisis struck, banks could be allowed to fail without crashing the entire economy because ALL modern banks can experience a bank run.

Under this proposed system, bad investments can be written off and purged and the economy would quickly recover. But under our current system, the bailouts will get bigger and bigger until the dollars we bail out failed institutions with will become worthless.

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