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Friday, August 1, 2008

The Fed Abstracting Away Banking Pain

posted by on August 1 at 15:45 PM

Anthony asks if this:

is bad.

Anthony, it depends on how abstract you want to be.

When you save money at a bank, most of the money gets lent out to someone else. Look at your account balance. Shift the decimal place one to the left. That’s about as much of your money your bank actually keeps around.

The whole banking system relies upon the notion that:

1. These loan investments (made with your money) will eventually be repaid.
2. Huge numbers of people won’t ask for all their money back at once.

Let’s say 1 ends up being false—say because banks invested in a bunch of secured debt that ends up having no verifiable assets securing the debt. All of your money the bank lent out is gone. Poof.

You come by to cash a check. If we’re living in the the early 1920’s (or the early 2000’s) the following occurs:

You: I want my money.

Bank: One moment sir!

Bank turns from you and cries out.
Bank: Calling all suckers! Please place your money here!

Sucker: Here’s my money!

Bank takes the money and turns to you.

Bank: Here’s your money sir!

You: Thank you!


After the last sucker has been found and fleeced (1929 version):
You: I want my money.

Bank: One moment sir!

Bank turns from you and cries out.
Bank:
Calling all suckers! Please place your money here!

No suckers arrive.

Bank turns to you.

Bank: Fuck you, your money is gone.

You: Fuck you! I’m ruined!


After the last sucker, 2008 version:
You: I want my money.

Bank: One moment sir!

Bank turns from you and cries out.
Bank:
Calling all suckers! Please place your money here!

No suckers arrive.

Bank turns to the FDIC and asks for a loan. Receives such a loan.

Bank takes the money and turns to you.

Bank: Here’s your money sir!

You: Thank you!

Ready for the trippy part? The FDIC, ultimately, is secured by the full faith and credit of the Federal Government. In turn, the credit of the US Government is secured, well, by you and me. The taxpayers.

The incompetent, failing bank—that has both made huge numbers of bad loans and lost the confidence of new investors—can count on one last big sucker to pay us back. Us.

Heller could not write it better.

My primary bank account is at Washington Mutual. Like everyone else who has money saved at Washington Mutual, I should be concerned. I’m not. My account is FDIC insured. Even if the whole bank goes belly up, as IndyMac just did, up to $100,000 of my investment will be returned to me. Since I’m a Stranger writer / graduate student, I do not even vaguely approach the $100,000 limit. Even if WaMu sinks, I’ll float. Because, through the FDIC, I’ll pay myself back all the money WaMu lost me. With my money, that I pay in taxes.

Well, not exactly. For now, the FDIC is solvent and doesn’t need an infusion of cash from the Federal government. And, while investors are increasingly terrified about lending to banks like WaMu, they continue to buy up US government debt. In other words, the investors have decided most banks are too risky, forcing the banks to borrow from the FDIC instead. The FDIC in turn borrows from the federal government, that in turn borrows from the same frightened investors. Brain hurting again?

Welcome to the land of leaky abstractions.

Anthony, you’re a computer guy. I have the perfect metaphor for you.

TCP, the protocol underlying the majority of the web, absolutely guarantees that a given message will arrive, complete and in order. TCP does this by using IP. IP guarantees absolutely nothing. So TCP makes the promises and attempts to deliver them with IP. Most of the time, it works splendidly.

If someone trips and pulls the ethernet cable out of the wall, TCP will keep making promises that IP cannot deliver.

The banks tripped, and the global investors are pulling their plugs out. We’re promising to honor all debts, by taking the investors’ money to guarantee the investors’ money. It should turn out great, if we collectively believe it’ll turn out great.

(Crossposted.)

RSS icon Comments

1

Fricking genius illustration. Just lovely work. Thank you!

Posted by tomasyalba | August 1, 2008 3:56 PM
2

You're one of the best things going for this paper, Science.

Posted by Non | August 1, 2008 4:16 PM
3

Jonathan, pull your money out now. WaMu has lost access to the repo loan market and the rate they have to pay on commercial paper has gotten bigger. People who sell CDOs on WaMu have started requiring cash up front an increased their rates to 13%. That translates into them betting that the odds are 50% that WaMu will default within five years. It probably won't affect you, since you're under the $100k mark, but save yourself the potential trouble.

Posted by Gitai | August 1, 2008 4:19 PM
4

Thank you for this (with absolutely no hint of snarkiness)!

Posted by coffeeboss | August 1, 2008 4:22 PM
5

But I don't waaaaanna pull my money out of WaMu!! I've had genuinely good customer experiences with them!

Posted by Ben | August 1, 2008 4:26 PM
6

Oh, just go with BECU or WSECU or SECUWA like the rest of us, Ben.

Posted by Will in Seattle | August 1, 2008 4:39 PM
7

Another masterful post. Your ability to take abstract and sometimes difficult concepts and distill them down so that non science, math, econ people can understand them is awesome. Having worked as a technical writer for years I know how hard it is to do that and how much talent as a writer it takes. You are an asset and we're lucky you take the time to Slogucate us.

Posted by PopTart | August 1, 2008 5:01 PM
8

WaMu isn't going anywhere. Their stock price and profits may suffer for a few years, but they are very well capitalized and have a ton of liquidity. They overexposed themselves in the mortgage market, but they have enough other products that they will survive.

Posted by I disagree with what you said | August 1, 2008 5:14 PM
9

Jonathan will eventually bring SLOG to ruin if he continues approaching every issue with facts and common-sense explanations rather than knee-jerk emotional reactions.

Seriously, great job.

Posted by JA3 | August 1, 2008 8:20 PM
10

I've got $ in WaMu too (because they bought out Great Western Savings & Loan years ago), and have been worried because its stock has hovered between $3 and $5 a share for the last month. Stories of J P Morgan buying them have been in the news since January. I can't figure out why WaMu's got such a low value right now, compared to most "financials" because there hasn't been any news of of them suffering losses, because of massive subprime loan defaults.

Posted by E | August 2, 2008 8:33 AM
11

FDIC is an insurance organization, and as such the money that is used to cover bank failures comes from premia paid by the banks themselves. Furthermore, the amount they pay depends on how likely they are to go bankrupt (based on risk of investments and the amount of reserves they keep).

Ultimately, like all insurance, we all pay a small portion of our deposits to guarantee against catastrophic failure. You may not like that you haven't been given a choice in this matter, but it's not some sinister scheme.

Posted by F | August 2, 2008 12:40 PM
12

the collapse of these banks is terrifying and i'm totally weirded out that no one is really conscious of the precipice the entire banking system is teetering over.

Posted by zach | August 2, 2008 9:19 PM
13

jonathan golob is fucking awesome. that's all i have to say.

Posted by nicole | August 2, 2008 9:36 PM

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