Mike Smithson; wrong, wrong, wrong....

The blogosphere wouldn't exist if people only posted on subjects where they have a clue. This means that sometimes you come across some stunningly ill-informed posts.

Mike Smithson's post on PoliticalBetting about why savers in Icelandic banks deserve to lose every penny is one of them. Since I've seen people refer to it to justify why Icesave savers 'should be hung out to dry', I thought I'd point out why...

Mike's point is that the Icelandic banks were paying higher interest rates, which obviously meant they were a riskier proposition, so anyone losing money as a result deserves what they're getting. There are two problems with this.

First, do savings account interest rates represent the risk of losing your money? For most economists, the answer is a pretty clear No. If Natwest offers me 5% interest on my money, that's not because there is a 1 in 20 chance of Natwest going bust over the next year. Fundamentally, bank desposits are not a bet. Natwest can pay 5% because they are lending my money to someone who can use it for something more productive; say a loan at 10% to fund a business project which will return 15%.

The picture is more complicated, because of marketing. Most high street banks don't compete on interest rates, because they know that many customers will go to their branch and take whatever savings account is on offer. Anyone who isn't a high-street bank has to offer good rates to get noticed and acquire customers. If Icesave paid 0.5% more than HSBC, it's quite likely to be a marketing tactic, not a premium for taking more risk.

There are plenty of investments where higher rates do mean more risk; it's just that savings accounts aren't one of them, because of deposit protection.

For ages, peoples' savings in bank accounts have been guaranteed. There is a very good reason for this. In difficult times, the slightest rumour about a bank can result in confidence in that bank collapsing, and the bank going bust even when it doesn't need to. Deposit protection stops this. If it weren't for deposit protection, many British banks would have gone under last September when Northern Rock hit the rails, and we'd probably already be in a deep depression.

If peoples' bank savings were not effectively guaranteed by the government, then Mike Smithson would be right; higher interest on your savings means higher risk. It would also mean that by now banks would be collapsing left, right and centre as people fled from the banking system to put their money under their mattress instead. What little confidence there is in British banks would be replaced by mass panic.

It's lucky the economy isn't run by politicalbetting.com...