Most Americans assume that the banking system as we know it has been around since the end of the Revolution. Not so!
We all know of the animosity between Thomas Jefferson and Alexander Hamilton. Jefferson opposed a national bank on principal. He stated that it was not in the Constitution that there should be a central bank; Hamilton argued that it was implied in the Constitution. George Washington signed the law creating a national bank in order to promote trade and industry. The law expired in 1811 and Congress did not renew it until 1816. Congress attempted to renew the law in 1832 however it was vetoed by Andrew Jackson. Our current banking system was not created until 1914.
The issuance of federal debt without backing by tangible assets inevitably leads to inflation unless it is moderated by events which slow the velocity of money, or how quickly money travels from one hand to another, and how far it goes. The idea is that as long as the federal government is able to collect enough taxes to pay interest on the debt issued in order to increase the money supply, or issue more debt, there will never be a problem with trade and commerce. The necessity of a healthy banking system is, in this model, required for individuals and corporations to borrow enough to “capitalize” business. When this credit dries up, businesses fail.
The tradeoff is that there is always a chance that those in power might be able to control a central bank and unfairly benefit from the government’s efforts to “moderate” the economy. We are now experiencing such activities.
According to our elected representatives, healthy banks are essential for economic growth. One can’t disagree with that premise. One CAN question how banks should be kept healthy. Should it be the government’s responsibility or that of the shareholders of those banks? Should this premise be generalized to major employers, such as Chrysler and General Motors, as an extension of this policy? Ford has been taking a real beating and is probably going to get worse.
The answer to all of this is for shareholders, not the government, to make sure that these banks and companies are not taking undue risk. After all, it is supply and demand that is supposed to moderate markets, not government intervention. When government tampers with the supply/demand curve, you can bet that these shareholders will continue to allow these companies to take undue risk in order to bolster earnings and thus their returns on stocks. Reducing risk by virtually guaranteeing bailouts does nothing more than allow risky behavior to continue. This does not serve investors or the markets. Neither does it serve taxpayers who ultimately support these shareholders. One could argue that it is these taxpayers who ultimately benefit in this bailout will keep stock prices higher than they would ordinarily be and 401Ks and other savings programs will be there when these taxpayers need them. However, no one should be investing money in stock that they can’t afford to lose, particularly those who are less than ten years away from retirement. Instead of worrying about whether their investments are at risk, they should be questioning their investment advisors. They shouldn’t rely on the government to mitigate their risk.
Professor Kupferman is an adjunct professor for the Polytechnic Insitute of NYU's Executive MBA program.