In 2013, there were bank bail-ins in Cyprus.  This means that some depositors essentially had their money seized from them.  Ever since that time, there has been some speculation, at least on the web, that the same thing could happen in the United States.

This could easily happen in Greece any day now.  If I lived in Greece, I would not have my money in the banking system there if I could help it.  But Greeks use the euro, which is controlled by the European Central Bank.  They can’t create money out of thin air to bail out the banks there.  Only the ECB could do that.

In the U.S., I believe the chances of any kind of bank bail-in are extremely low.  You have your money indirectly confiscated on an almost continual basis because it loses its purchasing power because of the Fed’s monetary inflation.  But in terms of the nominal value of your deposits, the chance of a direct confiscation is almost nothing.

After the great fall of 2008, the Fed bailed out the banks, along with some other financial institutions.  The American people hated this, but it still happened anyway.  The American people would have hated it worse if there had been bank failures and the FDIC (backed by the Fed) refused to make depositors whole.

Then the Fed began buying mortgage-backed securities (MBS) as part of its quantitative easing programs.  It would create money out of thin air by buying U.S. government debt, along with the MBS.  But you can easily bet that the Fed was not paying the going market rate for the MBS.  It was paying the original value on them.

Let’s say a bank owns a whole bunch of mortgages that are originally worth $1 billion.  Then half of the mortgages go bad because people stop paying on them.  They essentially walk away from their upside down house.  Now that same group of mortgages is paying out half of what it was before.  Let’s say they are now worth $500 million.  Well, the Fed comes in and buys them for the original value of $1 billion, thus saving the bank.  It is essentially a bank bailout for $500 million in this example.

Of course, the Fed and the media described this process as an attempt to help keep mortgage rates down.  Perhaps it had that effect, but it was a bank bailout nonetheless.  But since most people don’t dive that deeply into the topic, or they simply don’t understand it, the Fed got away with a hidden bank bailout.

Now the subject of the day is the Fed possibly raising interest rates.  When you hear this, it is in reference to the federal funds rate, which is the overnight lending rate for banks.  For the last 6 and a half years, much of the new money created by the Fed has gone into excess reserves at the banks.  This has kept the federal funds rate near zero.  Since banks easily meet their reserve requirements, they typically have little need for overnight borrowing.

As economist Robert Murphy recently pointed out, the only way the Federal Reserve is going to raise the federal funds rate is by increasing the interest paid to banks for their reserves.  The Fed would have to sell too much in the way of assets in order to raise the federal funds rate.

Murphy gives an example of what will happen if the target rate goes to 3 percent.  Using the approximate current reserves of $2.4 trillion, the Fed would be paying out $72 billion per year to the banks.  This is money that would have been remitted back to the Treasury if not paid to the banks.

In other words, if the Fed does raise the federal funds rate as expected, it will just be a further bailout of the banks.

The first time the Fed bailed out the banks in 2008, it received a lot of criticism from the American people.  Since that time, it has used two other methods to bail out the banks – buying mortgage-backed securities through quantitative easing and paying interest on bank reserves.  These two other methods have yielded little criticism from the American public.

If the Fed can bail out the banks quietly with little criticism, why would we see a bank bail-in that could start something of a revolution?  The answer is, we won’t.  The Fed will keep quietly bailing out the banks and the American people will unknowingly accept it.