Lately, there has been a lot of discussion on the issue of demonetization. Most of the books I’ve read seem to miss the root cause of the problem. Debanking is a symptom of deep problems in our governance system. “Regulations” cannot solve problems because they are caused by regulations.
There are many causes for debanking. Here are some:
1. Federal drug prohibition
2. Federal income tax
3. Federal Deposit Insurance
The first two were Progressive Era initiatives, passed just before World War I. The third bill was passed during the Great Depression. (Interestingly, FDR strongly opposed deposit insurance, but signed the Glass-Steagall bill anyway, given the importance of other provisions.)
Thanks to deposit insurance (and related policies such as “too big to fail”), profit-maximizing banks are able to avoid social excesses, knowing that some of the consequences of their mistakes will be borne by taxpayers. You are encouraged to take risks. Because of this moral hazard problem, deposit insurance almost inevitably leads to bank regulation. Banks are under pressure to act to please the bureaucrats who regulate them.
Both drug laws and income taxes are extremely difficult to enforce. As a result, the federal government has increased its reliance on the banking system to support efforts to prevent money laundering and tax avoidance. Even if drugs are legalized at the state level, they are still crimes at the federal level. Therefore, most banks have shut down their marijuana operations.
Giving regulators the power to shut down non-conforming banks will almost inevitably set in motion “mission creep” and make regulation increasingly politicized. People from all walks of life are targeted. Certain ethnic groups associated with terrorism are viewed with suspicion. Americans living abroad are considered potential tax evaders and often have difficulty finding banks that will accept their deposits.
It is questionable whether this can be resolved through regulation. There are too many ways for regulators to exert subtle indirect pressure on banks. For example, although the Federal Reserve has completely abolished formal reserve requirements, banks now hold much larger reserve balances than they did when minimum reserve levels existed. This is partly due to the policy of paying interest on reserves, but also to the fact that banking regulators are increasingly pressuring banks to hold very large reserve balances.
If we really want to reduce the problem of debanking, deregulation would be far more effective than additional regulation. Legalize drugs. Abolish deposit insurance. Eliminate the rule that cash transactions over $10,000 must be reported to the government. Replace income tax with consumption tax.
Obviously, such dramatic changes are unlikely to occur in the near future. But nothing else could possibly work. If we are not willing to address the root causes of debanking, we need to accept the fact that debanking is here to stay and, in fact, will become a bigger problem over time.
P.S. caitlin long has a great Twitter thread explaining the complexities of the debankment issue.
