Why Not Let Banks Fail?

By: Jacob Hornberger

Imagine that for the last 100 years, the federal government’s policy was to bail out every business that was in danger of going under. The policy would consist of shoveling large amounts of subsidies into the business in order to help it remain in business. If, however, the business failed anyway, the federal government would pay a large sum of money to the owners of the business as well as to the business’s employees to enable them to transition to other lines of work.

Now, for a true-blue socialist, this would sound like a tremendously fine idea. It would conjure up images of Medicare for All, the socialist healthcare system by which the federal government would provide or guarantee healthcare services for everyone — for “free.”

In actuality, however, it would be an enormously bad idea, which I think everyone, except true-blue socialists, would instinctively realize. 

After all, where would the federal government get all that money to cover all the businesses that fail on a regular basis. Yep. Taxation! The feds would have to be taxing the American people — big time — to keep up with providing subsidies to all those failing businesses. It wouldn’t be long before Americans found themselves paying income taxes totaling maybe 90 percent or more of their incomes to provide all the money to fund this giant socialist scheme.

Moreover, all that free money would encourage all sorts of inefficient businesses. Everybody would be opening up businesses knowing that if they failed, the government would be there to bail them out. Obviously, that would only exacerbate the taxation problem.

The United States now has an economic system in which there is massive governmental intervention, both with respect to large welfare-state programs (e.g., Social Security and Medicare) and economic regulation. Nonetheless, there is still an instinctive commitment to the principles of a genuine free-market economy — that is, one in which economic enterprise is free of government control and intervention — one in which people are free to keep everything they earn, do what they want with their own money, and freely enter into economic transactions with others. That was America’s founding economic system. 

Everyone knows that in a free market, there are no guarantees of success. Life entails risk. Some people take the road of high risk. Other try to play it perfectly safe. Most people live their lives somewhere in between.

Many people invest money in the stock market. When they do so, they are buying stock in a particular company. They know that the value of that stock can go up and it can go down. They also know that the company could even go under, which could entail a total loss of their investment.

When that happens, the government doesn’t bail out the investor, even if the investor has lost his entire life’s savings. Moreover, no one cries out for the government to do so. It has become part of our economic culture that people invest their money at their own risk. If people don’t want to risk losing their money in the stock market, they should stay out of the stock market. 

Obviously, this no-bail-out policy should cause people to be cautious about which companies to invest in. Since the government isn’t going to bail out investors, it behooves people to do research on companies or to rely on trusted financial advisors who have done their homework on companies. This leads to a more enlightened citizenry and more efficient businesses.

Why not treat banks the same way? If people put their money in a bank that fails, why should they be treated any differently from people who invest their money in a company that fails? If they choose the wrong bank, why should taxpayers be forced to cover their bad or wrong decision? Why not simply let the bank go under, just as we let companies go under? 

In a genuine free market, people would be much more careful about which banks to put their money into. Like with the purchase of stocks, they would be more likely to do research on banks or rely on trusted financial advisors who do that for a living.

People who wished to take bigger risks for a higher return would select banks that were riskier than others. People who wished to play it safe would select more secure banks with a lower return. 

Under the banking system in which we live today, the government “insures” deposits up to $250,000. Yet, the government doesn’t always follow this policy. As we see with Silicon Valley Bank and Signature Bank, the government sometimes covers all the deposits — including those that exceed $250,000 — in the event of a bank failure. Moreover, oftentimes the failed bank is simply absorbed into the banking system rather than simply permitted to go out of existence.

Obviously, this system doesn’t encourage due diligence on the part of depositors. Why should anyone research the financial condition of a bank when the government is going to cover deposits if the bank goes under? Why should anyone worry about buying stock in a bank if the government is going to bail out the bank if it fails? 

Over time, the entire banking system inevitably becomes weaker and more unstable. At first, individual banks fail, which the government is able to cover. Ultimately, however, this type of system inevitably leads in the direction of an industry-wide banking collapse, one that the government lacks the money to cover, unless it taxes the citizenry an enormously large percentage of their income. 

That’s, in fact, why the government continues raising the amount of its deposit “insurance” and why it continues to bail out depositors and banks that fail. The government wants to assure depositors that everything is “okay” with its socialist banking system, when, in fact, everything is not “okay” with its socialist banking system.

One of the biggest mistakes Americans have ever made was to allow the government to socialize their banking system. We should get government out of the banking business and restore our heritage of free markets to this sector of the economy. Separating banking and the state is the key to a strong and viable banking system.