Home Judge’s Opinions What Happens When the Firemen Are the Arsonists?

What Happens When the Firemen Are the Arsonists?

by Andrew P. Napolitano
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In the past week, two top-20 American banks failed. A bank failure occurs when government regulators determine that the current and likely demand for a return of deposits cannot be met. When this determination is made, the feds enter the picture and declare the bank insolvent, order it to close, and go running to the Treasury Department and the Federal Reserve or both looking for cash to bail out uninsured depositors.

Depositors are insured by an agency of the feds, up to $250,000 per bank account. If the depositors’ losses are greater than that amount, the feds can leave them on their own or take taxpayer dollars or fiat (Latin for “let it be done”) money and compensate them.

How do the feds decide whom to bail out and whom to leave alone? That is one of the moral problems with government regulation. The government is not beneficent. It does with tax dollars or fiat money whatever it thinks will keep it in power.

In the cases last week, the feds bailed out depositors, not investors. So we have a system regulated by the feds, insured by the feds and partially bailed out by the feds. Sounds fool-proof, doesn’t it? The Fed can just add zeroes to a bank’s deposits (fiat money) to make funds available to depositors and at the same time attack the bankers whose investments turned sour when liquidity was badly needed.

The bankers who ran the two now-insolvent banks invested depositors’ funds in bonds. The bonds had artificially low interest rates due to the control of interest rates by the Federal Reserve. As the Fed began to raise interest rates, supposedly to fight inflation by making it more expensive to borrow money, institutional borrowers drew down deposits to pay for business expenses, and the two banks sold their bonds so as to have the funds to meet their depositors’ demands, but at a loss.

Interest is the rent one pays for the use of someone else’s money. Interest rates should be negotiable like other rent, and the negotiations should be a function of supply and demand, just like nearly all rent is; except apartments in New York City, where rent controls have produced long-term shortages.

So, when the Fed kept interest rates low, bankers bought cheap bonds. Yet, when they needed cash and offered their low-interest bearing bonds for sale, the value of those bonds had shrunk because of the presence of new bonds on the market paying three times the interest as the old bonds, thanks to the Fed.

The Fed raised interest rates to cool the inflation it caused by putting fiat money into the money supply, thereby having more money chasing the same goods and services, thus causing inflation.

Under what constitutional clause can the Congress permit fiat money and the Fed control of interest rates? The short answer is: None. The longer answer addresses history and due process.

The Legal Tender Act of 1862 permitted Congress to issue paper money, not backed by precious metals. This led to cash created out of thin air. President Abraham Lincoln not only waged war on civilians and the states; he waged war on the value of money. When the war was over, the Supreme Court declared the act unconstitutional.

Unable to print fiat money required more fiscal discipline than the Radical Republicans running the federal government in the post-Civil War years could muster. So, after reducing the number of justices on the Supreme Court from 9 to 7 and then to 6 — so as to deny the impeached but acquitted President Andrew Johnson the ability to fill vacancies — Congress raised the number back up to 9 after Ulysses S. Grant was elected; whereupon he appointed three big-government types to the Supreme Court which re-heard the Legal Tender Cases and ruled that fiat money was constitutional after all.

Morally, the means of exchange can be whatever the buyer and seller, or whatever the lender and the renter, agree upon, except in totalitarian countries where the central bank has the authority to compel all to use its banknotes — even when that central bank can print all the banknotes it wants, even when the act of printing the banknotes devalues all other assets by adding cash to the money supply, even when the banknotes have no inherent value.

Canny borrowers and lenders responded by executing contracts that required payment in gold or silver. These so-called gold clauses were eventually invalidated by the courts as violative of the scheme for the federal control of banks.

The Federal Reserve was enacted by progressives who wanted federal control of all banks and conservatives who wanted federal bailouts. Its stated purpose was to reduce inflation, approach full employment and assure banking stability. How well has that worked?

There is simply no authority in the Constitution for this. The court last looked at this in 1819 and ruled that the feds could own a bank, but there is nothing in that ruling about the bank regulating the value of currency by printing it and setting mandatory rates for renting it.

Where does all this leave us? We have a banking system that encourages banks to lend money that they don’t have by borrowing fiat money from the Fed and keeping minimal reserves. The system permits bureaucrats to set interest rates depending on political needs; it effectively prohibits supply and demand from determining rates; and it can print all the cash it wants, irrespective of the natural economic

All this results in a government theft of wealth without due process.

President Joe Biden wants to punish the bankers who caused this. He will find them all at the Federal Reserve. Does anyone care about the government trashing the Constitution and prohibiting free choices? We should; they are the causes of our misery today. They are the instruments of arsonists trying to extinguish the fires they started.


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