Friday, May 21, 2010

Quote of the Day: James Grant

The substitution of collective responsibility for individual responsibility is the fatal story line of modern American finance. Bank shareholders used to bear the cost of failure, even as they enjoyed the fruits of success. If the bank in which shareholders invested went broke, a court-appointed receiver dunned them for money with which to compensate the depositors, among other creditors. This system was in place for 75 years, until the Federal Deposit Insurance Corp. pushed it aside in the early 1930s. One can imagine just how welcome was a receiver's demand for a check from a shareholder who by then ardently wished that he or she had never heard of the bank in which it was his or her misfortune to invest.
~ James Grant


  1. James Grant is a smart guy and I've had the privilege to see him talk on numerous occasions and have marveled at his insights into financial history. Still, this quote is an oversimplification in my opinion and it's one that is bandied about quite often in today's environment.
    Bank failures in the 1930s brought the unemployment rate to 25%. A lot of the banks failed not because they were mismanaged (ala' Bear Stearns - which should have failed) but because of the nature of the fractional reserve banking system. When fear runs rampant the good along with the bad are taken down.
    The problem facing us is to distinguish between the two. This is not easy.
    It is worthwhile in this debate to remember that banks are different from other institutions. They are information gatherers. As the middleman they gather credit quality information on their borrowers, all of which is lost when they go under. This is society's loss when they go under.
    The idea that the FDIC is responsible has surface appeal but it is like the argument that got us where we are today that Greenspan bought hook line and sinker - that the market can police itself and that derivatives need no regulating.

  2. I agree with you the Grant quote is an oversimplification, and I certainly wouldn't recommend going back to the pre-FDIC days. But somehow we need to figure out how to walk that fine line between over regulation and no regulation, and incentivize our financial institutions to behave responsibly, ethically, and not take undue risks. Easier said than done, but I'm not sure a 1,400 page bill is what the doctor ordered. Regulators always seem to be about two steps behind the industry and asleep at the wheel, no matter how many regulatory agencies are created.

  3. I tell you Grouch I hate to admit it but I almost feel like we need to go back to Glass-Stegall. I believe the banks just like Fannie and Freddie turned into big hedge funds with their proprietary trading and this was a big part of the problem.