Now, traditionally, we think of bank runs as depositors flocking to the banks to withdraw
their funds at the same time, pushing the bank into insolvency and bankruptcy.
But as we saw in the most recent financial panic, there was a different run on the bank
in the so-called shadow banking sector.
Can you explain what happened in the repo market that had such a significant effect
on the entire banking system?
Well, in the most recent run, what happened was that short-term people who loaned short-term to the bank, not the actual depositors, but people, for example, who bought the bank's commercial paper, 30-day paper, repos and so on,
What they did was that they saw that the bank was unstable and they began to sell off this commercial paper, that is, not renew the loans as they came due, so that the bank, keeping in mind the bank always borrows short and lends long, the bank was not able to finance its holding of all these long-term assets like mortgages and mortgage-backed securities and so on. So it was very difficult for them to come up with money. At that point, it was a contagion effect and the
The Federal Deposit Insurance, for the most part, it does not cover the shadow banking
sector.
Do money market funds have any forms of protection to mitigate runs on the short-term market,
other than bailout?
Actually, they do.
I mean, before this crisis, money market funds rarely, if ever, had a problem.
There were one or two that broke the buck, which meant that the value of their shares,
which they maintained at one dollar per share, went down below the value of a dollar.
But what happened was that the larger fund that owned these money market funds would
usually bail them out.
So the few times that it actually happened that they lost some money, let's say 10 cents
The owner of the fund was able to make the depositors, or rather the shareholders as they're called, whole.
So what protects them is the fact that money market funds do not have federal deposit insurance and because they do not, depositors are very careful about which funds they invest in.
So the money market funds make sure that they keep their investments very secure.
Well, do you think that a run and short-term funding market will be a proximate cause to
the next major financial panic, and how widespread would you expect it to get before the Fed
would step in?
Well, what I see happening is, once again, we're beginning to see an asset bubble. Yesterday, it was reported that prices of housing went up 12.5% in one month in April throughout 20 major cities in the country.
And in some cities, like San Francisco, San Diego, and elsewhere, the rise in prices were something like over 30%.
So we're beginning to see a bubble in the housing market again, which means that these prices may ultimately be unsustainable.
Once these prices begin to fall, as well as, let's say, stock prices, which have been falling, then you're going to find that the bank's assets are falling in value and we're going to have a problem again.
So, rising interest rates, I think, in the long-term market now, because mortgage rates are rising, you know, that's a potential cause of the crisis.
And let's move on just to the Federal Reserve, which kind of seems to be the central focus here.
Now, you said that it would be better for the Fed to be under the control of Congress rather than the Federal Reserve Board. Why is this?
Well, the argument against what I said was that, well, you know, you can't have Congress,
which is so subject to short-term political influences, controlling the Fed.
So we have to leave it to the experts, quote-unquote, to control the Fed.
But when you do that, what you've done is you allowed a number, a bunch of bureaucrats
to have independence and to run the Fed as they see fit.
And there's no oversight whatsoever, okay?
Obviously, having the Treasury oversee, the Congress and Treasury oversee the Fed is not the perfect solution.
I prefer a completely denationalized money, a gold standard.
But given that we don't have that system, that we don't have a gold standard, that banks can create money,
I'd rather see the Fed be much more transparent because Congress will look into the affairs of the Fed.
They'll have to be much more careful in their activities.
I would choose elected politicians over unelected, appointed bureaucrats any day of the week.
And how would we get to a world without the Fed?
I mean, the Fed is the lender of last resort and an integral part of the financial system.
How could we wind it down to see a world without it?
Well, that's a very good question.
The Fed, I mean, there are many different plans out there about how to get rid of the
Fed.
to put it under treasury supervision, but one thing you can do is forbid the Fed from
ever again buying anything in the open market. When the Fed buys government treasuries or
mortgage-backed securities, it does so by simply, in effect, printing up the money,
creating it out of thin air, and then writing a check on itself to buy the, let's say the
mortgage or the treasury bill. But in that case, the money then gets into circulation.
and it causes inflation, so if you prevent the Fed from buying anything ever again, you've in effect defanged it, you've removed its power to create money.
And in that world, you're right, it would not be a lender of last resort, it could not bail out failing financial institutions.
But then, if you get rid of the Fed's lender of last resort and get rid of Federal deposit insurance, then the banks will be on their own.
They'll have to be very careful, like money market funds are, about where they invest and for how long a period of time they invest.
They would no longer be able to borrow short-term or even to promise depositors to give them their money back at any time, but then invest in 30-year mortgages.
So competition, to answer your question, would force banks to be much more prudent, much more responsible.
Well, what about also repealing legal tender laws and the taxes on gold and silver?
I mean, if we just repealed these laws, would it just help wind down the Fed without necessarily having to abolish it?
Yeah, that's also an alternative. What that would do is if you repealed all sorts of excise sales and capital gains taxes on gold and silver,
and also on foreign currencies, then banks would be willing to create deposits or to lend or to allow you to have deposits in terms of,
let's say more stable foreign currencies like maybe the Euro or the Swiss
franc also people begin to use gold and silver naturally and there will be
banks that would grow up that would take gold and silver deposits okay so in other words
without the legal tender laws and all of those taxes you would have competition
in currency as we call it other currencies would be able to compete with
the Fed no so the Fed would not be able then to inflate the money supply to
Okay, and what I have you here, I want to just take a moment to talk about the NSA scandal with Edward Snowden and this whistleblower movement that's starting to emerge. Is it possible that whistleblowers could threaten confidence in the U.S. payment system now that it's possible that electronic payments are being tracked by the government?
I guess in the sense that it would give foreign groups, I guess this is the argument, an entree
or a bigger opportunity to be able to hack into our system, maybe, but I really don't
see that practically happening.
I don't think the type of information that Snowden has and may potentially give to foreign
and Governments and Foreign Media, such that that's a realistic possibility.
And to touch on competing currencies, the future of currencies seems to be going digital
as cryptocurrencies such as bitcoins are gaining popularity, which are partially anonymous
too.
And bitcoins have been used to donate funds to whistleblower protection organizations
such as Bradley Manning's Defense.
We have just about 30 seconds left, but do you think it's possible that cryptocurrencies
are helping fund whistleblowers that are working towards damaging the stability of the US dollar.
I think Bitcoin is helping in this area.
To what extent, I'm not very sure.
I was just at a conference, a PortFest conference in New Hampshire, and Bitcoin was being accepted
and there were various panels talking about Bitcoin.
So I think it's being used as a crypto means of payment.
I wouldn't quite call it money yet because nobody really quotes prices or not many people
Well, thank you so much for joining me. This is Joseph Salerno. He's the Academic Vice President of the Ludwig von Mises Institute. He's a Professor of Economics at Pace University. Thank you.