by John Lindsay

Created on: March 11, 2009   Last Updated: March 17, 2009

A comment by Fed Chief Ben Bernanke that "major financial institutions will not be allowed to fail" by implication means protection for large banks.

That is not what some government leaders are saying. Senator John McCain wants government to allow the banks to fail. In more normal times than we are in today, Senator McCain's concerns would be actionable and conscionable; a bank would be allowed to fail.

But we are not in normal times. Unfortunately for those of us who want some payback for the reckless actions of the banks, this will have to wait. Mr. Bernanke is not concerned about one bank but rather the whole financial system.

He is on the right track. Here's why: Banks have two attributes that cement them to our everyday lives. To operate, they in essence get a charter to operate' from government provided they have enough capital and follow the rules provided by government.

If government rules are not adequate to the task they require change and update. Mr. Bernanke's comments may seem like a "put" or protection for the banking sector. Puts allow you to sell a stock at a given price which is valuable if the price of the stock is about to fall.

We may feel like the banks don't deserve protection because we are angry and annoyed with the chaos that has resulted from their risky lending operations. But the comment belies the vital importance banks have for us as individual mortgage holders, investors and taxpayers.

Banks act like huge electronic switch boxes. Each bank is a nexus of many lines of financial instruments. Banks together form a huge system where the "switching" of flows from one bank to another and so on provide us with the liquidity we need.

The recent financial crisis might be compared to a home that gets a power surge in its main switch box. When that happens, power is turned off by the circuit breakers and we have to manually reset the breakers to get the power moving again.

Electrical power may not resume as quickly as we would like because a thunderstorm may have damaged a large part of the electrical grid. This concept aligns with Mr. Bernanke's comments.

However, Mr. Bernanke is a student of history. He has made an in-depth analysis of what happened during the Great Depression of the 1930's. It is his view from the research he completed many years ago that the collapse of the banks in that time period is what made the prolonged hardships of the Great Depression so severe.

In comparison, Canada's banks have not asked for any government funds and are in no danger of failure. In fact all Canadian banks made profits last year in billions of dollars. The Bank of Nova Scotia or Scotiabank (BNS-T, BNS-N) as it is called is one of the "top 10 most stable banks in the world" according to a report in the Financial Post, 04-Feb-09.

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