Could A Run On The Banks Occur?

One of the most powerful images of the Great Depression is of the tragic run on the banks. When depositors became panicked that banks could not cover all of their obligations, they stampeded to withdraw their money. They were correct- the banks could not pay back all of the depositors, and as a result they went bankrupt, taking the depositors money with them.

In the wake of that crisis, the current FDIC insurance system was established. This system allocates a federal guarantee of $100,000 per account.

It is intended to ensure that depositors can have full confidence that their savings will not be lost, even in the unlikely event that their bank should fail.

Under this system, US banks have been considered among the most reliable in the world.
However, as we enter a period of unprecedented financial turmoil, many depositors are wondering whether they are adequately protected in the event of a systemic failure of the banking community.

In order to examine this concern, we need to understand some of the distinguishing features which differentiate the current banking climate from the one which existed in the time of the depression.
The most prominent feature of the current system is the extent of integration and interconnectedness,

both within the US and on a global level.

This creates a situation where the entire nation and indeed the entire world are one large and interdependent system, so that a failing in any one area has the potential to bring the rest down along with it.
Gone are the days when one could avoid a local recession by investing in an overseas boom.

Second, much of the investment capital circulating today is managed electronically, which means that transactions happen at much greater speed.

Thus, a downward trend which might have taken months to play out can now occur within hours.
Both of these factors mean that a panicked sell-off today can have calamitous repercussions that far exceed those of the great depression both in extent and in speed.

Given this background, some more cautious investors raise two alarming issues.
First, even if depositors individual accounts are guaranteed by the government, how would the government possibly administer the distribution of funds in the event that the entire banking industry were to implode, and records were lost or inaccessible?

In an era of electronic records, couldn’t critical data be lost or distorted to the point where a reimbursement of depositors would become infeasible?

Second, is the US government’s own financial house in adequate order to serve as guarantor for the deposits of its entire citizenry?

During the Bush years, unprecedented government spending led to the accumulation of over ten trillion (yes, with a ‘t’) dollars of national debt, a staggering and unprecedented sum.

Add to that the hundreds of billions the government is pledging for various bailout and stabilization packages, and a troubling picture emerges. It appears that consumers have overspent and then left the banks holding the bill, the banks have done the same to their investors, and now, the investors are doing the same to the federal government. Passing along responsibility to a higher echelon does nothing to resolve the underlying lack of wealth.

In light of all these factors, some are beginning to doubt the realism of implementing FDIC insurance, should it ever be needed. When asked what is the best position in which to weather  the current crisis, one clever analyst remarked, “either cash or fetal”. More Americans are beginning to wonder whether perhaps they will find themselves in the latter, wishing they had selected the former.

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