No, Virginia, nothing is really risk free

The financial world confronts us with ineluctable uncertainty and risk. Its future is unknowable, not only for borrowers, lenders, and investors, but also for governments and central banks. No matter how hard anyone might try, risk cannot be made to disappear; it can only be moved around.

People all over the world long for their bank deposits to be risk free. Governments attempt to satisfy this longing by creating deposit insurance and by bailing out depositors and other creditors of failed banks. Of course, as in Cyprus this year, the government itself may be broke. Historically speaking, this is a common occurrence: there have been more than 250 defaults on government debt since 1800, up to the notorious defaults by Argentina in 2002 and Greece in 2012, which gives us a long-term average of about one default on government debt per year.

Governments constantly strive to promote “confidence” in the banking system, whether or not such confidence is warranted. They wish to induce what we might call “deposit illusion” — that the safety of deposits is unrelated to the soundness of the banks’ assets. But the inescapable fact is that deposits fund banking assets, which are inherently very risky, and these assets are subject to periodic losses which are unexpected and of magnitudes previously not even thought possible.

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About the Author

 

Alex J.
Pollock
  • Alex J. Pollock is a resident fellow at the American Enterprise Institute (AEI), where he studies and writes about housing finance; government-sponsored enterprises, including Fannie Mae, Freddie Mac, and the Federal Home Loan Banks; retirement finance; and banking and central banks. He also works on corporate governance and accounting standards issues.


    Pollock has had a 35-year career in banking and was president and CEO of the Federal Home Loan Bank of Chicago for more than 12 years immediately before joining AEI. A prolific writer, he has written numerous articles on financial systems and is the author of the book “Boom and Bust: Financial Cycles and Human Prosperity” (AEI Press, 2011). He has also created a one-page mortgage form to help borrowers understand their mortgage obligations.


    The lead director of CME Group, Pollock is also a director of the Great Lakes Higher Education Corporation and the chairman of the board of the Great Books Foundation. He is a past president of the International Union for Housing Finance.


    He has an M.P.A. in international relations from Princeton University, an M.A. in philosophy from the University of Chicago, and a B.A. from Williams College.


  • Phone: 202.862.7190
    Email: apollock@aei.org
  • Assistant Info

    Name: Emily Rapp
    Phone: (202) 419-5212
    Email: emily.rapp@aei.org

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