Understanding The S&L Mess


Bank failure is as American as apple pie. The first American failure took place in Rhode Island in 1809, when a bank capitalized at forty-five dollars issued eight hundred thousand dollars in bank notes, a sum equal to more than seventeen thousand times the resources behind it. In the 1990s the latest bank failure, alas, almost certainly took place less than a week before you began reading this article, as another savings and loan association was taken over by the government.

The 182 years between have been marked by literally tens of thousands of bank failures. In sharp contrast, Great Britain, whence most of American banking theory and practice comes, has not had a major bank failure in well over a hundred years.

Why should the richest and most productive capitalist economy on earth have such a dismal record in safeguarding a system so central to capitalism? The answer lies in the peculiar nature of the business we call banking, in our national history as a federal republic of sovereign states, and in our politics. While no one could dispute that our Constitution and our politics have been, on the whole, a triumphant success, American banking is perhaps the ultimate proof of Sir Winston Churchill’s contention that “democracy is the worst form of government except all those other forms that have been tried from time to time.”

Banks are in the money business, and that, ipso facto, makes banking a very peculiar business indeed. Cash on hand, for instance, is an asset in most enterprises; it is usually a liability to a bank because it is owed to the depositors. Loans, on the other hand, are assets because they are owed to the bank. If an ordinary business goes broke, it is a financial problem for the owners, the employees, and the creditors, who, usually being professionals, have no one to blame but themselves. When a bank goes broke, however, it can affect the personal economic well-being of nearly everyone in the community or even, if the bank is large enough, the entire country.

And bankers, unlike other businessmen, must always serve two masters. Depositors want safety, borrowers want easy credit. Treading the delicate line between these two largely incompatible demands has been the very essence of successful banking.

Because banks are in the money business, we need first to answer the question, What is money? As is often the case with questions that seem obvious, the answer is not quite so obvious. That piece of expensive, beautifully engraved paper in your pocket, the one with the portrait of George Washington on the front, is, certainly, money. But what makes it so? A dollar bill is in itself nearly worthless, except perhaps to someone in the market for an engraving of our first President. It has no intrinsic value, as gold and silver coins do. Nor does it represent something of value on deposit somewhere. To be sure, the government says it is money, or at least “legal tender.” The Confederate government, however, said its dollar bills were money, and no one believed it, with disastrous consequences for the Confederacy.


But you can take a U.S. dollar bill and go into the marketplace, where anyone will happily exchange one dollar’s worth of goods for it. Why? Because people have every confidence that they, in turn, can take it into the marketplace at a later date and exchange it for goods of equal value. It is this characteristic, and this alone, that makes it money. To state it formally, money is any commodity that is readily accepted in the marketplace in exchange for every commodity.

Many things have served as money at different times and different places. The famous stone coins of Yap Island in the Pacific, which weigh several hundred pounds apiece, are one example. American cigarettes in immediate postwar Europe are another. Before banks, Western civilization considered only gold and silver to be money. Today most money has no material existence at all but rather is nothing more than elaborate on-and-off patterns of microscopic electric switches deep in the bowels of vast computer networks. Regardless, as long as you can take your Visa card and use it to buy whatever you want, those blips are money.

As I said, banks are in the money business. They safeguard it, they lend it, and, most important, they create it. The easiest way to understand what a bank does is by looking at the earliest history of modern banking in Britain (oversimplifying considerably).

The first English bankers were the goldsmiths of Elizabethan and Jacobean times. By the nature of their business, they had to keep a supply of precious metals—that is, money—on hand to fulfill orders. Sometimes they had more than they needed at the moment, and the goldsmiths began lending out this surplus money, at interest, to people who could give satisfactory collateral, such as goods or land.