Central Banking 101: Why Bank Insolvency Should Never End in Money Printing

One of the things I discovered when I was in Japan in the 90s, when they had bank insolvency problems, is virtually nobody understood anything about how banks work. If you spent roughly three hours with the annual report of a large bank, you would know more than politicians, and economists, and IMF people about how the bank worked and what the proper solutions were.

The basic format of bank insolvency, or ultimately, default or bankruptcy; is the same as a corporation or a family. You figure out what the liabilities are, which is to depositors and bond holders, and they get paid back on a partial basis, depending on their seniority and chain of creditors.

It’s very simple bankruptcy law that’s been around for 500 years, and you just apply to the bank, which is just another type of corporation, another type of balance sheet structure.

It’s pretty straightforward, and we actually did this in 1933 in the United States during the Bank Holiday.

What basically happened was that they took all the banks and said, ‘We’re not going to cover it up anymore. Either you’re actually fine, in which case, we’ll just open you up again, or you’re going to have to go through this process and fix the problem.’

The Bank Holiday basically solved the bank insolvency problem of the first part of the Depression. And Franklin Roosevelt was a big hero.

Banks have been around for a long time, and bank insolvency happens all the time. There are proper ways of dealing with this – fair, legal ways that have been established over 500 years of capitalism.

There’s this vague notion that maybe we want to leave ourselves the option to print money to get out of this insolvency…and that is absolutely not necessary. These countries that have had gold standard systems in the past, can certainly deal with bank insolvency and all of the work-outs related to that, without debasing their currency.

We want to make sure people know how to do that so we don’t just keep piling one disaster on top of the next.

Regards,

Nathan Lewis
for The Daily Reckoning

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