Banks and Bailouts

First published on automaticfinances.com

Banks keep making news. One caption in the April 18th Washington Post reads "Bank Profits Mask Peril Still Lurking." Readers learn the biggest of America's banks like Citigroup and J. P. Morgan Chase are reporting large first quarter profits, but remain pessimistic about their future and the future of the economy.

The Federal government has been bailing out the nation’s banks since last summer, handing out billions in emergency reserves with as many as 500 banks mentioned, always with a press release telling the public there must be bailouts or the banks and economy will collapse.

A collapse of the financial system is more complicated than the government wants to talk about. One type of collapse would occur if banks could not clear checks for their checking account customers. You and I go to pay our phone bill and the check bounces, but it’s not our fault the bank has run out of reserves.

That could be called a calamitous collapse. Technically it could occur because the United States uses a fractional banking system, which means individual banks only hold a fraction of their checking account liabilities as reserves to pay checks. Typically the Federal Reserve requires monetary reserves around 15 percent for checking account liabilities, the rest can go to loans. When customers with checking accounts also make deposits and borrowers make their loan payments 15 percent will be enough.

When borrowers default by the billion, banks will not have reserves to pay on their checking accounts, which signals a collapse of the banking system. Not to worry though because the Federal Reserve bank has the ability and full authority to provide the necessary reserves to America’s banks and they have been doing just that.

Making sure there are reserves for checking account customers could be called an essential and adequate bailout. It is the minimum that must be done to keep payments flowing and prevent an economic collapse.

However, the government is going far beyond that minimum with its bank bailouts. They press billions more of reserves on the banks, telling them to forget about defaulters and go find some more borrowers. In effect, the government wants our banking system to lead America out of recession. It is not working though, at least not so far.

The bank profits mentioned in the article above are coming from more recent loans for spending made with the bailout reserves, but bank officials themselves are saying these loans went to other weak and potentially defaulting borrowers. Many banks, especially large ones, have been doing a large share of their business in credit cards for some time, but wages and employment are in no shape to expect credit card lending to revive the economy.

We need spending to get the economy going, but right we will have to trust the Obama spending plan and not the banks. Banks will follow America out of recession, but there is no sign yet they will lead us where we need to go.