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Run on the American Union Bank during the Great Depression
A run on the bank refers to when a significant number of a bank’s clients withdraws their deposits at the same time. Mass withdrawals are usually motivated when depositors fear their bank is, or will soon be, insolvent—in other words, cannot repay its depositors because its liabilities are greater than its assets.
Insolvency leads to bank failures. If bank runs happen across the banking system, collapse will occur and have detrimental effects across the economy. Bank runs, as you might expect, became a key feature of the tragic 2008 financial crisis that caused much financial and emotional suffering to people around the globe.
In this article, the Zero Theft Movement will cover what bank runs are, the potential damage they can cause, and a real world example.
Read more on how the 2008 financial crisis came about:
Bank Runs Definition
A run on the bank occurs when a bank’s clients/depositors expect the bank to imminently fail. Depositors swarm the institution, rushing to withdraw their money.
U.S. banks practice ‘fractional reserve banking.’ Essentially, fractional reserve banking means a portion of all deposits remains immediately available in vaults and ATMs. The portion is required by law, under the Federal Reserve’s ‘reserve requirement.’ Historically, the requirement has been around 10%. Banks use the rest of the deposits to make investments (e.g. loans).
This means, when a bank run happens, banks don’t have the immediate liquidity to return their clients’ deposits. To meet its obligations to clients, the bank might have to sell its long-term assets immediately at potentially less-than-ideal rates depending on the market at that time.
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Types of Bank Runs
What depositors decide to do with their withdrawn funds differentiate the three main types of bank runs. Only that last type has particularly severe consequences or a spillover effect to other banking institutions and the economy as a whole.
- Direct redeposit: Depositors opt to put their funds into a different bank, which they view as safe(r).
- Indirect redeposit: If depositors believe no banks are safe, they can purchase safe assets such as US Treasury bills (a.k.a a ‘flight to quality.’). Whoever sells the T-bills can deposit the funds into a bank they perceive as safe, completing the indirect redeposit.
- Run on the banking system: When neither the depositors nor the sellers of safe assets redeposit funds in any bank, disaster can ensue. The banking system will experience a depletion of its money supply in the uptick in creation of currency, due to fractional reserve banking. Economic activity across the board decreases, and fewer banks would be willing or even able to purchase the assets other financial institutions are trying to sell off to meet their obligations.
Bank Panic: A Vicious Cycle
Ultimately, the U.S. banking system very much depends on maintaining the public’s trust, a potentially volatile thing. And rightly so.
When you’re dealing with money, especially the life savings of many, even rumors of your bank’s failings can cause panic. No one wants to lose all of their hard-earned money, so the desperate rush to withdraw money ASAP does not come as a surprise. The fear alone, though, can create a self-fulfilling prophecy, where a bank may be going through a rough patch (not actually failing) and people react by pulling their deposits.
Fear breeds fear. Bank runs can lead to herd withdrawals, potentially bringing a bank to failure.
Mass withdrawals lead to more withdrawals; everyone trying to exit before the bank reaches insolvency and eventual failure. Thus, the vicious cycle begins. There needs to be enough direct and indirect redeposits to achieve some degree of stability. Otherwise, a run on the whole banking system occurs.
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The Federal Deposit Insurance Corporation (FDIC)
Congress established nationwide insurance on bank deposits though the Federal Deposit Insurance Corporation (FDIC). The independent agency provides some peace of mind to citizens, prevents bank runs and consequent bank failures.
Historically speaking, bank failures have actually been uncommon (the Great Depression and the 2008 financial crisis notwithstanding). But when they have occurred, it has been predominantly instances of direct redeposit and indirect redeposit, not a run on the banking system.
According to research conducted by the Library of Economics and Liberty, on the years between 1865-1936:
“Increases in this ratio [of bank runs] have occurred in only four periods since the Civil War, and in only two—1893 and 1929–1933—did an unusually large number of banks fail. Thus, market forces and the banking system on its own successfully insulated runs on individual banks in most periods.”
Due to FDIC insurance, first instituted in the 1930s, U.S. depositors will not lose money even if there is a run on their bank and it fails. Individuals who have their money deposited in federally insured credit unions also have insurance through the National Credit Union Share Insurance Fund (NCUSIF). In both cases, protection extends to $250,000 per depositor, per institution, per ownership category.
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Washington Mutual, a Bank Run in the 2000s
Despite the securities in place, bank runs have occurred even in the more recent past. The run on the banking system, sparked by the global financial crisis in the late 2000s, contributed to the massive economic fallout.
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Between the years 2008-2012, the FDIC closed 465 failed banks.
Washington Mutual (WaMu) was one major investment bank that experienced a massive bank run that factored into its implosion. Moody’s, the credit rating service, severely downgraded WaMu’s debt status and financial strength, according to a Business Insider article.
Unsurprisingly, Moody’s review and the financial crisis as a whole stoked the fear of many depositors. A massive run on the bank ensued.
“The downgrade roared across the country. WaMu customers, reminded once again that their money might not be safe, pulled $600 million out of WaMu that day…Soon, other rating agencies followed suit, sparking another massive bank run that would ultimately become the reason FDIC officials gave for closing WaMu. In the next three days, customers pulled another $2.3 billion out of WaMu.”
Statistics
Rolfe Winker, from the Reuters blog, published charts tracking the day-by-day outflow and inflow of WaMu funds in July and September of 2008
The Aftermath
The September 2008 bank run effectively ended WaMu. JP Morgan Chase swooped in and acquired the company near the end of the month, making a payment of $1.9 billion.
“Washington Mutual experienced not one but two bank runs in its final months. The first started after the failure of IndyMac Bank in California. The Second came as talk swirled that other banks were looking to acquire WaMu.”
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IndyMac Bank
Another bank that collapsed during the financial crisis, IndyMac experienced a run on the bank that led to its seizure by federal regulators in July 2008.
According to the FDIC’s press release:
“…The bank relied heavily on “higher cost, less stable, brokered deposits, as well as secured borrowings, to fund its operations and focused on stated income and other aggressively underwritten loans in areas with rapidly escalating home prices, particularly in California and Florida.”
John Reich, then-director of the Office of Thrift Supervision (OTS), penned a letter explaining dubious practices by IndyMac and OTS’s regulators. Watchdog ProPublica writes: “What Reich didn’t mention in his letter was that IndyMac had supplanted brokered deposits with uninsured deposits, offering some of the best interest rates in the country in hopes of luring people trolling the Internet for investment opportunities.”
Fearing failure, clients ran IndyMac, withdrawing ~7.5% of deposits.
The FDIC estimated, in the press release linked above, that resolving IndyMac would be between $8.5 billion and $9.4 billion.
Conclusion
Bank runs can lead to significant bank losses, closures, and overall economic decline. FDIC and NCUSIF insurance should reassure many of you, as you will not ever completely lose your savings beyond $250,000. Even without it, the data has shown that a few bank failures do not necessarily come with such grave consequences.
Runs on banks played a considerable role in exacerbating the 2008 financial crisis, an event that predatory investors likely caused and profited from. While years have passed since, Wall Street, as well as other economic sectors, may still be rigging the economy against us, the American public. But the Zero Theft Movement has the solution to end this corruption.
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