Unless I’m wrong, and you know how to solve it, in which case let me know in the comments. I’m curious. Or get it published in an Economics journal, and get the Nobel prize.
Consider this scenario: Vinny the Loan Shark, whom you owe $50,000, came up to you at 9:00 this morning and said, “Gimmee my fifty back by 5:00 tonight or I’ll break both your legs.” Vinny is a very direct guy. Isn’t it great to get away from stuffy circumlocutions?
Fortunately, you own a house worth $100,000. No problem! You’ll just sell it by 5:00 this evening, and you’ll have enough money to pay Vinny back and then some. You and your legs will be fine. What’s that? You can’t liquidate your house that quickly? Or dear, you do have a problem. I hope your health insurance is paid up.
Before you censure Vinny too harshly, grok this: When it comes to banking, you and I are Vinny.
See, we all want banks to offer checking accounts so we can use them to pay for stuff. Obviously this only works if you can spend the money in those accounts any time you want. So, from your point of view, the funds in that account are a zero-maturity asset. From the bank’s point of view, since they have to make payment whenever a check is cleared, those funds are a zero-maturity liability.
The problem, of course, is that most of the bank’s assets are in rather illiquid forms like 10-year loans they made to businesses, 30-year mortgage loans they made to families to buy houses, etc. They can’t liquidate all that instantly. So if a bunch of checking account owners – Vinnies – come up to them at once and say, “We all want our money back right now,” the bank can’t comply.
This is called a bank run and leads to that exciting scene in the movie It’s a Wonderful Life in which the bank where the hero works suffers a run and he has to deal with the emergency. It also leads to the same thing happening in real life, which is more exciting but less entertaining.
“OK,” you say, “just prohibit banks from holding very much of their assets in 10-year business loans, 30-year mortgage loans, etc.” Alas, that won’t work, because you and I demand that banks provide mortgage loans so we can buy houses. And businesses need loans for various purposes, etc.
So here’s the problem: You and I, the public, demand that banks borrow money from us with zero-maturity checking accounts and lend to us with 30-year mortgage loans. This is called “maturity mismatch,” for obvious reasons, and it’s not just an unfortunate accident that banks are set up this way. The public demands that they be set up this way. How are we supposed to square this circle?
I don’t know. So far, no one else knows, either.
Deposit insurance has greatly reduced the problem of bank runs, but as the crisis of 2007-2009 showed, we are far from Eden.
I once heard an economist say that he thinks the current system— riven though it is with occasional banking panics, waves of failures, etc.— may actually be the best that can be achieved! It was much worse in the bad old days. At the start of the Great Depression, there was a banking crisis that forced about 30% of the nation’s banks to shut their doors! Believe me, the regulators are very aware of the maturity mismatch problem. We’ve been tinkering away with banking policy in the last 80 years and seem to have improved things, but certainly haven’t achieved perfection.
So: If you know how to totally fix banking, send a quick email to Jerome Powell. He’ll appreciate it.