The Value of Trust
The recent financial crisis is all about trust. Trust in banks, trust in business, trust in government and trust in each other.
Its obvious that abuse of trust led to many of these problems. If, for example, morgage brokers hadn’t created so called “stated income loans” many fewer mortgages would be in default. Borrowers on the other hand should have heard alarm bells going off when participating in this scam, but I guess people are just dumb.
Now the fallout from this is that many loans made throughout the financial system are turning bad and the money markets are frozen because banks dont even trust each other. In times like this, people buy “safe” government bonds in the belief that the government can always print more money if it needs to.
Which really isnt as bad as it sounds. If the government is willing to act as a lender of last resort, it is also capable of being the bank of last resort for depositors. Since rates on short term govt bonds are close to zero this kind of makes sense.
Another problem is that if the government really becomes a player in the banking business, what is to prevent it from stomping out private banks? After all private banks have to follow government regulations, but who regulates the treasury?
What happens, for example if the Treasury takes its deposits and makes bad loans? This is basically the way Fannie Mae and Freddie Mac operated and wound up with negative balance sheets. What happens if the loans to the Treasury are not repaid?