The $30 billion dollar rescue of First Republic bank by a collective of Tier-1 financial institutions is strangely reminiscent of a practice used to prevent bank failures as far back as the early 20th century, according to a professor of finance at Cornell University.
Back then, bank runs occurred frequently, culminating in the panic of 1907. In response, the US established the Postal Savings system in 1911 to allow consumers to deposit money at Post Offices in addition to banks.
But there was a bit of misdirection involved, which Maureen O’Hara called “gerbil banking” in a piece for Forbes on Thursday,
“When individuals became concerned about bank solvency and withdrew their funds, they could put the money in Postal Savings instead of under their mattresses,” O’Hara said.“And what would the Postal Savings system do with the funds? Put the money back into the banks!”
That wheel of money helped keep the banking system afloat while also giving Postal Savings system interest on its bank deposits. And it actually worked pretty well, until the Great Depression, O’Hara said.
Flash forward, and consumers are taking their money out of regional banks and putting it in large institutions they consider to be “too big to fail.” Then, playing a similar role as the Postal Savings system a century ago, a group of big banks deposited $30 billion in First Republic to keep it afloat.
However, there is a key difference between then and now: FDIC insurance. Deposit insurance has largely protected retail depositors, who, if they deposit more than $250,000 limit, can open accounts at other banks.
That means there isn’t likely to be a 21st-century revival of the Postal Savings system, O’Hara argued.
But, for now, there’s a new gerbil on the wheel.
Contact Andrew Kessel at andrew.kessel@proactiveinvestors.com
Follow him on Twitter @andrew_kessel