Last week in a speech at an event in London, Janet Yellen, Chair of the Federal Reserve, was quoted saying that she does not believe there will be a run on the banking system at least as long as she lives. Despite widespread criticism from analysts claiming another financial crisis is not only possible but highly likely, and questions about her longevity aside, she’s undoubtedly right. To understand why, we need to know what a bank run is:
Back in the old days, a bank run would involve depositors queuing up to withdraw their cash. Once withdrawals exceeded vault cash, it was game over – the bank would go cap in hand to investors or the central bank for a bailout that would ultimately depend on their assessment of its assets (typically, loan receivables) versus liabilities (deposits payable). These days, banks are far more complex. Assets and liabilities can be manipulated at will by accounting wizardry and financial engineering. The sheer size and systemic nature of their portfolios necessitate a domino effect when a single bank goes bust, potentially bringing down the entire system as we almost witnessed in 2008.
What occurred in 2008 wasn’t a bank run, but an implosion in value of toxic assets, namely collateralized debt obligations. A bank run itself is largely impossible in today’s digital world as you can’t remove your currency from the banking system; cold hard cash makes up barely 3% of the total currency in circulation, the rest is electronic. A bank run is only possible if you can withdraw your cash from the banking system, but the banking system has evolved to prevent this. The best you can do is transfer currency from one bank to another.
In the context of the modern banking system, Yellen’s comments aren’t technically inaccurate or controversial at all. The question is whether her statement was deliberately misleading or whether she genuinely believes the banking system is “safe”. I’d personally like to think it’s the former, as the latter would suggest she belongs in a mental health facility, not chairing The Federal Reserve.
System-wide debt and derivatives have grown by $ trillions since 2008, making banks now bigger and more susceptible to catastrophic breakdown than they were when labeled “too-big-to-fail”. The only reason all US banks recently passed so-called ‘stress tests’ is because the tests themselves are so limited in scope they’re practically useless – it’s like testing the strength of a wooden bridge by walking across it before driving over it with a semi-trailer – try raising rates to a historically normal level of 5% and you’ll see exactly how much ‘stress’ the system can really take.
The absolute insanity of claiming the banking system is anything but highly vulnerable to another financial crisis, means Janet’s words last Tuesday are nothing more than an attempt to feign confidence in the economy and banking system, and prevent it from collapsing before her term ends next year. That she had to blatantly mislead the public in her statement is a strong indication that the next financial crisis is imminent.