Last week I had over $1,000,000 in a checking account at Bank of America. Next week, I will have $10,000. Why am I getting in line to take my money out of Bank of America? Because of Ben Bernanke and Janet Yellen, who officially begins her term as chairwoman on Feb. 1. Before I explain, let me disclose that I have been a stopped clock of criticism of the Federal Reserve for half a decade. That’s because I believe that when the Fed intervenes in markets, it has two effects — both negative. First, it decreases overall wealth by distorting markets and causing bad investment decisions. Second, the members of the Fed become reverse Robin Hoods as they take from the poor (and unsophisticated) investors and give to the rich (and politically connected). These effects have been noticed; a Gallup poll taken in the last few days reports that only the richest Americans support the Fed. (See the table.)
Why do I risk starting a run on Bank of America by withdrawing my money and presuming that many fellow depositors will read this and rush to withdraw too? Because they pay me zero interest. Thus, even an infinitesimal chance Bank of America will not repay me in full, whenever I ask, switches the cost-benefit conclusion from stay to flee. Let me explain: Currently, I receive zero dollars in interest on my $1,000,000. The reason I had the money in Bank of America was to keep it safe. However, the potential cost to keeping my money in Bank of America is that the bank may be unwilling or unable to return my money. They will not be able to return my money if:
Many other depositors like you get in line before me. Banks today promise everyone that they can have their money back instantaneously, but the bank does not actually have enough money to pay everyone at once because they have lent most of it out to other people — 90 percent or more. Thus, banks are always at risk for runs where the depositors at the front of the line get their money back, but the depositors at the back of the line do not. Consider this image from a fully insured U.S. bank, IndyMac in California, just five years ago.
Some of the investments of Bank of America go bust. Because Bank of America has loaned out the vast majority of depositors’ money, if even a small percentage of its loans go bust, the firm is at risk for bankruptcy. Leverage, combined with some bad investments, caused the failure of Lehman Brothers in 2008 and would have caused the failure of Bank of America, AIG, Goldman Sachs, Morgan Stanley, Merrill Lynch, Bear Stearns, and many more institutions in 2008 had the government not bailed them out. More