Do you believe central bank assurances?

Published by the R Street Institute.

To reassure savers worried about the safety of their deposits, the Reserve Bank of India (India’s central bank) recently announced it “would like to assure the general public that Indian banking is safe and stable and there is no need to panic.”

The problem is that when government officials issue such assurances, do you believe them?

Governments confronted by the risk of a banking crisis have to say the same thing regardless how severe the risk really is. They must say that the system is safe and you should not panic, because they are afraid that, by sharing any doubts, they would themselves set off the panic they fear. Therefore, their statements of assurance have no informational substance.

“When it becomes serious, you have to lie,” Jean-Claude Juncker, then head of the eurozone finance ministers, with admirable candor said of the European financial crisis of the 2000s.

“We have no plans to insert money into either of those two institutions,” Treasury Secretary Henry Paulson said of Fannie Mae and Freddie Mac in the summer of 2008. One month later, he began inserting into both of them what became $187 billion of bailout money.

Governments and banks in stressed situations are up against Walter Bagehot’s insight into the fragility of credit. “Every banker knows that if he has to prove he is worthy of credit,” Bagehot wrote in 1873, “in fact his credit is gone.” I imagine that will always be true.

The term “credit” comes from credo = “I believe.” In a threatened crisis, you suddenly realize that you have not much ground, if any, for believing in a bank’s soundness or believing the government’s assurances that things are fine.