Friday, August 15, 2008

Ferris Bueller and Banking Bailouts

Money and banking are boring.

They are the most incomprehensible parts of any macroeconomics textbook. I beleive the banking system can be made more fun using an example from the brilliant film Ferris Bueller's Day Off.

In the movie, Ferris "borrows" a Ferrari from his best friend's father. He takes it for a drive and then parks it at a garage. The valet is a wily one, and he decides to take the car out for a spin. We see the valet tearing through the city streets as if he hasn't got a care in the world. Luckily he decides not to steal the Ferrari and he returns it Bueller at the garage.

Put simply, the garage is the bank. The valet is the banker.
Ferris Bueller is a depositor at the bank.
The valet happens to be a borrower at the bank as well.
The Ferrari is money.


The garage is only required to store a fraction of the cars it takes care of. This is called "fractional reserve banking". It lends the rest to people who want to drive them in the meantime.

If the car is returned by the end of the day then all is well. Ferris can go home. If however the Ferrari is not returned, Ferris is royally screwed.

This is why it is not a good idea to lend cars to bad drivers.

Now let's say that the government is going to provide as many cars as the garage may need, that is, it is willing to bail out a failing garage. This incentivises lending cars to poor drivers. It doesn't matter if cars crash all over the place, there is always a steady flow of new Ferraris from the government.

That is the problem with government bailouts of Northern Rock (UK) and Fannie/Freddie (USA). Government bailouts allow banks to stay in business whether they act responsibly or not.



1 comment:

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