Quote:
Originally Posted by markbot
Banks hold short term debt (savings deposits, etc) but invest in long-term assets (mortgages, etc) since liquidity is valued in the market place. This means that financial institutions are inherently prone to failure via a bank run (think of the movie It's a wonderful life).
a bank run is a self fulfilling prophecy as there is a dual nash equilibrium between "biz as usual" and bank run. if people think there is a bank run, this actually causes the bank run. this essentially means that only the government can coordinate the market place such that there is no bank run by effectively insuring deposits or giving the banks the power to prevent withdrawals.
the thing is that in the US only consumer deposits are insured. bear stearns et al all failed because the there was effectively a bank run in the wholesale market...where there is no insurance.
EVEN IN FREE MARKET CAPITALISM, the government must prevent banks from failing. think about the Great Depression and all prior recessions before deposit insurance. bank failures used to cause and extend very severe recessions.
to prevent moral hazard and the excessive risk taking that it can cause....the government should still prevent banks from failing...but they should also wipe out the equity holders. However, in the financial crisis, this didn't always happen....the equity holders were saved when they probably shouldn't have been.
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But if I recall, the FDIC was setup to handle failing banks. The FDIC is a government controlled entity funded by the banks (they actually have to pay a premium for the "insurance" function the FDIC provides).
So any account holder with total deposits 250,000 or lower (I think that's what it is now) at a bank, will be covered in full. If the total of their deposits at a failing bank total more than 250,000 there is a possibility that they can lose that money over the 250,000 mark, but, typically the FDIC arranges for the failing bank to be taken over by a healthy bank which results in no loss of any deposits at all.
I think that system works well, it's just that recently we've had SO MANY banks that were failing they got a bit bogged down.