Lyn Alden on bank safety

In a recent Reason magazine interview, Lyn Alden makes a very good point:

And Lyn Alden, founder of Lyn Alden Investment Strategies, says “banks are basically highly-leveraged bond funds with payment services attached, and we treat it as normal to keep our savings in them.” She argues that the Federal Reserve makes it nearly impossible for banks to hold the bulk of their customers’ deposits in cash because “regulators want banks to be reasonably safe, but not ‘too safe.’ They want all banks to be leveraged bond funds to a certain degree, and won’t allow safer ones to exist.”

Is this really true?  Do regulators refuse to allow ultra-safe banks?  John Cochrane makes the same claim (from a 4-year old blog post):

Suppose an entrepreneur came up with a plan for a financial institution that is completely safe — it can never fail, it can never suffer a run, it offers depositors perfect safety with no need for deposit insurance, asset risk regulation, capital requirements, or the rest, and it pays depositors more interest than they can get elsewhere.

Narrow banks are such institutions.  They take deposits and invest the proceeds in interest-bearing reserves at the Fed. They pay depositors that interest, less a small profit margin. Pure and simple. Economists have been calling for narrow banks since at least the 1930s.

You would think that the Fed would welcome narrow banks with open arms.

You would be wrong.

Both are referring to the fact that the Fed refuses to approve “narrow banks”, which invest their funds in the safest way possible—accounts at the Federal Reserve.

The media focuses on mistakes made by bankers and/or regulators, but the banking system is set up to be unstable.  Our political leaders want banks to take risks.  And when the inevitable happens, there’s a great deal of moral grandstanding.