In a recent Reason magazine interview, Lyn Alden makes a very good point:
And Lyn Alden, founder of Lyn Alden Investment Strategies, says that “banks are essentially highly leveraged bond funds with payment services attached, and we consider it normal to keep our savings there.” She argues that the Federal Reserve makes it nearly impossible for banks to hold the bulk of their customers’ deposits in cash because “regulators want banks to be reasonably safe, but not ‘too safe.’ They want all banks to be leveraged bond funds to some degree, and will not allow safer funds to exist.
Is it really true? Are regulators refusing to allow ultra-safe banks? John Cochrane makes the same claim (from a 4 year old blog post):
Suppose an entrepreneur comes up with a plan for a totally safe financial institution – it can never fail, it can never suffer panic, it offers depositors perfect security without the need for deposit insurance, risk regulation assets, capital requirements or whatever, and it earns depositors more interest than they can get anywhere else.
Narrow banks are such institutions. They take deposits and invest the proceeds in interest-bearing reserves at the Fed. They pay depositors that interest, minus a small markup. Pure and simple. Economists have been calling for tight banks since at least the 1930s.
You would think the Fed would welcome narrow banks with open arms.
You would be wrong.
Both refer to the fact that the Fed refuses to approve “narrow banks”, which invest their funds in the safest way possible – accounts at the Federal Reserve.
The media focuses on mistakes made by bankers and/or regulators, but the banking system is designed to be unstable. Our political leaders want banks to take risks. And when the inevitable happens, there’s a lot of moral grandstanding.