Secondly, a deposit-taking institution is leveraged, even if it does not fund itself in wholesale markets: retail deposits are debt. So banks’ capital adequacy can quickly be imperilled by a fall in asset prices. In that sense, the “liquidity” and “solvency” explanations of the current crisis are inseparable. Especially in a world in which banks’ trading portfolios are marked to market, a drying up of liquidity in markets brings about a fall in asset prices, and so a depletion of banks’ net worth. All that underlines just why our predecessors placed such great weight on official interventions to maintain the safety and soundness of banks. 7 If anyone doubted it, this crisis underlines how problems of funding liquidity, asset-market liquidity and solvency are intertwined. And those dimensions of a systemic crisis map into the authorities’ capability, in principle, to be a Lender of Last Resort; a Market Maker of Last Resort; and a provider of Capital of Last Resort. Central bank provision of liquidity insurance, and LOLR Bagehot’s famous dictum, in Lombard Street, was that, to avert panic, central banks should lend early and freely (ie without limit), to solvent firms, against good collateral, and at “high rates”.
What a relief, one might think, that we consumers don't have to pay for all this. But who is it that has to pay? Because someone ultimately has to bear the costs. It is easy to initially assume that it is the retail trade and the banks that benevolently pay for payments. But it is not that simple. The merchants need to have their costs covered; otherwise they will not be able to run their businesses. And the same applies to the banks. The costs of all payments therefore gradually arise as the markups on the prices of the goods and services we buy. Milk and vegetables may become a little more expensive in the shop and the interest on our deposits at the bank may be a little lower than would otherwise have been the case. It is thus we consumers and bank customers who ultimately pay the costs of all payments. But we do not see them. We are therefore led to believe that they do not exist – or that someone is paying them. Shouldn’t the actual costs be visible? Is this a good system? Normally, we want to be able to see what various goods and services cost. The price helps us decide how much we will buy. We do not have any such price signals regarding the different methods of payment. The real prices are hidden. And this raises the question: If we knew what it actually costs, would we change our method of payment?