Hasteko, Ikus Mosler-ek: nondik dator dirua?
Segida1:
Those interested in how best to regulate banks may be interested in this post a few days ago by John Cochrane (economics prof in Chicago).
http://johnhcochrane.blogspot.co.uk/2016/04/a-better-living-will.html
Cochrane basically favours the system advocated by Milton Friedman, Positive Money and others. But he goes a bit off the rails in that article, or so I claim in a comment after the article.
I referred Warren to that Cochrane post, and Warren’s reply (in an email) was thus.
“To me it’s all about the blind leading the blind. A bank ‘fails’ only because a regulator says it fails, and in that case the CB provides liquidity to continue day to day operations without business interruption for ‘main st. and the bank president reports directly to the regulators, rather than to the board or the shareholders.
At that point in time it’s become a ‘public bank’ just like the Fed and the regulators decide what comes next. They can continue to operate as a public bank indefinitely, for example, while they probably are figuring out how to get it back to being a private bank. The easiest way is to sell it all to another bank, which may or may not result in anything left over for the former shareholders, and may even require ‘public funds’ to keep insured depositors whole, depending on the extent of the losses/price of the sale.
If they don’t find a buyer they can then start liquidating by selling the deposits, which generally trade at some premium, funding the rest at the CB. Then they can start selling off the assets- the loans and securities, etc. along with any real estate owned, until it’s all gone. Again, at that point, any funds left over can go to the former shareholders or to the govt. as some kind of liquidation fee, etc. And it the asset sale doesn’t produce enough to repay the CB liquidity provided that’s a loss for the govt. that gets added to the deficit.
That’s it, mate. Not all that much to it, and there is no such thing as ‘too big to fail’ when looked at that way.”
Hi Warren,
I don’t favor any sort of preferential treatment for banks (as compared to other businesses) like allowing regulators (aka taxpayers) to rescue a bank which can’t pay its creditors on the due date. That equals a subsidy of the bank industry.
An FDIC system is better: that pays for itself, thus no subsidy is involved. But even there, I object to the basic risk involved in traditional banking, i.e. “borrow short and lend long” – maturity transformation (MT). All MT does is to create liquidity (aka money). But the state can create whatever amount of money is needed to keep the economy at full employment, as every MMTer knows. So why run the “MT risk”?
The Cochrane / Friedman / Positive Money system avoids that risk. Only the state creates money: private banks don’t. The private bank industry is split in two: one half just accepts deposits which are kept in a totally safe manner. The other half lends to mortgagors, businesses etc, but that half is funded just by equity (or similar). Failure is virtually impossible for either half.
Also regulating that system is very simple: regulators just need to look at the liability side of lending institutions’ balance sheets – there shouldn’t be anything resembling a deposit there.
We’ll have to have another meeting to sort this out. I suggest a selection of Brits fly out to some strange island in the West Indies for a meet-up. We can do some tax-dodging while there. That’ll pay for the flight..:-)
Ralph.
Warren replied to the email I sent him (see my comment 19th April, 12.25, starting “I don’t favor..”). Plus I replied to his reply. We both inserted comments in the original email. I’ve set out the original email below with my new words prefixed by “Ralph:” and ending in XR. and his by “Warren:” and ending in XW.
Hi Warren,
I don’t favor any sort of preferential treatment for banks (as compared to other businesses) like allowing regulators (aka taxpayers) to rescue a bank which can’t pay its creditors on the due date. That equals a subsidy of the bank industry.
Warren: What does ‘rescue a bank’ mean?
If shareholders lose everything who has been rescued? XW
Ralph: By “rescue”, I meant some of the options you referred to. E.g. turning a loss making private bank into what you called a “public bank” and continuing to “operate it as a public bank indefinitely”. And using public funds to bail out depositors constitutes a “rescue / subsidy”, (though as I said, if that’s done via a self funding FDIC system, that’s not too bad. But FDIC doesn’t cover LARGE banks in the US, does it?) XR
An FDIC system is better: that pays for itself, thus no subsidy is involved.
Warren: Borrowers pay via higher rates. XW.
Ralph: Agreed: and it’s quite right that they should pay. XR
But even there, I object to the basic risk involved in traditional banking, i.e. “borrow short and lend long” – maturity transformation (MT).
Warren: Interest rate risk is not allowed and liquidity guaranteed so what’s the risk apart from default? XW.
Ralph: Liquidity can only be guaranteed (particularly for large banks) thanks to very large dollops of public money. Far as I can see the Fed loaned about $600bn for around 18 months at a derisory rate of interest to those banks in order to save them. That amounts to a subsidy. But quite apart from that subsidy, default of large banks involves serious externalities: i.e. falling aggregate demand, higher unemployment etc. XR.
All MT does is to create liquidity (aka money).
Warren: I’m not sure you fully understand what I mean regarding bank liquidity? XW.
Ralph: Misunderstading here. I was referring to liquidity for the economy as a whole, not just for banks. I.e. when a bank accepts $X of deposits and lends that on to say a business, the business has $X to play with, plus the original depositors also have (or think they have) the original $X to play with. $X has been turned into $2X. Messers Diamond and Rajan referred to that risky liquidity creation process in the abstract of a paper of theirs (link below). As they put it, “We show the bank has to have a fragile capital structure, subject to bank runs, in order to perform these (liquidity creation) functions.”
http://www.nber.org/papers/w7430 XR.
But the state can create whatever amount of money is needed to keep the economy at full employment, as every MMTer knows. So why run the “MT risk”?
Warren: As I said a discussion of public purpose regarding permitted bank lending it’s in order. XW.
The Cochrane / Friedman / Positive Money system doesn’t involve that risk.
Warren. Right. Only private equity lending allowed. That’s a political option. XW
Only the state creates money: private banks don’t. The private bank industry is split in two: one half just accepts deposits which are kept in a totally safe manner. The other half lends to mortgagors, businesses etc, but that half is funded just by equity (or similar). Failure is virtually impossible for either half.
Warren: Right, which substantially limits lending and likely raises borrowing rates.
So if you think that serves public purpose fine! It’s an option! XW.
Ralph: I quite agree it limits lending and raises borrowing rates. As to the demand reducing effect of that, that’s no problem at all because the state has an infinite capacity to compensate for that by raising demand – as pointed out very eloquently by Mosler’s law..:-) As to higher rates as such, the only important question there is whether rates are a move towards or away from the free market rate. If that’s a move TOWARDS the free market rate, then I claim that raises GDP. My reasons for thinking that DOES constitute a move towards a free market rate are thus. A lender is normally a person (or firm) which does some work, earns some money and then abstains from spending that money so as to transfer spending power to a borrower. Even if the lender just inherits money from a rich auntie, at least they consciously decide to abstain from spending so as to enable the borrower to spend.
In contrast, some (but not all) of the money loaned by banks is simply produced from thin air. I.e. in effect, private banks can still print and lend out home made £10 notes like they used to in the UK prior to the abolition of private note production 1844. That’s an entirely artificial privilege for money lenders (aka banks). There is no more reason to let banks create / print money than there is let any other type of business do so. That artificial privilege for banks is actually written into UK law (not sure about US law). That is, as Richard Werner has explained, banks are excused the so called “client money” rules.
I’ve gone into more detail on some of these points in a recent paper which is appearing in some economics journal in the near future. See:
https://mpra.ub.uni-muenchen.de/70162/1/MPRA_paper_70162.pdf
I’m not at all sure I’ve got everything right in that paper. There may even be some horrible blunder there. Still, that’s life. XR.
Also regulating that system is very simple: regulators just need to look at the liability side of lending institutions’ balance sheets – there shouldn’t be anything resembling a deposit there.
Warren: True. No regulation required for monetary or risk reasons. Fraud and consumer protection maybe. XW.
We’ll have to have another meeting to sort this out. I suggest a selection of Brits fly out to some strange island in the West Indies for a meet-up. We can do some tax-dodging while there. That’ll pay for the flight..:-)
Warren: Anytime!
Best
Warren
