Can financial crisis be avoided?

“Fortunately we are now several years past the virtual collapse of our financial system in 2008,” says host Mary Walden. “Lending has gradually been increasing, and legislation has been enacted to try to prevent future downturns.” She asks husband N.C. State University economist Mike Walden why some analysts say this won’t prevent a repeat sometime in the future.

Mike Walden: “Mary, if you look over our history, our economic history — and in fact the history of any modern economy — periodically, the financial system does get into trouble.  So you can’t say that it was just because of the housing boom and complicated mortgages that led into the latest financial crisis because we didn’t have those in earlier crises, and we still had problems. And one report that just came out, I think, really hits the nail on the head here in my opinion, and it says that really the periodic financial crises that we have are due to one simple fact: that we have what’s called a ‘fractional banking system.’

“This simply means that when you take money to a bank or any other financial institution — I’ll just use a bank as an example — and put that money in the vault, the bank doesn’t keep all that money in the vault. What the bank is going to do is maybe keep 10 percent, 10 cents on the dollar in the vault, and it’s going to loan out the rest. That’s how that system has worked forever, and of course, the big benefit of that is that more loans are made — that generates more economic development, more spending, and allows people to borrow money to buy homes and cars etc.

“But when you have something in the economy that occurs that causes people to worry, ‘hey I need to get my money out of the bank,’ then they rush to the bank, the bank doesn’t have all of the money and we get a financial crisis.  And we actually had a form of this in 2008. So, what this analysis suggests is that as long as we have a fractional banking system, and again there are big benefits to that, we’re going to periodically have these problems in the financial system. And perhaps the better approach is to plan for them, recognize they’re going to come, and try to make those crises as mild as possible.