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Street roots
13
Xd PUÍV1 Vi
How corporations, banks are cheating with our money
Feb. 28, 2014
BY ROBIN HAHNEL
C O N T R IB U T IO N ^ W R IT E R
F I inhere are two kinds of cheating going
on in our economy, every moment of
every day, that few people are aware
of. One is named “corporation” and the
other is named “bank.”
Cheat No. 1 Corporations: The defining
characteristic of a corporation is that it
enjoys limited liability, the owners of a
corporation are anonymous and
untouchable, and only the assets belonging
to the corporation can be seized by its
creditors. What does this mean?
If you engage in some behavior that
damages others they can sue yoti for
everything you own. They can go after your
bank accounts, stock portfolio, house, car;
furniture, or anything else they deem of
value including your wages. But if à
corporation engages in some behavior th a t,
damages others their liability is limited to
the value of assets owned by the
corporation. Mind you, the corporation has
owners who are people just like you and me,
with bank accounts, stuck portfolios,
houses, cars, furniture and salaries. And it
is these people who are ultimately in control
of their corporation’s behavior. But victims
cannot go after the assets of the owners of
corporations. All assets of the owners of the
corporation are protected. What this means
is that corporations can cheat those they
damage whereas the rest of us cannot. <
For most of capitalist history thé limited
liability cheat was disallowed. A system in
which the most powerful players enjoy the
advantage of limited liability denied to the
rept of us is relatively recent The first
modern limited liability law in the world was
enacted in 1811 by the state of New York.
However, the limited liability cheat proved
so advantageous that by the late1800s all
state governments and most countries in
the world found it necessary to grant
corporations limited liability in order for
them to be able to compete successfully
against cheaters licensed elsewhere.
The limited liability cheat clearly
encourages risk taking. The question is if
this is socially beneficial e r harmful.
Supporters argue that without the limited
liability cheat wealthy investors would be
too 'disinclined to participate in large risky
ventures, slowing the pace of socially useful
risk taking. Critics argue that limited
liability promotes reckless risk taking at
others’ expense. After a decade of
observing limited liability in action iir
England, Edward William Cox, a lifelong
member of the Conservative Party, had this
to say in 1855: "
“There is a moral obligation, which it is
J».
O ftla h o e l
Robin H ahnel is a
political activist and
retired visiting
Professor o f economics
a t Portland State
University. H e is a
co-creator o f the post-
capitalist economic
model known as
participatory
economics^ along with
Z Magazine editor
Michael Albert. He is
also Professor ..
E m eritus a t
American University ?
in Washington, D C.
the duty of the laws of a civilized nation to
enforce, to pay debts, perform contracts and
make reparation for wrongs. Limited liability
is founded on the opposite principle and
permits a man to avail himself of acts if
advantageous to him, and not to be
responsible for them if they should be
disadvantageous.”
Whether socially usefid or damaging, I’m
sure every one of us would like to avaiL
ourselves of the limited liability cheat that
corporate law awards only to corporations.
Cheat No. 2-Banks: Banks have been
with us longer than corporations with
limited liability. Banks accept deposits,
which depositors are free to withdraw at
will. But in fact only a small percentage of
the deposits are kept on hand because
banks lend most of the deposits to
borrowers who are only obliged to pay off
their loan on a schedule specified by the
loan-.agreement In other words, banks are
bigamists: They have a legally binding
marriage with first wife depositors and a
legally binding marriage with second wife —
borrowers. Only if first wives are lenient and
fail to exercise their full marital rights of "
withdrawal are banks not insolvent - caught
like bigamists in the act — every day.
If banks were required to keep all
deposits in réserve to eliminate any
possibility of becoming insolvent (should
first wife depositors chose to exercise their
full marital rights), they could make no
loans and therefore they could make no
profits. In other words, “bank” means
réservés will be only a fraction of deposits,
Which means there'is always some risk of
insolvency.
Worse still, the easiest way for any bank
to increase its profits is to keep less
deposits in resérve, and thereby increase
the risk of insolvency. Unless the rate of
interest a bank charges borrowers; on
average, is higher than the rate it pays
-depositors, on average, it cannot make a
profit But a bank must compete with other
banks for depositors and loan customers; So
it can only reduce the rate it pays on
deposits so much before it would lose
depositors, and it cart only raise the rate it
charges borrowers so much before it would
lose loan customers. On the other hand,
while the “spread” between the rate
charged for loans and paid for deposits is
limited by competitiort among banks, a bank
can increase profits by increasing the
fraction of its deposits it loans out by
decreasing the fraction it keeps as reserves.
If a bank cuts the fraction of deposits it
holds in reserves in half it will double its
profits.
The bigamy cheat is that the bank is
betting itsfirst wives’ money, not its own,
when it makes loans. If the loan pans out,
the bank keeps the profits. But if the loan is
not repaid, for whatever reason, it is the *
first wives who lose their money.
The bigamy cheat proved So lucrative that
historically banks could not resist driving
one another to keep less and less reserves
on hand in their stockholders’ lust for
profits; which led to frequent, severe runs
on banks where
innocent depositors
bore the brunt of the
damage. Public
Seat® critics^ s ijs e ll
outrage ultimately
Isie
lsd e C m w argue th a t
gave rise to a
!»©caas<>aaks
fca w p r a w n
minimum legal reserve
requirement and
so aflept at p ly in g palitficiaas
government '’-'•'osit.
t® f®8»®we reg »latlesis a fte r
insurance. However
fin
a n c ia l eases liawe >asse<
neither of these
we o n ly le a l © w rsslws II we
“regulatory reforms”
eliminates the dangers tM a k we eaa sabjeet Jh®» f®;
inherent in the
•coHipeteBt re fa ia lio ffl,
banking industry.
Reserve requirements
prevent banks from
running reserves down
to the point where there is so little on hand
that even a small increase in withdrawals
leaves them insolvent And deposit
insurance reduces the probability of
depositors panicking at the first sign of
trouble at their bank, leading to a run. But
short of a 100 percent reserve requirement
- in which Case there would be no banks -
and fully funded deposit insurance - which
no government can afford - the risks
inherent in a bigamist industry reniain, even
if somewhat diminished.
Just as in the case of the corporate
limited liability cheat, the bank bigamy Cheat
has its defenders.and its,critics; Defenders,
argue th a t if we did no t allow banks to be
bigamists there would be too, little socially
productive lending. Critics have long argued
that unregulated banking is an accident
waiting to happen. Some Critics, myself
included, now argue that because banks
have proven so adept at plying politicians to
remove regulations after financial crises
have passed, we only fool ourselves if we'
think we can subject them to competent
regulation, and therefore private banking for
profit is. a luxury we can ill afford. Better to
have public banks not driven by stock
holders to increase profits in ways that
create unnecessary social risks. In any case,
I’m sure we all would like to avail ourselves
of the bigamy cheat and bet other people’s
money, keep any winnings, and have arty
losses be theirs.
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