From the Right



What Happens When the Firemen Are the Arsonists?

Judge Andrew P. Napolitano on

In the past week, two top-20 American banks failed. A bank failure occurs when government regulators determine that the current and likely demand for a return of deposits cannot be met. When this determination is made, the feds enter the picture and declare the bank insolvent, order it to close, and go running to the Treasury Department and the Federal Reserve or both looking for cash to bail out uninsured depositors.

Depositors are insured by an agency of the feds, up to $250,000 per bank account. If the depositors' losses are greater than that amount, the feds can leave them on their own or take taxpayer dollars or fiat (Latin for "let it be done") money and compensate them.

How do the feds decide whom to bail out and whom to leave alone? That is one of the moral problems with government regulation. The government is not beneficent. It does with tax dollars or fiat money whatever it thinks will keep it in power.

In the cases last week, the feds bailed out depositors, not investors. So we have a system regulated by the feds, insured by the feds and partially bailed out by the feds. Sounds fool-proof, doesn't it? The Fed can just add zeroes to a bank's deposits (fiat money) to make funds available to depositors and at the same time attack the bankers whose investments turned sour when liquidity was badly needed.

The bankers who ran the two now-insolvent banks invested depositors' funds in bonds. The bonds had artificially low interest rates due to the control of interest rates by the Federal Reserve. As the Fed began to raise interest rates, supposedly to fight inflation by making it more expensive to borrow money, institutional borrowers drew down deposits to pay for business expenses, and the two banks sold their bonds so as to have the funds to meet their depositors' demands, but at a loss.

Interest is the rent one pays for the use of someone else's money. Interest rates should be negotiable like other rent, and the negotiations should be a function of supply and demand, just like nearly all rent is; except apartments in New York City, where rent controls have produced long-term shortages.


So, when the Fed kept interest rates low, bankers bought cheap bonds. Yet, when they needed cash and offered their low-interest bearing bonds for sale, the value of those bonds had shrunk because of the presence of new bonds on the market paying three times the interest as the old bonds, thanks to the Fed.

The Fed raised interest rates to cool the inflation it caused by putting fiat money into the money supply, thereby having more money chasing the same goods and services, thus causing inflation.

Under what constitutional clause can the Congress permit fiat money and the Fed control of interest rates? The short answer is: None. The longer answer addresses history and due process.

The Legal Tender Act of 1862 permitted Congress to issue paper money, not backed by precious metals. This led to cash created out of thin air. President Abraham Lincoln not only waged war on civilians and the states; he waged war on the value of money. When the war was over, the Supreme Court declared the act unconstitutional.


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Christopher Weyant Dick Wright Bart van Leeuwen Jeff Koterba Gary Markstein Joey Weatherford