Money Sage (archive)

We have always, always, considered ourselves to be mainstream thinkers. We have dismissed the "lunatic fringe" of the investment world as "the lunatic fringe." Now, we must admit, that we are becoming increasingly concerned that the "lunatic fringe" may not be so lunatic, after all.

Our confidence in "mainstream thinking" is being eroded by a combination of grotesquely incorrect mainstream forecasts, developments coming to light about bank and financial institution behavior which challenge credulity, and what has proven thus far to be a too little, too late response to an emerging financial iceberg on the part of the monetary and governmental policymakers.

We have NEVER been goldbugs, nor have we ever doubted the total reliability of the New Deal institutional and policy innovations which established a strong safety net for the banking and financial systems, and the overall economy. This despite the grievous policy errors of the central bank during the Great Depression.

Now, however, we are beginning to wonder.

We have been asked about the reliability of the FDIC. Having always had absolute faith in federal deposit insurance, we have never doubted that the government would back up its commitments. We have never believed that it is within the realm of possibility -- not to mention probability -- that Congress might, under certain acute circumstances, trim, or even withdraw, the backing of the United States it has so wisely extended to the FDIC.

Since it would take a government of truly unutterable stupidity to erode, or undercut, the most important bastion of our financial system -- deposit insurance -- it has always seemed unthinkable that they would reduce, or even eliminate, the taxpayer's risk in guaranteeing the FDIC unlimited support in the event of a grave financial crisis.

We still believe this to be the case. However, we will admit that a tiny worm of doubt is beginning to gnaw at us. It is easy to be fully confident when no crisis appears remotely on the horizon, or even within the realm of conceivability. However, when the possibility of such a crisis does materialize, we feel a need to reconsider our basic assumptions.

Since the unthinkable actually appears to have occurred within the banking system, we need, for the sake of analytical rigor, if nothing else, to "think about the unthinkable," to borrow a line from the nuclear strategist, Herman Kahn.

The FDIC, like any other insurer, has very little in the case of ready assets to meet a sudden, exceptional level of demand. Unlike the typical commercial insurance firm, the FDIC does NOT have assets upon which it can draw in the event of a sudden demand for liquidity. It has no real estate to sell, or borrow against. It has no bonds or stocks to liquidate. What it does have -- and what we have always presumed made it the most reliable insurer in the world -- is the backing of the United States. This backing, however, is contingent upon the will of Congress. Should Congress withdraw this backing, the FDIC, in an emergency, would be unable to meet its obligations.

The question boils down to this: what are the outermost limits of governmental stupidity? While the limits seem to be very broad indeed, there is, we continue to believe, an absolute stupidity boundary which even the government will not cross. This means that we can rely on the FDIC insurance guarantee.

However, having said that, we will admit that our heretofore complete certainty has diminished SLIGHTLY. One thing is very clear: should the point ever be reached where the government must make a decision, we have little doubt that it will do what it has always done, and what its compelling self-interest unquestionably requires: it will DEFEND ITS OWN CREDIT. In other words, it will make good, as it always has, on its obligations to owners of Treasury securities. The bottom line, we think is this: however safe FDIC insured deposits may prove to be in some unimaginable crisis, they will NEVER possess the security of Treasury obligations.

Moneysage 2008 ©