Creating a Safe Bank
How many times do we have to go down the duration mismatch road with fractional reserve lending and nearly $9 trillion of Fed QE to prove the current banking doesn’t work?
Once again, systemic risk morphed into economic stress, bank failures, and then a bailout of the banking system, not just Silicon Valley Bank.
If you think only depositors got bailed out, you are mistaken. The Fed put a system backstop on $600 billion in bond losses. And although bank executives will lose their jobs, they cashed out tens of millions of dollars in stock options along the way.
Specifically, we need a bank that puts 100% of its assets in overnight treasuries and makes zero loans. The bank would not need any loan officers or many operational personnel for obvious reasons. There would be no need for FDIC guarantees because there would be zero risk of a run and zero risk of losses. We can still keep the FDIC term in place, but realistically it would not be needed. In essence, we would create a 100% reserve bank.
Such a bank might pay one percentage point less than the Fed ‘s overnight rate for safekeeping. If the overnight rate fell below 1 percent, the bank would charge a fee for safekeeping. The bank could also do term deposits at a slight discount to corresponding treasury yields. Depositors would be required to hold assets to term.
To prevent runs on existing banks right, we would let every bank participate in this offering. Customers would have a chance to place their deposits into safekeeping accounts at existing banks.
Bank Lending
To make loans, I propose banks would have to attract investment money instead of lending money into existence. They would do so by offering higher than market interest rates on term deposits, but those deposits would not be guaranteed.
As an added benefit, this setup would end fractional reserve lending. We would have a full reserve system, unfortunately one that is not backed by gold, but it would be a huge step in the right direction.
The immediate economic reaction would likely be contractionary, but that seems to be what the Fed wants now anyway to rein in inflation.
Alternatively, perhaps we could phase these ideas in over a 10-year period to mitigate risk.
Fed Should Admit Responsibility for Asset Bubbles
The Fed needs to admit it is largely responsible for these recurring bailouts.
Via QE, the Fed stuffed cash nearly $9 trillion in deposits down the throats of banks and that is why deposits soared so much in the first place.
Then despite the obvious risks, regulators eliminated all reserves on deposits and treasuries encouraging Silicon Valley Bank and other banks to seek yield.
It’s true that there were three rounds of fiscal stimulus, and the last one under President Biden was totally unwarranted as well as highly inflationary. But it’s the Fed’s job to understand that risk.
Unfortunately, the Fed not only sponsored the biggest asset bubble in history, it also failed to understand how free money, student debt cancellations, and zero percent interest rates might cause inflation.
Why Is There a Fed?
If the Fed cannot see the obvious, why is there a Fed? The only answer I can come up with is Congress would be worse.
The Fed aside, there is only one way to truly eliminate borrow-short, lend-long risk, and that is to go to a full reserve system where loans are not borrowed into existence and businesses and banks can have a bank where it is 100% certain their deposits will not be lent.
Admittedly, this could cause some short-term pain. Perhaps it would be the end of 30-year mortgages. But it would also serve to end financial speculation due to cheap money. And, as I suggested, perhaps there is a way to phase this in.
Why the Fed Doesn’t Want Full Reserve Bank
In the span of 20+ years, the Fed has blown three economic bubbles and we have had multiple bank bailouts.
The Fed does not want a full reserve bank because it wants inflation.
Inflation benefits those with first access to money. Banks, the already wealthy, and governments via tax collections are first in line.
Now that the Fed has created inflation, it doesn’t want that much of the tiger it unleashed.
Central Bank Digital Currencies
Another reason the Fed does not want a safe bank is so that it can sponsor its own digital currency.
Instead of sound money or merely sounder money, the Fed wants to be free to blow bubbles to fix the messes it creates while not understanding what inflation even is.
Those who believe the CPI or its PCE cousin measures inflation are wrong. Neither measure directly includes home prices or asset bubbles in general.
And we have proven once again that inflation and asset bubbles matter, not just alleged consumer inflation measures.
Serious change is needed. Instead, the Fed supports more of the same serial bubble-blowing measures, complete with bailouts and a charlatan digital currency savior on deck as its fake solution.
This post originated on MishTalk.Com.
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Mish
Mish, you are highly
informed, but I’m sorry, why should we take your idea of what a bank should be
over what a free market might produce? A banking system designed by the
dictates of some narrow authority, simply to remove all risk, is a bit naïve.
And dictating that banks be allowed to lend deposits only to the federal
government serves only to reinforce big-government deficit spending.
Banks lend money to
the real economy, that is what they do. They create money in the process; they don’t mean to, it’s just what happens. They hedge duration risk, that is also what they do. If they
don’t, they fail. End of story. Money is credit, always has been,
always will be. Centuries of trying to make it gold, or silver, or overnight
treasuries, or fiat currency, or whatever else, is how we ended up with such a
convoluted system.
Removing the few remaining market freedoms from the current banking system will make for an even
bigger disaster. How about we go the opposite direction and just let the
banking system be? Allow creative destruction to determine what a bank should
be. Let the bad ones fail, so that the good ones don’t have to compete with
subsidized ones. Remove all centralized control, all regulation, all
guarantees. In a free market, shareholder wipe-outs and deposit hair cuts are
not the end of the world, they are an absolute necessity. As long as they occur
naturally, and you don’t allow that kindling build up.
An unfettered banking
system will likely be far smaller, systemically unimportant, and made up of many
more smaller banks. Most banks would likely be very well-run, with the
expertise to manage assets and liabilities in such a way that nearly all duration
miss-match risk is eliminated. Or at
least reduced to a systemically unimportant level. Nobody today can say that
banks can’t do this, because nobody today has ever even seen a free market
economy. But we should not be afraid of it just because nobody can visualize
it. I am certain it would function far better than what we have.
…the process will continue to remove money from the economy until there is no money and no economy.
“
Yeah, dude! Gold will just evaporate into thin air, until none is any longer there. You know, like, because, some clown can’t, like, lend out 2 kilos if he only has 1 kilo. Then, yeah, all the gold will disappear into some other dimension…..
And then, since there is no Gold anymore, that mystical dude named “The Economy” will, like disappear, too. Scary stuff, man! I mean, noone could possibly grow a bushel of wheat more than he could eat, and trade it for some other guy’s barrel of oil, were it not for the presence of the Gold that mystically disappeared because some yahoo on “Wall Street” couldn’t lend out two limos despite only having one…..
Please, people…… WTF!!!!!
glad to see, upon reading on, that Prof. Summers explains himself in the
comments. Still, I was taken aback upon first seeing this tweet by him
attributing SVB’s troubles to its having done what all banks always do!”
can, if we want, minimize money velocity, and go back to the days when a
savings account was just that – and not an adjunct to our checking accounts.
Data compiled by Joseph Aschheim for member banks,
by size of bank, and by ratio of time to total deposits, revealed that: as the
ratio of time deposits to total deposits rises:
(1) the ratio of total expenses to total earnings is
higher;
(2) the ratio of net profits to capital accounts is
lower;
(3) the ratio of net profits to total assets is
lower;
(4) the ratio of dividends to capital accounts is
lower; and
(5) the ratio of capital accounts to total assets is
lower.
All these relationships ad up to one conclusion:
“the higher the ratio of time to total deposits, the less profitable are banks
of a given size group”.
But exactly the opposite policy is being pursued.
The increased loan volume and increased bank earnings are not offset by
profits. They are reduced by a higher ratio of interest expense and bad debt.
if you’ve ever read anything by Gurley & Shaw you will immediately
recognize that they were completely lost.
Finance, December 1962, 622-633.
Savings Deposit Rate Policy,” The Journal of Finance, September 1959, 407
footnote.
Conference on Savings and Residential Financing 1961 Proceedings, United States
Savings and loan league, Chicago, 1961, 42, 43.
Journal of Political Economy December 1959, 580-88; Board of Governors, “Member
Bank Operating Ratios” Federal Reserve Bulletin, July 1960, 811.
and Policy Implications, “The Journal of Political Economy, February 1959,
59-71
Savings Institutions on Commercial Banks.”
1951
in: Monthly Review, January 1961 “What Makes for a More Profitable Bank?”
Determination of Profit or Loss of Savings Accounts in Commercial Banks, New
York, 1951.
Comptroller of the Currency, United States Treasury Department, Irwin, 1963,
pp. 369-386
136-137; and 1956 Annual Report, Federal Deposit Insurance Corporation, 83-84
Implications, Journal of Political Economy, October 1960
1960, pp. 21,22,79,80,88,90
The Bankers Magazine
311-23
United States, 1969 Leland Pritchard
Governors reduced the reserve requirement on checkable deposits to zero. This
action ended the Fed’s ability to control M1.”
“The FED will obviously, sometime in the future, lose control of the money
stock.” May 8, 2020. 10:38 AMLink
Financial
Times – As Sheila Bair said: “It should replace the shock and awe of major
interest rate hikes with new targets based on money supply, and aggressively
shrink its portfolio, selling securities at a loss to do so, if necessary.”
JULY
22, 2022, The writer is a former chair of the US Federal Deposit
Insurance Corporation and a senior fellow at the Center for Financial Stability
Waller, Williams, and Logan seem to agree.
They “believe the Fed can keep unloading bonds even when officials cut interest
rates at some future date.”
link Daniel L. Thornton, Vice President and
Economic Adviser: Research Division, Federal Reserve Bank of St. Louis, Working
Paper Series
“Monetary Policy: Why Money Matters and
Interest Rates Don’t”
The FED could stop inflation dead in its
tracks. But Powell thinks banks are intermediaries, lending savings to
borrowers.
In 2010, the PBOC’s RRR went to 18.5% – “to
sterilize over-liquidity and get the money supply under control in order to
prevent inflation or over-heating”
The Keynesian economists have achieved their
objective, that there is no difference between money and liquid assets.
We knew how to stop this already. In 1931 a
commission was established on Member Bank Reserve Requirements. The commission
completed their recommendations after a 7-year inquiry on Feb. 5, 1938. The
study was entitled “Member Bank Reserve Requirements — Analysis of Committee
Proposal” its 2nd proposal:
“Requirements against debits to deposits”
Member Bank Reserve Requirements: Analysis of
Committee Proposal, Box 107 (stlouisfed.org)
After
a 45-year hiatus, this research paper was “declassified” on March 23, 1983. By
the time this paper was “declassified”, Nobel Laureate Dr. Milton Friedman had
declared RRs to be a “tax” [sic].
Contrary
to professional economists, banks aren’t intermediaries. Banks don’t lend
deposits. Deposits are the result of lending. In the circular flow of income,
all bank-held savings are lost to both investment and consumption.
It’s a grand delusion. Banks don’t lend
deposits. Commercial bank lending/investing is a function of the velocity
of its deposits, not a function of its volume of deposits.
But the banks had excessive concentrations of assets into a
few categories, i.e., the banks were gambling.
Bankers’ Magazine 1962: “To bankers accustomed to thinking
of banking in terms of their own individual bank operations these statements
may seem strange and unreal-perhaps theoretical. Their everyday experiences have demonstrated
beyond any reasonable doubt that a bank’s lending capacity is increased when
funds flow into the bank These funds,
they know, build up the bank’s balances with correspondents and, insofar as the
funds are not require by law as a reserve against the incremental deposit inflation,
they can be used to buy securities or make loans. Even when dealing with their own borrowing customers
bankers are aware that the deposits credited to the borrower’s account are
checked out in large part and the bank loses an equivalent amount of its correspondent
balances.
In other words, the individual banker thinks of his banking operations
as being of an intermediary nature. He
sees his bank as standing between savers and borrowers, transmitting to worthy borrowers the savings of the bank’s customers. There is nothing in the individual banker’s experience to dispel the
illusion that he is operating an intermediary type of financial institution. And it is for the reason the bankers and
their associations have been, and are, such vigorous proponents of time deposit
banking.”
A String”
the eligible borrower.”
Any institution whose liabilities can be transferred on
demand, without notice, and without income penalty, via negotiable credit
instruments (or data pathways), and whose deposits are regarded by the public
as money, can create new money, provided that the institution is not
encountering a negative cash flow.
Where did I say banks rely on saving deposits to create assets (loans)?
Why do you think banks issue bonds (liability) as well as buy them (asset)? Why not only buy bonds (assets)?
they’re just trying to hasten Armageddon so Jesus comes back before the next truck payment is due