Bailouts: Cracks in the Financial System?

Bailouts aren't new...

The recent years have seen multiple cracks appear in a system that we've all trusted for centuries, the financial system. Decades of debt upon debt have raised heightened sensitivity to the actions and trust of banks.

After an all-night emergency meeting with the euro zone and the International Monetary Fund, Cyprus announced Saturday morning that it would impose a tax on deposits in return for a €10 billion bailout. Deposits below €100,000 were to be taxed at 6.75%, those above at 9.9%, raising a total of €5.8 billion. The levies, especially those on small savers have created a political backlash in Cyprus and beyond.

Cyprus Financial Crisis

“The very nature of banking has been shaken to its roots with this decision, for banking depends upon trust,” Dennis Gartman wrote in his daily Gartman Letter, “trust that has now been shattered; torn asunder, broken…destroyed.” Wall Street Journal, March 18th 2013

The raid on Cypriot bank deposits, held in the name of ordinary people, businesses, institutions, communities, and prudent savers, breaks one of the fundamental trust-based relationships that has sustained western societies for centuries.

The comparison is obvious — if bank deposits can be raided by a government in one bankrupt eurozone country, then why not in another? As Spain has requested a €40bn bailout for its banks, can Spanish depositors be certain or even confident, that they will not face similar demands?


Bailouts aren't new, we only need to look back at the Global Financial Crisis of 2008-09 when the U.S. Treasury and the Federal Reserve System bailed out numerous very large banks and insurance companies, as well as General Motors and Chrysler. US Congress at the urgent request of President George W. Bush passed the Troubled Asset Relief Program or "TARP", funded at $700 billion. The banks have largely repaid the money and the net cost of TARP may eventually be in the range of $30 billion. The bailout of Fannie Mae and Freddy Mac, which insure mortgages, totals $135 billion by October 2010, and could be much higher, depending on the future of the housing and mortgage markets.

On November 24, 2008, American Republican Congressman Ron Paul wrote, "In bailing out failing companies, they are confiscating money from productive members of the economy and giving it to failing ones. By sustaining companies with obsolete or unsustainable business models, the government prevents their resources from being liquidated and made available to other companies that can put them to better, more productive use. An essential element of a healthy free market, is that both success and failure must be permitted to happen when they are earned. But instead with a bailout, the rewards are reversed – the proceeds from successful entities are given to failing ones. How this is supposed to be good for our economy is beyond me.... It won’t work. It can’t work... It is obvious to most Americans that we need to reject corporate cronyism, and allow the natural regulations and incentives of the free market to pick the winners and losers in our economy, not the whims of bureaucrats and politicians."

So where does this end?

Can a population continue to bailout failures?

More importantly, are we starting to see cracks form in a system that failed to adapt? The structures, economics and distribution of the worlds largest banks aren't geared towards the modern economy. They are rigid, deeply entrenched systems that resemble the early 1900's. The amont of productive lost through rigid heavy business models don't fit in a world where the consumer is in the power seat. Transparency means the internal workings of a bank can be quickly opened up for their performance flaws and pulled into question, even amongst the strict information security and data protection polices.

...are we starting to see cracks form in a system that failed to adapt?

Although the comparison is slim, we don't have to look far to find large institutions that weren't rescued. Borders and Blockbuster were left to 'fall on their sword' as their businesses failed to adapt to the modern world.

Victoria Grant, 12 years old, became an overnight Internet sensation after a video of her slamming Canadian Banks and the government for robbing the people, went viral. "I've discovered is that banks and the government have colluded to financially enslave the people of Canada, she said at Pubic Banking Institute conference in Philadelphia."

Consumer unrest and displeasure has fuelled dozens of startups to begin the process of re-inventing the system. Businesses like Currency Cloud aim to provide a simple, transparent currency market that bypasses the hefty margins for middle men. Green Dot's reloadable prepaid card in the US is the nations fastest growing deposit product, as consumers move to more predictable transactional accounts. Betterment does the asset allocation for investment portfolios automatically based on your time horizon. They let you explore different scenarios (based on solid historical data, which is not an indicator of future results, but at least a starting point), adjust your horizon, and even set different goals at different time horizons.

There is a trend here... each of these startups has learnt the lessons of Silicon Valley and put the consumers needs and experience first. Building transparent, engaging products that will revolutionise the market. To date banks and large financial institutions have pointed to decades of stability and trust to justify their role in society. Recent 'bailouts' and 'pony ups' only bring that role into question.