There's a small, grassroots effort underway attempting to urge Americans with bank accounts at the "too big to fail" banks to move their accounts to smaller, community-based banks. The idea is that these banks behaved more responsibly during the mortgage boom, so therefore it's safer to put your money there.

From moveyourmoney.info:

People all over the country are choosing to move their money out of “too big to fail” banks and into smaller, community-oriented financial institutions that generally avoided the reckless investments and schemes that helped cause the financial crisis.

It’s a grassroots effort that has the potential to shift power in the financial system away from Wall Street and back to Main Street.

The campaign was supposedly started by Arianna Huffington of Huffington Post. In an article on that website, Bill Maher of Comedy Central fame writes about the Huffington idea, urging people to follow the lead. His reasons include:

1. The local bank will see you as a person, not as an account number.
2. Local banks tend to reinvest in your local community.
3. Moving money to a local bank serves as "a big step toward fixing our broken financial system".
4. "It's easy, and painless, and will send a powerful message to Wall Street and to our leaders in Washington."
5. The big banks "took our money... but cut back on lending."
6. The big banks "took our money... and made record profits -- and paid themselves record bonuses."
7. The big banks "took our money... then returned to the risky behavior that led to the worst financial crisis since the Great Depression, with record unemployment, bankruptcies, and foreclosures."

The problem with all this is that while some of it is true, the most important parts are completely, 100% false. Let's look at each claim more closely.

The local bank will see you as a person, not as an account number.

This is true. I have my accounts in a local bank, and I enjoy the fact that the people who work there know me by name when I walk in the door.

Local banks tend to reinvest in your local community.

This is also true. Regional and community banks overwhelmingly invest within their region or local areas.

Moving money to a local bank serves as "a big step toward fixing our broken financial system".

This is where the Huffington/Maher argument starts to fall apart, because moving your money to a local bank actually does nothing at all to fix a broken system. To see why, let's look at the rest of the arguments Huffington and Maher make.

"It's easy, and painless, and will send a powerful message to Wall Street and to our leaders in Washington."

This is fantasyland. If you think that the average American with their average-size accounts (compared to the large corporate accounts) mean so much to the big banks as Huffington/Maher would have you believe, you obviously don't understand where the big banks get the overwhelming majority of their depositors. Those depositors are the major corporations, and they've got tons more money on deposit than all the rest of America combined. Even the local banks understand this. When a local bank manager goes out to his/her community to drum up more business, s/he doesn't go door-to-door in the residential areas. Instead, s/he goes to the largest local businesses and try to win them over. That's where the most money can be found.

The big banks "took our money... but cut back on lending."

This is true, but misleading. It suggests that the banks should have been lending out the money all along. This is exactly what they were doing! It's what led to the crisis in the first place! Do Huffington, Maher, and their followers not understand that the risky lending that took place did so because the banks of all sizes had run out of safer investments and that they were mislead by the investment ratings companies? Pulling back on lending is the right thing to do for a bank that's in trouble. They need the time to recoup losses via existing loans before they get involved in more lending again. Huffington and Maher also demonstrate complete ignorance regarding why the bailout money was supplied to the banks in the first place. It wasn't for the purpose of getting banks back into lending mode. It was given to them because there was insufficient government insurance of deposits to cover the anticipated losses.

Most of bad mortgages held by banks that were "too big to fail" were not issued by those banks! The mortgages were actually issued by investment banks, a huge insurance company, and a series of mortgage-selling companies that were not commercial banks. Merrill Lynch and Lehman Brothers were investment banks that ultimately got merged into the commercial banks that were "too big to fail". AIG is an insurance company that insured too much of the bad real estate investments. Countrywide was actually a mortgage lending company, not a bank. Fannie Mae and Freddie Mac, who got the whole failure thing rolling, were government created investment funds that bought mortgages created by mortgage companies. Fannie and Freddie are also not banks.

In other words, the banks that were "too big to fail" did not, for the most part, make the bad loans themselves. Instead, they invested in mortgages that were created by other companies, mostly mortgage companies. These investments were (and are) known as derivatives, and they were well-rated investments by the government mandated and supported ratings companies and systems (Moodys and S&P are the too biggest investment ratings giants, by far, and they had the government's stamp of approval every step of the way!).

The big banks "took our money... and made record profits -- and paid themselves record bonuses."

Well, yes and no. Yes, they took the money. Yes, they paid bonuses to those of their employees who helped bring in good investments and made good loans. But because they were being paid their justly earned compensation (yes, those bonuses were earned!) right after the bailout, these employees unjustly became the focus of the crisis, as if the crisis was all their fault. It wasn't! This is like blaming a company's salesman for the fact that the company's bookkeeper stole the money from the company's bank account and took off for Bermuda!

Does all this mean that I don't hold the "too big to fail" banks responsible for their foolish investment practices? Certainly not, but I also think we should be honest about the full nature of the crisis. This crisis did not occur solely because of big banks. The entire banking system contributed to it, as did the Wall Street investment machine. Yet, even this doesn't explain the full nature of the crisis. At the root of it all is the monetary system itself.

The big banks "took our money... then returned to the risky behavior that led to the worst financial crisis since the Great Depression, with record unemployment, bankruptcies, and foreclosures."

This is just plain double-talk. How can Huffington and Maher claim in one breath that the banks refuse to make loans, and then in the next breath claim that they're continuing to make risky loans? Isn't the direct contradiction in their claims obvious, even to them?

Reality

Let's look at the real world, and not the fantasy world of Huffington and Maher. What really drove the crisis was not risky lending practices. What drove the crisis was the fact that (1) banks have long been permitted to lend money that doesn't belong to them without the express permission or consent of the money's owners on a loan-by-loan basis; (2) banks lend money long-term (30 years on a mortgage loan) using money they've promised to return to the money's owners in the short-term (checking, savings, CD, and money market accounts); and (3) banks and government issue our money supply backed by nothing at all except the mirage of the "full faith and credit of the United States". In fact, the only things that back our dollars are debts (including mortgage loans of all kinds, not just subprime mortgages). That's right, every dollar in existence today was issued by a bank (either the Federal Reserve or one of its member banks) issuing a loan based on money that did not previously exist!

I call these three root causes the three forms of "legalized fraud" that lie at the root of every financial crisis the modern world has ever seen, including both the current crisis and the Great Depression. Notice that the average person is not permitted to engage in such behaviors. Even mortgage companies are not permitted to engage in them. Even Wall Street investors are not permitted to engage in them (although they certainly profit from them!) The only entities who are permitted by law to engage in them are the banks and the government itself. That's crazy! If "legalized fraud" had been illegal, the financial crisis could not have happened! Why? Because without the banks buying up the derivative investments using money that did not belong to them, there could not have been any question of any bank being "too big to fail"!

The only reason there was a fear of an economic collapse was that the big banks could not cover the demands of their depositors because they had foolishly bought Grade A investment known as "derivatives". They bought those investments using depositors' money. If the banks had used their own money instead of depositors' money, and if they had failed, no one (other than the bank's investors) would have cared. There would have been no financial crisis. And here's the part that neither the government nor Wall Street nor the mortgage companies nor the Fed nor the Treasury Secretary nor the talking heads on television were willing to tell you. The reason they were all afraid is that the FDIC did not have anywhere near enough money to cover the failures of those banks. In other words, if the banks had failed, millions of depositors of all sizes would have been left holding the bag, and that certainly would have led to a major depression.

Most people haven't been paying attention to the FDIC, what with Haiti and Health Care Reform and Yemenese underwear bombers, but the FDIC is probably the most important issue facing us these days. Banks large and small are all still in dreadful shape (including the community banks), because the next round of mortgage resets is scheduled to take place this year and next, peaking in 2011 like they did in 2008. This time, the mortgages will be Alt-A and Option ARM mortgages rather than subprime mortgages, but the result will be the same. Banks of all sizes will be ready to topple over, and the FDIC won't have enough money on hand to cover all the losses. Notice how the FDIC collected the next three years worth of premiums from their banks in advance? Notice how President Obama called for taxing the big banks on the bailout money they received? The popular reason given is that this is designed to stop the bonuses and get the money moving again, but the real, hidden reason is that the powers-that-be are terrified because the FDIC, even with all this extra help, still won't have enough funds on hand to cover the coming bank losses.

The true history of small banks.

The Huffington/Maher proposal distracts from the real problem and leads people to falsely believe that moving their money to smaller banks is safer than keeping it with the big banks. They argue that the small banks behaved more responsibly in the current crisis than the larger banks, but longer term history does not support their view. For generations, the smaller banks have always been the riskier banks. During the 1920s and during the Great Depression, tens of thousands of banks failed. All of them were local, community-based banks. Further, banks with less than $100 million in assets are not required to maintain any reserves. At least the big banks have to keep 10% of their depositors' money on reserve (apart from the first $100 million). The small, community banks don't have to keep any money on reserve at all. Guess which is riskier?

If Huffington and Maher really want to help solve the crisis, they should promote the ending of legalized fraud. Appealing instead to a false illusion of safety in smaller, community banks is completely irresponsible.