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3 Ways the U.S. Banking System Can Collapse

The banking system of the United States is one of largest and most active in the world, and it is often (arguably) described by Treasury and Federal Reserve Bank officials as one of the most financially solid. This does not mean, however, that it is impervious to collapse. The magnitude of the U.S. banking system can only guarantee that a potential collapse would be more spectacular and damaging than in other nations, and history has already proven this fact multiple times. Recent examples of such collapse include the Great Depression of the 1930s and later during the Great Recession and Global Financial Crisis of 2008.

Most people remember the major bank failures of 2008: Citi, Wachovia, and Washington Mutual. Those were just the largest retail banks; it is important to remember failed investment banks such as Lehman Brothers, Bear Stearns and Merrill Lynch as well as specialty banking institutions such as Countrywide and the government-sponsored entities Fannie Mae and Freddie Mac. From 2008 to late 2012, more than 460 banks in the U.S. failed; this required government takeover of financial institutions, and this situation was exacerbated by the massive bailout provided by the U.S. Treasury to banks such as JPMorgan Chase ($256 billion), Wells Fargo ($25 billion), Bank of America ($15 billion), and many others.

Many banking analysts are concerned that the U.S. system could once again collapse. The lessons learned from the bursting of the housing bubble mostly apply to home lending standards and securitization of mortgage debt; it is unlikely that the next collapse will happen due to that same reason. Nonetheless, there are three current situations that could bring about the next downfall of the American banking system:

Major Banks Losing Clients’ Trust

Banks are not very popular right now for more than one reason. Less than 10 years after being bailed out by the U.S. Treasury, JPMorgan Chase and Citi plead guilty to criminal charges of participating in a global conspiracy to manipulate foreign currency exchange prices along with Barclays and the Royal Bank of Scotland. The collective penalties assessed by the U.S. Department of Justice were set at more than $5 billion; despite the criminal charges, no prison sentences were imposed.

The “too big to jail” preferential treatment given to bankers is only helping to undermine the trust that the American public is losing in the banking system. Although these scandals have not resulted in immediate bank runs, they have planted a seed of mistrust that could lead customers to consider alternative options such as bitcoin, gold, and peer-to-peer (p2p) lending.
Risky Profit-Seeking Methods

There is no question that banks have gotten way too large over the last few years. Stanford economics Professor Anat Admati recently pointed out that the average size of banks has risen to $1.36 trillion. Normally, this should not be a concern; however, the amount of money that banks invest in risky financial products such as derivatives is definitely a reason to worry.

Derivatives are financial instruments that can be very lucrative; nonetheless, they are so risky that even some day traders choose to avoid them. There is little transparency in the derivatives market, and the instruments that banks trade in this market are essentially bets on whether certain investments will fail. In essence, derivatives are complex casino plays that are not in character with the nature and purpose of banks to safeguard the deposits of their account holders.

The Potential Weakening of the U.S. Dollar

The sheer strength of the U.S. dollar in the global currency exchange is a major reason the American banking system is so massive and well capitalized. That strength owes more to the political power of the U.S. in the global stage than to the health of its economy. Now that the American economic empire has been tested, geopolitical analysts believe that rival powers such as Russia and China could curtail their respective Central Bank holdings in dollars just to make a political point. This situation could really test the strength of the U.S. banking system, and many analysts believe that it may not be able to withstand such a drastic geopolitical change.

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