I don’t know if I was more surprised by the twitter feed saying, that Ted Cruz “crushed” John Kasich on the “Bank of America question” or by Ted Cruz’s apparent ignorance of the U.S. banking system.
John Kasich, Ohio State buckeye, may not have offered the polished, persuasive, articulate reply of the former Harvard College debating team champ, first term Senator Ted Cruz. But Kasich – two-term governor, nine-term congressman, ex-investment banker, and the guy who last delivered America a balanced budget — had the advantage of actually understanding the mechanics of the U.S. banking system.
Ted Cruz, ideologue, clearly does not.
To recap, Fox’s Neil Cavuto asked Cruz, “If (Bank of America) were on the brink, you would let it fail?” to which Cruz replied “Yes.” Cruz then yammered on about sound money and (ironically, for an ideologue) the “philosopher kings” of the Federal Reserve.
When an incredulous Cavuto asked Cruz again, “Millions of depositors would be on the line with that decision. I want to be clear … you would let (Bank of America) go?” Cruz then backtracked somewhat and said he would not “bail out” a failed mega bank, but would, instead, have the Federal Reserve lend funds as the “lender of last resort” and “at a higher interest rate.”
But let’s unpack the Cruz scenario a little bit:
If Bank of America were in trouble, the Fed could, indeed, lend it money. But then the bank would have additional debt, so that its key ratio of debt-to-equity would scare off its depositors and its other creditors, causing Bank of America, ultimately, to be insolvent and to collapse.
That collapse would likely cause contagion in other banks. Depositors would likely “go to the mattresses”: withdraw their funds and keep them at home for fear their own bank might be at risk. Banks would fall like dominoes.
Kasich, on the other hand, also said he would not “bail-out” the bank. But he also said he would require bank equity capital to be increased, so that, prospectively, bank losses could be absorbed by shareholders. That would ensure that shareholders – not government – police moral hazard to avoid losses. The “people who own the capital (would have to) start pressuring the banks to not take these risky approaches,” Kasich said.
The Ohio governor said he would save depositors – not the shareholders who were bailed-out in 2008. He then said (to the moan of the crowd) “I would … separate those people who can afford it versus those who people who are the hard working folks who put their money in those institutions … when you are faced with banks going under and people who put their life saving in there, you gotta deal with it. You can’t turn a blind eye to it.”
As inarticulate and labored as his words may have been, Kasich was describing exactly how the system actually works now.
The FDIC insures deposits “up to at least $250,000,” so if a bank were to fail and the FDIC were required to step in and reimburse depositors, those depositors who lost up to $250,000 –“the hard working folks who put their money in those institutions” — would be fully insured (assuming Congress made good on the FDIC promise.)
Those who lost over $250,000 — “those people who can afford it” — might get additional deposits they lost.
The owners of the bank’s capital who relied on government as a backstop to their moral hazard, would be wiped out.
Kasich spoke of governing; protecting the interests of the people one has sworn an oath to serve. Cruz spoke of campaigning; appealing to the base – and, in this instance, the catastrophic – ideology of partisans to get their vote.
Style points clearly go to Cruz for debating.
But honor points go to Kasich. He might sound like your CPA, but his knowledge – and his judgement– was spot on.