Regular readers may recollect that in October I presented findings from a public opinion survey about the banking system. We used ICM to ask 2,000 people questions relating to the free banking vs. 100% reserves debate, and a summary has now been published by The Cobden Centre (.pdf). The key findings were:
The general population is highly uninformed about the banking system
- 74% of people think that they are the legal owner of the money
in their current account, as opposed to the bank
- 66% of respondents answered “donʼt know” when asked what
proportion of their current account was used in various ways by
- Only 33% of the general public favour the existing policy of
government backed deposits and a lender of last resort
UK high street banks are virtually insolvent according to the common use of the term
- By leveraging an average of 34 times its reserves, banks are behaving in a way that would not be considered legal in any other business
- A healthy solvency ratio is typically seen as about 20%. Of the 6 high street banks that we analysed the average is just 0.18%
- Although these banks have a positive asset/liability ratio, 20-40% of the assets comes from derivatives and possible “toxic” assets
Update: Steve Horwitz provides some very good commentary here.
Further update: I'd like to make a few comments in response to Steve and also Current. I think there's a danger of conflating what the paper actually says, my personal position, and Toby's own interpretation.
Steve casts doubt on whether the "sound money debate" exists outside of Austrian circles. I'm sure he's correct, but in the UK the idea that retail deposits should be kept separate from investment banking and 100% reserved is a topical issue that has the ear of the government. This is (and the financial crisis is more generally) a golden opportunity for demand in Austrian ideas. The Policy Exchange report cites our study and it spilled into some of the mainstream press commentary. I'm under no illusion about how marginal and radical these ideas are, but there's clearly some wider interest.
The paper itself was intended to mediate somewhat between those Austrians that advocate 100% reserves and those who advocate free banking. As I wrote in the report:
Much of the debate between these two positions rests on an empirical assertion about the degree to which the general public realise that commercial banks lend out demand deposits as loans
Since it's not an academic paper, I don't provide citations but I do in the slides of the talk that I gave and I don't think this is controversial. The point of the paper therefore is to *begin* to provide some evidence so that people no longer make groundless empirical assertions. "What the public believe" is notoriously hard to analyse, but I do think it crops up in the sound money debate so I do think it's worth trying to operationalise some kind of empirical work.
Steve argues that "what the public believes about their money is a distinct question from the nature of the contract they've actually signed" - totally correct. However since some people would argue that a contract is void if it isn't understood by both parties, it's a relevant issue. If the survey unambiguously found that people *do* understand the nature of banking, then that argument would disappear and we'd have learnt something. Of course we're never going to get unambiguous answers from a public opinion survey, so it's up to each of us to match it against our own priors.
Onto Steve's "nits". I agree that there's a trade off between "ease of access" and "safe storage". If you increase the amount of armed guards at a money warehouse (raising costs) you increase the potential for bankruptcy. In the paper I deliberately kept the analysis for each question as brief as possible. Steve's point is aimed at Toby's interpretation, not the paper itself, so I'll move on. Regarding nit 2, the summary is
UK high street banks are virtually insolvent according to the common use of the term; their legal privilege allows them to continue to trade.
I have to confess, that when we worked on this section I was viewing it as a critique of the status quo rather than fractional reserve lending. There is a danger that by defending the practice of fractional reserves Steve also defends the current leverage of the banking industry. The reason why the student team did a balance sheet analysis and compared it with other high street businesses was to show that banks are highly leveraged - to the point that in 2008 we declared them "virtually insolvent". This doesn't mediate the sound money debate because all sides would (surely) agree that banks are currently relying on legal privilege. This says little about the solvency of fractional reserve banks once you've stripped away deposit insurance, a lender of last resort, etc.
When we concluded "the current banking system is at the root of the current financial crisis. Banks claim their solvency but it is only thanks to legal privilege that they are not already bankrupt" I think Steve's interpreted that as a criticism of fractional reserve lending. He says "suggesting that fractional reserve banks are somehow inherently insolvent or illiquid is once again misleading" - but the paper is merely claiming that in 2008 the 6 UK high street banks whose balance sheets we looked at were inherently insolvent.
This part of question 5 is really poorly phrased - "if more than 1 in 34 people wish to withdraw all their money at the same time they would not have enough to pay out." That is only an accurate representation of fractional reserve banking if each and every depositor has the identical balance. The real question is "if customers tried to withdraw more than 1/34th of the bank's total deposits on any given day." More than 1/34th of the customers could come in and close their accounts on any given day with no problem at all if their accounts were all small enough. And given that most banks have corporate customers with very large balances, even a fair number of small balance customers could do so with no problem. If Tony does more of this research, I'd like to see that question worded properly.
Steve is completely correct. I've actually gone back through my correspondence because Steve was one of a number of economists who kindly offered early feedback on the questions. The purpose of this question was to establish what mechanisms people thought should be utilised to prevent bank runs. What we found is that 33% support government guarantees (i.e. deposit insurance), 33% believe normal bankruptcy laws would be enough, and 26% support 100% reserve requirements. My reaction to this was *wow*. This is some pretty widespread support for radical policy! The problem was that ICM thought that people wouldn't have enough background knowledge to answer the question directly, so asked us to add something to explain why there's a possibility of a bank run. Steve has pointed out that the way we've tried to phrase that is poor, and he's right. But it's an attempt to distill the issue into the introduction of a question aimed at the general public.
The problem with this type of research is that we wanted "free bankers" to feel that the questions weren't misleading, "100% reservers" to, *and* phrase them in such as way that ICM agreed they were clear. If we'd ignored ICM's advice then I think we'd have been open to a bigger critique since they provided an additional source validation. But clearly if I was doing it again I would change the way that is phrased. But I can't think of an alternative that is much clearer, which is probably why I won't be! My response to people unhappy with the questions though is to come up with better alternatives. This is a first stab, conducted by a student team with no background understanding of Austrian economics.
Finally, as an attempt to disentangle my own thoughts on the sound money debate from others, here's a working paper. I confess that after a good year or so of reading up the majority of the academic literature and following all the various blog debates I am past the point of satiation. I don't think I have much that's original to contribute, but I cover grain silos, contingent liabilities, legal privilege etc. Rather than jump into blog comments and cover the same ground I'll leave it there.