Disclaimer: The analysis offered herein does not
reflect personal views or wishes of the author.
By Daniel Fisher
"This is not a prediction, it is a certainty -- there will be serious disruption in the world's financial services industry... It's going to be ugly." The Sunday Times, London
``98 percent correct is not going to cut it.'' Fixes must be 100 percent successful. Cheryl Kane , Bank of America Group Executive Vice President
"So intertwined are the various financial institutions that if one fails, the entire system may be put at risk. "The financial industry is like a house of cards," shuddered one insider yesterday. "If one business founders, the others feel it." The Sunday Times , London
"In the banking system, 99% compliant is not good enough-it must be 100% " Federal Reserve Chairman Alan Greenspan.
The Fractional Reserve banking system, which lends out more than 95% of its stated deposits and requires public confidence to survive, is seriously threatened with collapse by y2k from several simultaneous causes. It also threatens the accounts of millions worldwide with being miss-transfered, mis-calculated, frozen or even lost forever after Jan 1,2000.
There are approximately 100,000 banks world-wide. Monetary transactions have become completely computerized over the past few decades with 90% of all bank assets electronically stored. Reliable, high accuracy mathematical date calculations are imperative in banking for everyday routine interest, payments and account transactions. The global wire system transfers several trillion dollars on a daily basis with the U.S. FEDwire alone handling $1 trillion daily.
This wire system requires the telecommunication system to be functional, which will also be suffering from its own y2k problems and systems failures in 2000. Without this ability to exchange information/data between financial institutions our present banking system could not exist. The velocity of money, the rate at which transactions take place across borders through electronic means, would be slowed or halted if the phone lines are dead, or electronic payment systems become jammed with digital chaos.
While banks routinely make mistakes, the year 2000 poses the risk of cumulative errors. This means that at some point the error rate becomes so excessive it overwhelms the system, making it impossible correct in a timely manner, rendering the system unusable.
The modern division of labor and means of trade and exchange rests on this means of payment, which includes ATM's, checks, credit and cash cards. Exchange of data must be congruent, compliant between every participating computerized entity, and any non-compliant bank must be cut off from the system to avoid spreading the y2k virus. Therefore any bank deemed non-compliant--and cut off-- will lose will shortly lose liquidity and fail.
Given the reported PR optimism and claims that financial institutions are ahead of the curve in y2k remediation efforts, a significant number banks probably will make the Dec. 31,1999 deadline. However, a very large fraction won't (completely) make it in time. Since large numbers of banks started in 1995, we should think that at least one would have crossed the finish line by late 1998 when they all said they were supposed to [Supposedly there have now been a handful--but that's it, a handful. A survey by Weiss found that 30% of banks and S&L's missed the deadline. The most recent legally binding disclosures to the SEC found that banks have only spent on average 52% of their allocated y2k budgets. In fact, according to the bell curve theory we should have hundreds of reports of banks meeting full compliance, and hundreds more every month. Yet at present, there are zero compliant money-center banks world-wide, and only a few publicly announced financial institutions that have made it....Citibank (now Citigroup, and spending nearly a billion dollars on its y2k repairs) said last year that it hoped to be the first. Contrast that sum, spent by only one bank, and the $1.3 billion that the 19 largest Japanese Banks are spending combined! (can you say Kamikaze?) Most give (blind, lawyer-approved) assurances that they'll get it done by mid-late 1999 with special attention to anti-bank run campaigns. A survey done one year ago by the Gartner Group of Stamford, Conn., found that at only 50 percent of large U.S. banks were halfway through the computer reprogramming phase. By contrast, only about 5 percent of large foreign banks were at the same stage.
It doesn't really matter if several large banks make it, is the huge fraction of small and medium and foreign banks that will not get compliant that is troubling. Remember that this is an international banking system with networked computerized data exchanges. Even if the U.S. were to get all its computers repaired, the non- compliance of foreign banks would mess up the system.
If we are optimistic for a moment and assume that 60% (about 7200) of U.S banks get (fully) compliant by Dec. 31, 1999. The failure of one third of banks to conduct business means banking--as a system--no longer becomes a system, it collapses. The rest of the world's banks are even farther behind the U.S., and some countries are doing almost nothing to repair their systems for y2k.
Ed Yardeni estimates 5-20% (that's more than 2000) of the 11,000 U.S. banks will instantly fail directly from y2k. But how can the rest of them survive if their loan customers are going bankrupt and defaulting on debt? In a severe economic contraction that y2k will surely bring, the potential for massive default at all corporate and private levels is staggering. Particularly in our debt overloaded society where even in a boom period there are record bankruptcies! We will almost certainly be in a global financial crisis when the U.S. joins the rest of the world in its recession/depression in the last quarter of 1999 and into 2000. We are on the verge of another 1930's style deflationary crisis which will severley affect solvency and liquidity as it is without y2k. In other words, imagine y2k hitting in the middle of 1929 or 1930!
There's one major difference between the 1930's and 1990's though : reserve requirements for banks in the mid-1930's ranged from 16-25%. Over several decades of systematic reductions, it is now around 6%. But this is also misleading; in reality cash reserves are only about 1.25% of deposits, with another 1.5% in other derivatives for a grand total of about 2.75% This works fine under routine circumstances when the economy perpetually booms and the public maintains faith in the banking system through comforting assurances that the FDIC will insure their deposit. The FDIC will not be able to cover the sheer magnitude of such failures...it holds only $1.25 in reserve for every $100 in deposit to cover failing banks. Besides, it too is not compliant. It will not withstand the y2k hurricane.
The public's concern for their savings will trigger an international bank run around late 1999. The banking industry is terrified of the year 2000. In fact, the Federal Reserve has admitted to printing more currency in anticipation of withdraws this year (a public relations ploy). So has Canada and many others. It will not be enough, however. The amount of cash in the system does not really matter; it is the instability of the fractional reserve banking system itself.
Asia's banks are already in danger with solvency problems and are doing little to repair their systems for y2k. Japan is doing virtually nothing to solve y2k. If they go down, we go down. Peter DeJager: " Japan will melt ". When the bank runs begin, they may be precipitated by Japan's weak financial health.
There are many reasons people will withdraw their cash this year;
* To have a month or two cash on hand for early 2000 "just in case" the banks, ATM's and retailers have trouble processing electronic payments. A rather innocent and legitimate move, but if every household tried to do this logistically impossible feat, there would be utter financial chaos.
* Flight to safety...This is the rational fear that their (bank or the system) may fail to solve y2k and will motivate some to close their accounts or move it to a safer location.
*Small businesses having extra cash on hand to meet payroll and other expenses.
* Fear of a predicted general bank run that will cause some to "get out early" while the going is good... *A negligible minority*.
* General solvency/deflationary banking problems occurring when the world's economy goes into serious recession/depression late this year and beyond (independent of y2k) which makes it profitable to 'stash cash in the mattress'. Probably will not begin in the U.S. but Japan or Europe.
*To spend it and stockpile up on usable survival goods and other consumer durables in anticipation of expected y2k breakdowns.
When the lines get longer and longer, people will start to say, "well, maybe I should take out a bit more than I planned". Then eventually... "All of it!". How many depositors does it take to completely shut down the entire financial system? About 5 %.
While 8 out of 10 still think y2k will be repaired on time ( it won't ), a whopping 25% of those surveyed expect to try to withdraw MOST OR ALL of their cash sometime this year if they believe it won't be solved, and 52% expect to "move their money around". In another study, 7 out of 10 of those informed about y2k expect to take their cash out before 2000. In a December 1998 USA Today poll, 16% said they will take out all their money, and 32% said "most" of it. In a recent CNN poll , half expect to take extra cash out before 2000.
This will not be possible, of course.
When this bank run begins, it will spread like wildfire until virtually all world banks are shut down by insolvency or government imposed emergency banking orders, putting the 1930's bank runs to shame. It is at this point that no one will deposit anymore money back into their accounts, and will mark the end the financial banking system as we currently know it through a complete financial collapse.
What occurs after this is unclear. The government could initiate techno-fascism by nationalizing the system under a series of executive orders/ martial law or attempt to implement a national ID/cash card thereby replacing cash altogether (assuming the telecommunication system stays up, and there are functional computers). Cash will, in all probability, remain king though. This would mean a deflation rate of more than 80% as the division of labor collapses though. But if we see a situation like the collapse of the Soviet Union where government issued fiat money becomes worthless through hyper -inflation or currency/monetary collapse, all bets are off. It is very probable (inevitable?) that the entire financial "system" will be replaced in the coming years.
since July 4,1998
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