It’s not every day that a clear example showing the horrors of central planning comes along—the doublethink, the distortions, and the perverse incentives. It’s not every year that such an example occurs for monetary central planning. One came to the national attention this week.

A company called TNB applied for a Master Account with the Federal Reserve Bank of New York. Their application was denied. They have sued.

First, let’s consider TNB. It’s an acronym for The Narrow Bank. A so called narrow bank is a bank that does not engage in most of the activities of a regular bank. It simply takes in deposits and puts them in an account at the Fed. The Fed pays 1.95%, and a narrow bank would have low costs, so it could pass most of this to its depositors. This is pretty attractive, and without the real estate and commercial lending risks—not to mention derivatives exposure—it’s less risky than a regular bank. According to Bloomberg’s Matt Levine, saving accounts for large depositors average only 0.08% interest.

So it’s easy to see why many believe that the Fed’s reason to refuse an account to TNB is unsavory: to protecting the crony too-big-to-fail banks. That is a plausible explanation for sure, but there is much more.

The Bank: Spindled, Folded, and Mutilated

There has been a long, slow process—punctuated by big changes in responses to crises—of perverting the banks. Before the first world war, when a retailer received consumer goods he would sign a bill acknowledging delivery. Typically, he had 90 days to pay, which was enough time to sell the goods through to the consumer. The wholesaler could endorse this and pass it to his creditors. The bill traded at a discount to its face value.

The creditor—perhaps the wholesaler—could endorse it and pass it to his supplier. The supplier could bring it to a bank. Banks were happy to discount a bill because bills earned the discount rate and they were very liquid. The bill was the perfect asset to back demand deposit accounts.

Banks also engaged in lending. They bought loans and bonds. A loan is not a good asset to back a demand deposit account, as it is not liquid. A bond is slightly better, but the problem is that the bond market can go “no bid” at times of stress. Which is precisely when depositors are demanding their money back, and hence banks need to sell.

So the government had a solution: create a rediscounter of bills—the Federal Reserve. Today, economists say the Fed was created as lender of last resort with an important caveat. It would only lend on quality assets. Well, bills are not lending, but clearing. If you had a $2,000 (100 ounces gold!) bill drawn on a baker for his flour delivery, you did not have much worry that the demand for bread would disappear (the commodity was insured).

So in its inception, the Fed was purportedly supposed to rediscount these bills. That is buy them, and provide the gold unexpectedly needed by the banks. They needed the gold because they backed demand deposits with loans or bonds. They didn’t expect the need, because they assumed that the bond market cannot become illiquid and did not understand that they caused the illiquidity by mismatching the saver’s demand deposit with the borrower’s long-term project. The saver said “I might want my money back by next Tuesday” and the bank said “right, 10-year railroad bond!”

Anyways, the theory was that banks could bring in some bills to get some gold, to pay redeeming depositors. The practice was that the Fed began buying Treasury bonds, thus distorting interest rates (which was illegal in 1913 and retroactively legalized in additional legislation many years later).

And the Fed did not just distort the interest rate. It distorted the very business model of the banks. Consider the so called open market operations. The Fed is prohibited from buying new bonds directly issued from the Treasury. So it buys them in the “open market”, which in practice means it buys from the big banks. The big banks now have a business that never existed in a free market—knowing the coming bond purchase schedule, buying those bonds for inventory and then unloading them onto the Fed a few ticks higher in price.