ON BANK RUNS AND HAVING NICE THINGS
Enter the bank! Somehow we were convinced to hand over our valuables to a private business for safekeeping. How did banks do it? Interest payments, government guarantees, big, squeaky vault doors saying “fortress”...but also because banks make our lives easier. We no longer worry about mice eating the bond notes under the floorboards, or marauders overtaking one’s pleasure cruise on the Danube. Our time is free to consume short form video content, which has been great.
So, we are all depositors, and our deposits today form the bedrock of the American economic system: they are used to create money in the form of mortgages and other loans (this is called fractional banking, as the bank is required to maintain only a fraction of the deposits entrusted to it). Most days, we take for granted that our money will be safe with the banks.
All this is well, good, and at its root radical—we earn individual paychecks, but we combine our money with that of our fellow man; and when we get a loan to buy a home or car, it is our fellow man who stakes us. But when these systems fail, and we face the risk of losing it all, alone, robbed of our treasure, panic ensues—in the form of a bank run.
The Silicon Valley Bank (SVB) bank run of 2023 is a good example. Whispers of the bank’s collapse spread on Twitter, Discord and other social media; elementary game theory says each depositor is motivated to act in his or her best interest, regardless of the effect it has on others, i.e., since the bank doesn’t have the liquidity on hand to meet demand if everyone withdraws at once, depositors race to withdraw their funds before others. In the case of SVB, withdrawals mounted, and the federal government intervened to stop a broader banking meltdown. The bank was placed under receivership, and the debacle became the third largest bank failure in US history.
One year later, the SVB fallout is ongoing. Regulators propose increasing the amount of deposits a bank must hold against loans—i.e. with a $100 deposit, the bank was able to lend $5,000, now it can only lend $1,500. Naturally, banks oppose this, saying it will make borrowing more expensive for consumers. Which is true! Fractional banking systems create liquidity for you and me, but creates the risk for us to lose it all (“all” defined here as deposits exceeding $250,000, which is the FDIC maximum amount insured).
We have come a long way from sewing jewels into the waistbands of suit coats, but our treasures are still not safe. Whether you use the bank or not, true security is impossible, that’s why we keep some of them in heaven. Social media and digital banking, though convenient, stimulate bank runs by quickening the pace of both rumors and withdrawals. We are left with a banking system that works for most people, almost all of the time—except for when it doesn’t, and when that happens, I’ll see you in line.