We have seen more than a few bank failures, both here and abroad, over the years. We do not, however, recollect having seen an actual run on a major bank. These sights were familiar in the early 1930s, BEFORE the advent of deposit insurance. Insofar as we know, they have never occurred in a developed country where deposits are protected by deposit insurance.
Deposit insurance has played a critically important role for the past 70 years. It has served as an indispensable firebreak between credit crises and bank failures, and between bank failures and a systemic collapse of the banking system. Consequently, it has been effective in performing its most important firebreak role: insulating the overall economy from the consequences of a financial panic. Since it is this connection which has historically constituted the chain leading to serious depressions, the positive role of deposit insurance has been of decisive importance.
The breakdown of this link in Britain -- a country known for its sobriety, prudence, and stiff upper lip disposition -- is disturbing. It is legitimate to pose some very troubling questions:
--Will further breakdowns occur?
--Will panic spread?
--How will governments and central banks respond?
What is painfully apparent is that CONFIDENCE has been DAMAGED. Since it is CONFIDENCE which stands as the crucial bulwark against panic and severe economic consequences, the Northern Rock panic is deeply worrisome. Clearly, the Bank of England has failed to maintain public confidence. The stout-hearted Governor, Mervyn King, has perhaps been a bit too stout-hearted. Bravado at a central bank, and the upholding of the Calvinist principle of "moral hazard" can have incalculable costs to a nation. This has been conveniently forgotten by central bankers everywhere, who, in mounting their high horses, have forgotten the 1930s and the lessons of history.
Let us hope that this serves as a wake-up call for our own Chairman Bernanke and his own obtuse colleagues.
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