Irish Liberty Forum

Who Benefits from Bank Bailouts?

with 18 comments

Well, according to this Daily Telegraph article it is not only banks, but both savers and borrowers too who benefit from the £500 billion government bailout like the one we have seen today in Britain. While it is true that the bank CEOs whose companies went bust, the depositors of those banks and current borrowers who are in debt in the banking system as a whole benefit it is certainly false to say that all banks, borrowers and savers benefit from a bailout.

What the telegraph has missed is the crucial point that Ludwig Von Mises made in ‘Human Action’ (1949) about the printing of money that the Austrian School has been repeating ad nauseum for over a century. This can be summarised as follows:

Inflation is defined as an increase in the money supply.
1. When money is printed the relative purchasing power of any unit of money already existing in the rest of the economy is decreased.
2. It is the person who receives the money first who benefits most from pre-inflationary prices and the person who receives the money last who suffers most from post-inflationary higher prices from a decrease in the purchasing power of their money.

As Peter Schiff likes to point out, Governments have no money, all they have is a printing press and the only effect they can have on an economy is a re-arrangement of who pays the debts for mal-investments.

In this case, it is clear that while the depositors of banks like Northern Rock have benefited from the fact that their deposits in the insolvent bank were not lost but guaranteed by government, all savers in other banks which had not collapsed saw an immediate decrease in the relative purchasing power of their savings. In this sense, it is precisely the savers who invested their savings in better run banks who lose out the most for they can now buy less because of this government intervention.

Furthermore, there is also the unintended and unseen consequence that this will encourage other banks to act more recklessly to maximise gain with the knowledge that if they take big enough risks and fail they will be bailed out. This is said to be why Merrill and Bank of America merged because having seen AIG get bailed out and Lehman fail they realised that the bigger you are, the more likely you will be bailed out. In other words, they wanted to be ‘too big to fail’.

Borrowers who indebted themselves before the bailout will benefit for they will now have to repay less in real terms because the value of the amount they borrowed off the bank will have decreased in the ensuing inflation from the bailout. But the borrowers who arrive after the bailout will be investing in a world where the pricing system has become utterly confused. The new money entered into the system by government will increase ten fold under the legalised fractional reserve banking system (FRB) as the banks get ‘loaned up’ which will cause another wave of mal-investments in the ensuing boom leading to the need for another bailout at a later stage. For these new borrowers it will be difficult to distinguish what is a good investment as the real value of goods will become difficult to discern from the inflation and the FRB system.

In the past, bank runs were necessary to remove poorly run and insolvent banks from the system to make way for the growth and expansion of prudent and well-run banks. Bailouts do not reward good business practice, they reward the politically connected at the expense of everyone. There is no incentive for banks to be responsible when risk is socialised amongst the population at large.

In short, only the politically connected and the indebted from before the bailout benefit from bailouts from their unique first access to the fiat produce of the Government printing press.


Written by NaomhAdamnan

October 9, 2008 at 7:23 am

18 Responses

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  1. […] Benefits from Bank Bailouts? Cross-posted at the Irish Liberty Forum: Who Benefits from Bank Bailouts? Irish Liberty Forum Well, according to this Daily Telegraph article Bank bail-out: The winners and losers – Telegraph […]

  2. This article displays a distinct lack of insight into the actual mechanism of the guarentees (not bailout’s, thats what the American’s are doing) implementation as well as their necessity to safe gaurd a faltering financial system which is the only buffer between individuals and the economy. Think about it some more and come back to us with something a bit more thought out


    October 9, 2008 at 4:39 pm

  3. Anonymous, there is no such thing as a bank guarantee. The Irish Government has no money. In fact it is in a tremendous amount of debt. If one bank fails either the Irish Government will have to default on its obligations or they will call upon the ECB to turn on the printing presses to pay for the collapsed bank which will create hyper-inflation and the herald the end of the Euro as a viable currency.

    Come back to us once you have thought about it a little more.


    October 9, 2008 at 4:56 pm

  4. The whole point of the bailout was to prevent failure. If a bank fails then the government will indeed be screwed, especially since it actually has no way of raising those funds without ECB permission (which I believe they might have got today, not sure though..). The whole point of the guarantee was to prevent a run on the banks which would have caused a collapse of the financial system and the lifeblood of the economy. They know they can’t pay out, but if they didn’t create the guarantee then we were all fucked. The fact that numerous countries across the EU zone have followed suit has proven the foresight of the Irish government.

    I for one think that the Irish government is, at the best of times, completely incompetent of scheduling their own craps, but I have to hand it to them on this one, they were ahead of the ball. Without this guarantee the Irish economy would be in free fall and we would be experiencing hyperinflation anyway for the very reasons that it occurred during the great depression, when government reaction was too little to late, and possibly even completely misdirected.

    If you can’t accept criticism and an alternative point of view, especially from someone who is clearly much more qualified to comment on the situation than you are, then I suggest you stop posting. Is that enough thought for you?


    October 13, 2008 at 11:33 pm

  5. P.S. There were two countries in dire straits at the time the guarantee was brought in, ourselves and Iceland. One government intervened in the market, one didn’t. Which country would you rather be living in right now?


    October 13, 2008 at 11:36 pm

  6. I give respect to those who deserve it. Your first post was rude and contained no content. Your second post was an improvement, but still rude at the end.

    Firstly, I don’t know how qualified you are, but I hope not too qualified, since there was deflation during the Great Depression of the 1930s, not hyper-inflation as you claim. Then again, a man who advocates war as a government tool to stimulate the economy just won the Nobel Prize, so maybe you indeed are very qualified.

    What is the point in bailing out the banks if in the process you destroy the very institution you are trying to save. Milton Friedman once said ‘there is nothing more permanent that a temporary government program’. As another poster (Graham) has already brilliantly explained,

    “The critical function of banks is to allocate capital according to where it can be used most productively, as expressed through the interest rates which people are willing to pay and the likelihood of these people to repay their loans. Banks should balance their desire to earn interest from making loans with the need to ensure that they have sufficient reserves to meet the current demands of their depositors and indeed pay interest to their depositors. These functions are hampered by interference with the interest rate and the enforcement of a government monopoly on the supply of money through the mechanisms of central banking. Yet so long as private, competitive banks exist within the structure imposed by the central bank, there can still be some degree of economic calculation performed by these banks.
    Now that all private bank risk has been socialised by the explicit guarantee of bailouts, the need for banks and bank customers to calculate these risks accurately has just been thrown away. All mistakes will be paid for by the government. The implications for the efficient allocation of Ireland’s productive resources are simply awful.”

    Nothing has changed in the real economy despite the guarantee. It is still in free-fall. House prices have continued to collapse, foreclosures are still increasing and unemployment is rising. So what has this guarantee actually done? This guarantee is anything but magical and in time it shall be revealed for the lie it really is. Now, instead of one or two banks collapsing and the stronger ones surviving, once confidence is lost in the government guarantee (which is no different from what we had before the new guarantee since confidence was lost in the last government guarantee of legalised fractional reserve banking but now its explicit not implicit) none of the banks shall survive in the coming bank-run holocaust. To avoid this, governments will have to refuse to let depositors withdraw their cash to preserve the integrity of the banks. The government has instituted the greatest tax of all upon its citizens. It has sold the future of generations of the inhabitants of this island for security of one sector of the economy. As Jim Rogers has put it,
    ‘Banks have been going bust since the dawn of time! Let them go bust, that’s the way capitalism works.’

    A cross-roads was reached in Ireland in the last three weeks. We could have let the banks fail and rebuild our economy so that all the malinvestments in housing were cleaned and we could start anew or we could nationalise the economy and bring a slow painful death to a functioning currency and a relatively prosperous society.

    Also, the Icelandic government has been heavily involved in their banking system. They in fact nationalised their three largest banks! Haha. This is the ultimate price that will be paid by the Irish government. It is only a matter of time. To believe the government that this guarantee has changed anything is folly.


    October 14, 2008 at 8:12 am

  7. I agree with you, the long term implications of the governments actions could be even more damaging to the economy yet the necessity of intervention was created by an external storm brewing in America, creating an atmosphere of fear in financial markets. The theory of the most competative bank rising to the top is fine in a world of complete information, yet when ordinary people are loosing savings and future projected consumption, it is damaging to everyone. Preventing this is of paramount importance.

    That was the point of the governments actions, the immediate safe gaurd the economy. Anglo Irish Bank was on the verge of bankrutpcy because of the liquidity constraints imposed upon it by lack of confidence in money markets worldwide. Its ability to continue functioning with sufficient liquidity is proven by it’s continued existence because of the government intervention.

    If you think that investors in Anglo should have paid the price for investing with them, well thats your business but in the short run intervention has definitely staved off a greater recession in Ireland than we are already experiencing. The information assymetries in the markets are undeniable and proper competative practices are almost impossible. This guarentee is a good short run solution, so long as it is properly managed. Whether that will happen or not is a completely seperate debate and probably something upon which we could agree?


    October 14, 2008 at 1:12 pm

  8. Thank you for a civil reply Anonymous.

    I agree that the explicit government guarantee on banking deposits has delayed an imminent financial collapse for most of the banking institutions in this country. However, who’s savings are going to be lost if these banks go down? The reason the banks are in trouble is because nobody has any savings. Over the past sixteen years many in society borrowed far beyond their means than they could ever repay. Forty-year mortgages for houses costing over one million euro for families on modest salaries drove these banks over the edge. If the banks collapsed, only less than 10% of the money claimed to be in the banks would actually be lost. That means that the debt slaves would be freed from their lifetime mortgages for over-valued bricks and mortar.

    The most damaging thing imaginable for ‘consumption’ is if people have to pay the majority of their wages on repaying mortatges and loans which is the case today. The spending splurge occurred over the last ten years and today people are feeling a terrible squeeze. If for the next 40 years they have to repay the 400 billion worth of loans on our banks balance sheets our economy will most certainly come to a halt and there will then truly be a ‘consumption’ problem.

    But this is not addressing the root of the problem. Why did people borrow themselves into debt? It was because the European Central Bank in concert with the Federal Reserve lowered interest rates below the market level stimulating several investment booms. The first big one was the dotcom boom. When that crashed they lowered interest rates further and the new cheaply available credit was invested into housing. But it was cheap credit that caused the problem, not the actual functioning of banking.

    When they talk about capitalising banks on the news I laugh. Capital, in the capitalist sense of the word, is derived from people’s savings. When a government prints 35 billion to buy shares in a company, like in the UK in RBOS, all they are doing is devaluing everybody else’s money because of the increase in the money supply. In fact, in the UK, the taxpayers are lending money to the banks, and then the banks lend the money back to the taxpayers at interest. Its insane! It does not address the underlying reasons why the banks refused to lend. (Banks can’t lend because the pricing system has become completely confused after two decades worth of increases in the supply of money.) If this ‘capitalisation policy’ is repeated often enough nobody will have any confidence in either the banks or the currency. As much as I would love to Anonymous, I cannot agree with you that if the guarantee was properly managed it would improve the situation we are in. I think at best it shall delay the same inevitable amount of pain. At worst it will worsen the situation but I cannot see how it will make things better.

    The problem in the US was caused by 1% interest rates by the Federal Reserve not predatory lending. This was a negative interest rate. If interest rates remain at 1% and you are only paying the interest on the loan, the Federal Reserve’s own inflation will reduce your loan in time to nil. Only a fool would not borrow as much as they could at those rates. When they subsequently increased the rate, the poor, who now had to actually repay their loans above inflation, defaulted and then banks started going bust. It is important that this is made clear. Low rates caused the problem. It was the Federal Reserve’s interference in the economy that set rates below the market rate that caused the initial boom and now the bust.

    I believe the very people who the state media are telling us that this intervention is trying to save are the people who are going to suffer the most and be exploited the most as a result. I feel it has been a con-job, whether through ignorance or worse, and that we are curing the patient by feeding him poison.

    Edit: percentages in debt from first paragraph


    October 14, 2008 at 11:18 pm

  9. I do not know if either of you know about Andrew Jackson’s U.S. presidency. I wanted to point it out as a historical reference of what would happen if the banking system did indeed collapse.

    Andrew Jackson was unhappy with the “Central” banking system, the Bank of the United States, and spoke out against it strongly. During his re-election campaign it was the main issue and he won by a landslide. He took that as a mandate to dismantle the bank.

    The U.S. banking system was in chaos for a decade after wards, but came back in much better shape. With less political power and government control I might add. It is that decade of chaos, that is the price of failure. It is the stronger system that is the reward for allowing it to fail. Is it worth it? That is what must be decided.


    October 18, 2008 at 1:00 am

  10. Thanks for your comment Stecha!

    I have read a little about Andrew Jackson. I have Murray Rothbard’s ‘A History of Money and Banking in the United States’ on my bedside table at the moment, just haven’t found the time to read it yet.

    I will quote Guido Hulsmann’s latest monograph to perhaps address your point:

    “Then there is the fear factor. If we follow a hands-off policy, the majority of experts tell us, the banking industry, the financial markets, and much of the rest of the economy will be wiped away in a bottomless deflationary spiral.

    The present essay argues that this is a half-truth. It is true that without further government intervention there would be a deflationary spiral. It is not true that this spiral would be bottomless and wipe out the economy. It would not be a mortal threat to the lives and the welfare of the general population. It destroys essentially those companies and industries that live a parasitical existence at the expense of the rest of the economy, and which owe their existence to our present fiat money system. Even in the short run, therefore, deflation reduces our real incomes only within rather narrow limits. And it will clear the ground for very substantial growth rates in the medium and long run.

    We should not be afraid of deflation. We should love it as much as our liberty.”

    Do you agree with Hulsmann yourself? What do you see as the solution?


    October 18, 2008 at 12:13 pm

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