Being a firm believer in caveat emptor, I'm not going to claim that fractional reserve banking is an outright fraud. Somewhere in the fine print the banks do state that your money may not be available immediately on request. However, it's not hard to see why people call it that, or why a strict separation was required between interest-bearing time accounts, like CDs, and fee-based demand accounts.
Runs on banks really isn't a problem. Banks can just resume doing what they used to do -- have a clause in the savings agreement that allows them to declare an emergency and defer withdrawals in exchange for paying their customers an increased interest rate.
Yes, that's what I was referring to by "the fine print". It doesn't change the expectation people have that their deposits are
theirs, whatever the bank may really be doing with them.
So long as the bank is fundamentally solid and the problem is just liquidity, you can even find other banks who will buy your deposits at the bank suffering from a run. They know they'll get paid the amount, plus more than normal interest, when the bank recovers its liquidity.
The problem is if a bank makes bad investments such as loans that will never be repaid. Insufficient equity is much more devastating than insufficient liquidity.
Agreed. You don't normally have serious bank runs due to mere liquidity issues. In a pinch, a bank in need of liquidity, but having sufficient equity, can always take out loans from other banks to cover short-term demand. The disconnect between depositors' expectations and reality is only revealed in the event of a large-scale economic downturn, such as at the start of the Great Depression, when the banks' investments are revealed to be systematically bad.
Moreover, in a situation like that--precisely the one the FDIC was supposedly instituted to protect against--the FDIC would be useless. They don't have anywhere near enough reserves to make up for a wide-spread run on the banks without printing up so much new money that the dollar would become worthless. The FDIC's only positive influence, if you can call it that, is to generate enough
false confidence to keep people from demanding immediate withdrawals once the crisis is revealed.
In the mid 80's, some Libertarians who believed that fractional-reserve banking was a fraud opened an "honest" bank. They stored your money in their vault and had 100% reserves. Of course, they couldn't pay any interest and even had to charge a small storage fee. Not surprisingly, their service wasn't very popular at all. (Though, in fairness, part of this is because the government insures bank deposits. Heck, in today's economic climate, they might actually do some business for people with amounts over the FDIC limit.)
Not a surprising result. The honest bank is in a similar position to someone trying to operate a self-sufficient toll road in competition with the public (tax-funded) roads. When people are already forced to pay for the public option, even a reasonable price for a private alternative is too much. The FDIC isn't exactly tax-funded (unless you count inflation), but it does come with the "reassuring" backing of the federal government and access to the Treasury. It's hard for a completely private insurer to compete.
Rather than a vault-only bank, I think I would offer two types of accounts (time and demand), and clearly explain the risks involved with the time accounts. The demand accounts would charge a fee, but have 100% reserves. The time accounts would pay interest, but withdrawal requests would be subject to delays and/or interest penalties, as with CDs, plus a prominent disclaimer that they are subject to investment risk and may lose value. By mixing the two you can get the same effect as a modern-style savings account, except with full disclosure and control over the level of risk. The only real problem in the first place was blending the terms of time and demand accounts while obscuring the details.
