Why This Harvard Economist Is Pulling All His Money From Bank Of America

Tyler Durden's picture

A classicial economist... and Harvard professor... preaching to the world that one's money is not safe in the US banking system due to Ben Bernanke's actions? And putting his withdrawal slip where his mouth is and pulling $1 million out of Bank America? Say it isn't so...

From Terry Burnham, former Harvard economics professor, author of “Mean Genes” and “Mean Markets and Lizard Brains,” provocative poster on this page and long-time critic of the Federal Reserve, argues that the Fed’s efforts to strengthen America’s banks have perversely weakened them. First posted in PBS.

Is your money safe at the bank? An economist says ‘no’ and withdraws his

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.)

Gallup poll

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.

In recent days, the chances for trouble at Bank of America have become more salient because of woes in the emerging markets, particularly Argentina, Turkey, Russia and China. The emerging market fears caused the Dow Jones Industrial Average to lose more than 500 points over the last week.

Returning to my money now entrusted to Bank of America, market turmoil reminded me that this particular trustee is simply not safe. Or not safe enough, given the fact that safety is the reason I put the money there at all. The market turmoil could threaten “BofA” with bankruptcy today as it did in 2008, and as banks have experienced again and again over time.

If the chance that Bank of America will not return my money is, say, a mere 1 percent, then the expected cost to me is 1 percent of my million, or $10,000. That far exceeds the interest I receive, which, I hardly need remind depositors out there, is a cool $0. Even a 0.1 percent chance of loss has an expected cost to me of $1,000. Bank of America pays me the zero interest rate because the Federal Reserve has set interest rates to zero. Thus my incentive to leave at the first whiff of instability.

Surely, you say, the federal government is going to keep its promises, at least on insured deposits. Yes, the Federal Government (via the FDIC) insures deposits in most institutions up to $250,000. But there is a problem with this insurance. The FDIC currently has far less money in its fund than it has insured deposits: as of Sept. 1, about $41 billion in reserve against $6 trillion in insured deposits. (There are over $9 trillion on deposit at U.S. banks, by the way, so more than $3 trillion in deposits is completely uninsured.)

It’s true, of course, that when the FDIC fund risks running dry, as it did in 2009, it can go back to other parts of the federal government for help. I expect those other parts will make the utmost efforts to oblige. But consider the possibility that they may be in crisis at the very same time, for the very same reasons, or that it might take some time to get approval. Remember that Congress voted against the TARP bailout in 2008 before it relented and finally voted for the bailout.

Thus, even insured depositors risk loss and/or delay in recovering their funds. In most time periods, these risks are balanced against the reward of getting interest. Not so long ago, Bank of America would have paid me $1,000 a week in interest on my million dollars. If I were getting $1,000 a week, I might bear the risks of delay and default. However, today I am receiving $0.

So my cash is leaving Bank of America.

But if Bank of America is not safe, you must be wondering, where can you and I put our money? No path is without risk, but here are a few options.

  1. Keep some cash at home, though admittedly this runs the risk of loss or setting yourself up as a target for criminals.

  2. Put some cash in a safety box. There is an urban myth that this is illegal; my understanding is that cash in a safety box is legal. However, I can imagine scenarios where capital controls are placed on safety deposit box withdrawals. And suppose the bank is shut down and you can’t get to the box?

  3. Pay your debts. You don’t need to be Suze Orman to know that you need liquidity, so do not use all your cash to pay debts. However, you can use some surplus, should you have any.

  4. Prepay your taxes and some other obligations. Subject to the same caveat about liquidity, pay ahead. Make sure you only pay safe entities. Your local government is not going away, even in a depression, so, for example, you can prepay property taxes. (I would check with a tax accountant on the implications, however.)

  5. Find a safer bank. Some local, smaller banks are much safer than the “too-big-to-fail banks.” After its mistake of letting Lehman fail, the government has learned that it must try to save giant institutions. However, the government may not be able to save all failing institutions immediately and simultaneously in a crisis. Thus, depositors in big banks face delays and defaults in the event of a true crisis. (It is important to find the right small bank; I believe all big banks are fragile, while some small banks are robust.)

Someone should start a bank (or maybe someone has) that charges (rather than pays) interest and does not make loans. Such a bank would be a good example of how Fed actions create unintended outcomes that defeat their goals. The Fed wants to stimulate lending, but an anti-lending bank could be quite successful. I would be a customer.

(Interestingly, there was a famous anti-lending bank and it was also a “BofA” — the Bank of Amsterdam, founded in 1609. The Dutch BofA charged customers for safe-keeping, did not make loans and did not allow depositors to get their money out immediately. Adam Smith discusses this BofA favorably in his “Wealth of Nations,” published in 1776. Unfortunately — and unbeknownst to Smith — the Bank of Amsterdam had starting secretly making risky loans to ventures in the East Indies and other areas, just like any other bank. When these risky ventures failed, so did the BofA.)

My point is that the Federal Reserve’s actions have myriad, unanticipated, negative consequences. Over the last week, we saw the impact on the emerging markets. The Fed had created $3 trillion of new money in the last five-plus years — three times more than in its entire prior history. A big chunk of that $3 trillion found its way, via private investors and institutions, into risky, emerging markets.

Now that the Fed is reducing (“tapering”) its new money creation (now down to $65 billion a month, or $780 billion a year, as of Wednesday’s announcement), investments are flowing out of risky areas. Some of these countries are facing absolute crises, with Argentina’s currency plummeting by more than 20 percent in under one month. That means investments in Argentina are worth 20 percent less in dollar terms than they were a month ago, even if they held their price in Pesos.

The Fed did not plan to impoverish investors by inducing them to buy overpriced Argentinian investments, of course, but that is one of the costly consequences of its actions. If you lost money in emerging markets over the last week, at one level, it is your responsibility. However, it is not crazy for you to blame the Fed for creating volatile prices that made investing more difficult.

Similarly, if you bought gold at the peak of almost $2,000 per ounce, you have lost one-third of your money; you share the blame for your golden losses with Alan Greenspan, Ben Bernanke and Janet Yellen. They removed the opportunities for safe investments and forced those with liquid assets to scramble for what safety they thought they could find. Furthermore, the uncertainty caused by the Fed has caused many assets to swing wildly in value, creating winners and losers.

The Fed played a role in the recent emerging markets turmoil. Next week, they will cause another crisis somewhere else. Eventually, the absurd effort to create wealth through monetary policy will unravel in the U.S. as it has every other time it has been tried from Weimar Germany to Robert Mugabe’s Zimbabwe.

Even after the Fed created the housing problems, we would have been better of with a small 2009 depression rather than the larger depression that lies ahead. See my Making Sen$e posts “The Stockholm Syndrome and Printing Money” and “Ben Bernanke as Easter Bunny: Why the Fed Can’t Prevent the Coming Crash” for the details of my argument.

Ever since Alan Greenspan intervened to save the stock market on Oct. 20, 1987, the Fed has sought to cushion every financial blow by adding liquidity. The trouble with trying to make the world safe for stupidity is that it creates fragility.

Bank of America and other big banks are fragile — and vulnerable to bank runs — because the Fed has set interest rates to zero. If a run gathers momentum, the government will take steps to stem it. But I am convinced they have limited ammunition and unlimited problems.

What is the solution? For you, save yourself and your family. For the system, revamp the Federal Reserve. The simplest first step would be to end the dual mandate of price stability and full employment. Price stability is enough. I favor rules over intervention. We don’t need a maestro conducting monetary policy; we need a system that promotes stability and allows people (not printing presses) to make us richer.

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Yen Cross's picture

   The epitome of educational prowess withdrawing from the " All Seeing Eye"?

THX 1178's picture

Yes. This "classical economist" is starting to sound a lot lot like Mr. Paul... or should I say Mr. von Mises...

I always thought it would be funny (after the collapse) to say "PhDs in economics from harvard are eating dogfood out of dumpsters with their mortarboards on and shit..."

But I guess they aren't all brainwashed...

I guess they aren't all bad eggs...

Live and learn...

Greenskeeper_Carl's picture

He is almost there. He mentions removing their dual mandate, whereas I would remove the fed itself from existence, which would put a decisive end to this 'dual mandate', which might as well be 'ass rape' then 'pick pocket'

Richard Chesler's picture

He sounds as if the emperor is naked. 

 

strannick's picture

Get gold you dumb Harvard bastard.

cifo's picture

I would pull my million out too, if I had one....

Pinto Currency's picture

 

The problem described by this "economist" is the standard problem with all fractional reserve banks.

These banks have demand deposit levels many times the cash actually available should depositors demand their money.

Fractional reserve is a scam, always has been, nothing new.

That he is now declaring an emergency on BofA has got to be his idea of a joke - where was he decades ago on this problem.

WarriorClass's picture

As a "fractional reserve" bankster, I only want to steal part of your money.

Not all of it.

http://americandictators.blogspot.com/

GetZeeGold's picture

 

 

Still waiting the My Gold program.....where I can exchange my IRA for Fort Knox gold.

 

Gold at $42 an ounce seems like a pretty good deal. I'll do that crap all day long.

Pool Shark's picture

 

 

Anyone who keeps $1 million in a BofA checking account is too stupid to give advice on financial matters.

 

Tom G's picture

But because you know better where to store your millions, you're a genius?

He's pulling it out. Maybe he got smarter?

People are far too judgmental in order to appear the most zero-hedgy and anti-establishment of them all!

I liked this guy's statements. But we all can't be as smart as you, perhaps.

Doña K's picture

I am sure that the guy has more than a million. Instead of keeping it in the bank, I would short the top 5 high flying stocks with no real earnings @ 200k each (you know which ones) and take two year sabbatical arround the world and when the SHTF wake up a multi millionaire.   

Pool Shark's picture

 

 

Tom G

Anyone who keeps more than $250,000 in any single 'bank' account is too stupid to own their money.

The fact that he used to have $1,000,000 in a BofA checking account proves his foolishness.

FDIC insurance limits mean anything to you?

 

fedupwhiteguy's picture

you can get additional fdic coverage over your funds by creating additional joint accounts. Such as using your child's or siblings SSN to create the coverage.

Creepy Lurker's picture

FDIC insurance means something to you? LOL

donsluck's picture

During the crises of '08 FDIC "rules" meant nothing. They insured everything and in fact allowed the investment banks to become covered, converting them to deposit banks under the FDIC umbrella.

Tom G's picture

You might be missing the point in an effort to prove yourself smarter than the average bear.

 

He is getting out.

And some of the things he says here ring very true.

How he managed his wealth previously is not known exactly, and it really isn't the point of the article. Either way, I don't need to point out one possibility of his previously foolish behavior to earn points amongst an online community. I enjoyed what he had to say. Did you disagree with the positions in the article, or just his former wealth management techniques (which you might be making assumptions about)?

Tom G's picture

Phrased differently: Is this guy on the Good Guys' Team, or is he a member of the Bad Guys' Team?

What he wrote indicates the former. How he managed his wealth beforehand is irrelevant. People wake up. Hopefully, more wake up daily. Should we insult all of them?

I used to be a neo-conservative. At some point I realized the error of my ways.

Would you dismiss anything I said about foreign policy because of the mistakes of my youth?

Vegamma's picture

I would pull my million out too, if I had one....


I always think I'm going to pull out in time, but well, you know.

Duke of Earl's picture

He's trying to protect his dollars against a scenario where major US backed banks would be unable to deliver and where the FDIC (government) cannot pay its insurance...and still thinks keeping it in dollars is a good idea.

In that scenario, he'll have a bunch of toilet paper with presidents pictures on it.  But hey, it will be in his mattress rather than a banksters!

Jafo's picture

When the SHTF happens it is not going to be a sudden transition to an end state.  It is going to be a process.  Yes, gold will be the last asset standing but before the US Dollar becomes worthless it is going to have massive purchasing power.  Just before the end physical dollars that have that property, not the digital dollars in the banks.  This is the point he is making.  Because of generations of conditioning physical dollars will buy you food and gas but credit cards will not be accepted and neither will gold be accepted by the super markets and the gas stations.  Anyone holding gold without a buffer of cold hard cash is going to be stripped of their gold.  Man, that would hurt.

Cynicles's picture

Harvard Grads that come to mind:

O'Riely, Øbama & this guy. 

Bindar Dundat's picture

Might be tempted to do all of the above as well as put 2-3%  into crptocurriencies , just in case.

irishlink's picture

Read between the lines. He has lost big on EM investements and down. 30% in dollar terms over the past year In Gold. In that scenario I would be very concerned for my million also. He is blaming ZIRP for luring him into bad investment . He is right and definitely not alone. The system is very fragile at this time.. Luxury good sales are down and the wealthy are trying to place their wealth into hard assets. Running scared!!!

samcontrol's picture

sometimes the rich don't run because they don't give a fuck.
I got hammered on my pms las year , yet I do not run, i go full retard and buy miners and agq options like never before. do or die, no running mate.

new game's picture

That fear has mom and pop doing funny things like buying that 80 acres over der. shit you not.

they have and are wise and worked hard-10percenters and as one said to me"i'll be damned if i'm going to lose my money i've worked my whole life for".

others are buying rentals in the city even if returns 5 percent. evidenced by my trying to do the same. vooosh gone last fall.

other classes of assets:gold, art, collectables, antiques, guns, cars.

wish i could stock pile some oil

no easy ride for you and me as we are  not part of the "club"...

HelluvaEngineer's picture

Correction: classic cars.  Or perhaps older 4x4 trucks.

Rafferty's picture

Nothing he wrote - to my mind - even indirectly says he personally lost out on these investments.

Theosebes Goodfellow's picture

The crime, Pinto, is not fractional reserve banking. The crime is duration mismatch. It's borrowing short and lending long. That's the crime.

nixy's picture

Would 'duration mismatch' be visable if FRB was made a hanging offence?

Hail Spode's picture

Fractional reserve banking?   Is that what you call it?  Where are the reserves?   That's the problem.  Or half of it.  The other problem is that should the banker's investments work out, they keep the profits, should they fail to work out, the funds are replaced at taxpayer expense.   

Bankers should be held personally liable for the assets of the bank, as in Switzerland, where they don't have these sorts of problems.   In addition, there should be a 20% reserve requirement, 5 to 1 leverage, not 55 to 1 as we have seen recently.  

The real problem is not fractional reserve banking, because in order to have FRB one must have reserves.  5 to 1 leverage is FRB, 55 to 1 is insanity.   20% reserve requirement, and when the value of their lending book drops so that it can't cover the other 80%, the bankers personally (they could buy private insurance) make up the rest.

That and many other thought-provoking ideas found here  http://www.amazon.com/Localism-A-Philosophy-Government-ebook/dp/B00B0GAC...

 

Spanky's picture

+1

For... an intriguing post.

Thanks for the link.

Iam_Silverman's picture

"Bankers should be held personally liable for the assets of the bank"

To take that even one step further - in the "Old Days" (think before the 1930's) the banks shareholders were also financially liable for bank malfeasance!  That would make you think twice about which banks you would invest in, wouldn't it?

SeattleBruce's picture

I'm sorry - he wants to prepay taxes as one of his alternatives? Gong on that one. Some of his other observations were much better than that.

buckethead's picture

Perhaps that comment was merely "playing well with others" in an attempt to avoid the tin foil dunce cap which is foisted upon all who reject fractional reserve banking and government confiscation outright. After all... He remains a Harvard Professor.

johnQpublic's picture

daeth and taxes are sure things

and he is talking about protecting his money, not making money from his money

given that caveat, prepaying taxes isnt a horrible idea at all

Thomas's picture

I agree with him in principle, but I am gonna take the unpopular role of devils advocate. All he is really saying is that fractional reserve banking has a fragile foundation that lends itself to bank runs. I didn't get any real insight into the current situation. Something tells me this guy is a few stocks short of an index.

Rafferty's picture

I'm out of line with him and most others but it seems to me that a bank run can be handled by just ramping up the printers.

 

Am I wrong?

Panem et Circus's picture

Would be much easier the Cyprus way. It's all digital, nobody has more than $100 cash in their wallets anymore. Just flip the "no-no" switch and stop a run before it starts.

buckethead's picture

He actually posed that scenario as plausible, but not entirely effective due to response time.

DIgnified's picture

Save your money on the AR.  Have you looked at what's buying them?  The kind of guy (read people) that buys a Harley but is to scared to ride it.  They'll be laying around everywhere a few days after suffering starts.

NidStyles's picture

If you're a real survivor, all you need is a good knife...  

mt paul's picture

and a piece of flint..

ebear's picture

and a hot chick in a fur bikini

samcontrol's picture

check, check, and check.

new game's picture

rolling papers, cofee, no booze-don't drink, camo, lots of quality clothes and shoes/boots

and the staples...check check > check.