Table of Contents
What is a Lender of Last Resort?
A lender of last resort (LoR) refers to an institution that provides emergency loans to at-risk banks (or other financial institutions). A nation’s central bank (e.g. the Federal Reserve) typically operates as the lender, intervening before the borrower collapses.
Resort lending may occur when (1) the borrower cannot secure loans anywhere else due to their financial troubles and (2) its collapse could have disastrous effects on the economy.
During the late 1800s, a series of banking panics in the U.S. destabilized the finance world. Financial institutions failed, and many lost their deposits. The lender of last resort was introduced to protect depositors by lending temporary liquidity to at-risk institutions.
Since the lender of last resort’s introduction, the Fed has bailed out countless companies. But critics argue that last-resort lending tempts banks to take unnecessary, and perhaps unethical, risks. High-risk, high-reward gambles arguably become low-risk, high-reward guarantees. All while endangering the economy, often harming the public.
In this article, the Zero Theft Movement will cover the theory behind the lender of last resort, as well as go in-depth on the potential moral pitfalls last-resort lending creates. We do this to ultimately ask the question: does the lender of last resort function enable crony capitalists to unethically profit off of excessively risky investments?
Massive bailouts often allow shareholders to make profits on failed investments. That’s not how an investment works for most people.
Don’t believe us? See what your fellow citizens are saying on the Zero Theft platform…
The Theory behind Last-Resort Lending
Economist Henry Thorton and journalist Walter Bagehot conceived the classical theory of lender of last resort. Thornton and Bagehot both emphasized the need to protect the money supply (i.e. total value of money available at a point in time), as opposed to individual banks. They argued that at-risk financial institutions generally should not have the option of last-resort lending. That individual banks should be left to fail. They also championed charging penalty rates, good collateral, and the exclusive accommodation of institutions that have established records of sound practices.
In 1802, Thorton published An Enquiry into the Nature and Effects of the Paper Credit of Great Britain. He identified The Bank of England (BoE) as a model for a lender of last resort because it had control over the issuance of banknotes and displayed a strictness in its lending. It could encourage relaxed, careless, and even reckless behavior by both individual and central banks. Thornton feared that the safety net would embolden financial institutions. That they would take wild speculative ‘risks,’ purely operating based on the guarantee that they would be saved. Of course, to Thorton, the consequences of failure to the economy or the public would matter much less to individual banks than the extreme potential success they could achieve without really taking any actual risk.
In 1873, Bagehot published Lombard Street: A Description of the Money Market. Bagehot made many of the same claims that Bagehot did while elaborating on the potential hazards of having a lender of last resort. Bagehot believed he had the best solution to fixing banking crises: huge loans offered at a very high-interest rate. He concluded that last-resort lending should function only as a temporary measure to address banking panics.
The Zero Theft Movement does not have any interest in partisan politics/competition or attacking/defending one side. We seek to eradicate theft from the U.S economy. In other words, how the wealthy and powerful rig the system to steal money from us, the everyday citizen. We need to collectively fight against crony capitalism in order for us to all profit from an ethical economy.
Terms like ‘steal,’ ‘theft,’ and ‘crime’ will frequently appear throughout the article. Zero Theft will NOT adhere strictly to the legal definitions of these terms (since congress sells out). We have broadly and openly defined terms like ‘steal’ and ‘theft’ to refer to the rigged economy and other debated unethical acts that can cause citizens to lose out on money they deserve to keep.