Friday, January 22, 2016

Proposals for Reforming the Banking System

Currently, the US financial sector pulls in upwards of 30% of all corporate income, which is both unacceptable and unsustainable. A financial services sector that is larger than the productive sector of the economy that it is intended to serve is entirely to large, and must be significantly reformed. While I support all of the proposals in Senator Elizabeth Warren's "21st Century Glass-Steagall" bill, I do not think the legislation is quite comprehensive enough. In my view, the proposals outlined below are necessary to truly reign in the financial sector and restore it to the safe, boring, utility system that it should be, to ensure a fairer, more efficient, and more productive US economy.

Much of this post comes from this article by the great Warren Mosler, and is intended to present proposals for the FDIC, CFPB, OCC, SEC, Treasury, Federal Reserve, and the banking system. I worked off of Mr. Mosler's many powerful and well-developed ideas and added a few of my own. The basic premise of these proposals is that the US government exists for a public purpose, and as an extension of the US government, the banking system does as well.

US banks are public/private partnerships, that exist for the public purpose of establishing a safe an reliable payment system, and providing credit to American borrowers based on nonpolitical credit analysis. In the housing market, for example, the federal government provides much of the background support and regulates processes, with final credit determination made by private bankers. Supporting this type of credit creation on an ongoing, stable basis also demands a source of funding that is not market dependent. Hence most of the world’s banking systems include some form of government deposit insurance, as well as a central bank standing by to loan reserves to its member banks.

The US banking system is an extension of  the US government, much like the US military. While Congress ultimately controls the military, it does not micromanage its daily affairs. The military has the discretion to move tanks and point guns without constant approval from Congress. Similarly, US banks are allowed to price risk and allocate credit without constant approval from Congress. However, the structure in which they do so would not exist without constant federal support, regulation, and supervision. Despite what you might hear from the right-wing think tanks, federal regulation and supervision does not place a net burden on honest lenders; on the contrary, it makes it possible for them succeed by relieving them of the impossible burden of competing with unscrupulous firms.

Further, national banks in the US are designated as “federal instrumentalities” in their federal charters. They have unique status among enterprises as “fiscal agents of the United States” who can accept and distribute deposits from federal spending. The ability to accept deposits, make payments on behalf of customers via the Federal Reserve System, and extend credit are unique prerogatives of banks. Since national banks are compulsory members of the Federal Reserve System, they also have a unique role in the implementation of fiscal and monetary policy in coordination with the US Treasury.  Due to these prerogatives, national banks are designated as federal instrumentalities, a designation that is not applied to any other type of enterprise. This designation emanates both from statute and decades of judicial interpretation.

It is important to understand that our monetary economy is essentially constructed as a series of records of accounts to track how we make claims on goods and services. This system of records is a creation of the human mind, from nothing.  The entire monetary system is created from “thin air”, so loan and deposits are just one form of asset and liability that is created within the monetary system. The supply of what we call 'money' is no more fixed than any person’s ability to type numbers into a computer.  In essence, all of the financial assets and liabilities created from thin air are simply accounting relationships that enable us to record how we interact within our economy. Bank deposits and loans are just one type of way we account for these interactions, though they’re a particularly important type of interaction because they represent the primary medium of exchange in the current US economic system.

Banking Under A Gold Standard

Under a gold standard or other fixed exchange rate regime, continuous and stable bank funding cannot be credibly guaranteed. In fact, fixed exchange rate regimes by design operate with an ongoing constraint on the supply side of the convertible currency. Banks are required to hold reserves of convertible currency, to be able to meet depositor’s demands for withdrawals. Confidence is critical for banks working under a gold standard. No bank can operate with 100% reserves. They depend on depositors not panicking and trying to cash in all their deposits for convertible currency. The U.S. experienced a series of severe depressions in the late 1800’s, with the ‘panic’ of 1907 disturbing enough to result in the creation of the Federal Reserve in 1913.

The Federal Reserve was to be the lender of last resort to insure the nation would never again go through another 1907. Unfortunately, that strategy failed. The depression of 1930 was even worse than the panic of 1907. The gold standard regime kept the Federal Reserve from freely lending its banks the convertible currency they needed to meet withdrawal demands and stay open. After thousands of catastrophic bank failures, a bank holiday was declared and the remaining banks were closed by the government while the banking system was reorganized.

When the banking system reopened in 1934, convertibility of the currency into gold was permanently suspended (domestically), and bank deposits were newly covered by federal deposit insurance. It has now been 80 years since the Great Depression. Thankfully, the United States and the vast majority of the wold has abandoned commodity currencies, and has for nearly a century used fiat currency systems. It would now take exceptionally poor policy responses for a financial crisis to cause another depression, although misguided and overly tight fiscal policies have unfortunately prolonged the restoration of output and employment since 2008.

The hard lesson of banking history is that the liability side of banking (deposits) is not the place for market discipline. That is, we cant rely on everyday depositors who "fund" banks, to adequately evaluate the balance sheets of these complex institutions, especially since our professional regulators continually struggle with this. Therefore, with banks funded without limit by FDIC insured deposits and loans from the central bank (reserves), all discipline is occurs on the asset side. This includes being limited to assets deemed ‘legal’ by prudential and consumer regulators, and minimum capital requirements also set by the regulators.

Therefore, to bolster the public purpose of banking (provide for a payments system and to fund loans based on credit analysis), additional proposals and restrictions are in order, which apply to insured depository institutions which includes commercial banks and credit unions. Private nondepository financial entities, such as investment banks and hedge funds, are not considered in this proposal.

Proposals for the broad banking system

1. Insured depository institutions should only be allowed to lend directly to borrowers and then service and keep those loans on their own balance sheets. There is no further public purpose served by selling loans or other financial assets to third parties, but there are substantial real costs to government regarding the regulation and supervision of those activities. The public purpose of banking is to facilitate loans based on credit analysis, rather than market valuation. The accompanying provision of government insured funding allows those loans to be held on the balance sheet to maturity without liquidity issues, in support of that same public purpose.

The justification for securitzation is that it helps to spread risk around the entire financial system that would otherwise be concentrated in originating banks. This point is perhaps bolstered by the fact that capital standards and supervisory actions by prudential regulators, in the past, have incentivized insured depository institution to move riskier, variable rate assets of their books, in the misguided attempt to improve the soundness of individual institutions. All sorts of loans can perform perfectly well while remaining on the balance sheet of the originator, if they are properly underwritten. And a broad based negative-feedback financial collapse like in 2008 can be prevented with the proper fiscal policy, which if targeted accurately can prevent large scale borrower defaults.

During the years from 1940-1980, when housing growth was strong, and the credit needs of Americans was adequately met, mortgage originators, which were mostly life insurance companies, savings and loans, and small commercial banks, held their mortgages on portfolio and did not feed the secondary market, with the obvious exception of Fannie and Freddie. No private secondary market was necessary during this period of prosperity. The growth of securitzation in the last 30 years did not enhance the ability of the banking system to extend housing credit-  on the contrary, it helped create a global financial crisis that destroyed tens of trillions of dollars in wealth and threw millions of homeowners into foreclosure. There is no real reason why 100% portfolio lending cannot meet the housing needs of the country. And finally from a consumer protection standpoint, securitization also often leads to poor record keeping and abuse by servicers. The extreme length and complexity of sorting out the post-2008 mortgage crisis is clear evidence of this.

So for all of these reasons, insured depository institutions should be prohibited from engaging in any secondary market activity. The argument that these areas might be profitable for the banks is not a reason to extend governmental banking enterprises into those areas.

2. US banks should not be allowed to contract and lend in LIBOR. LIBOR is an interest rate set in a foreign country (the UK) with a large, subjective component that is out of the hands of the US government. Recent events have demonstrated that in addition to being subjective, LIBOR is subject to manipulation and fraud.

Part of the recent crisis stemmed from the Federal Reserve’s inability to bring down rates on US LIBOR settings to its target interest rate, as it tried to assist millions of US homeowners and other borrowers who had contacted with US banks to pay interest based on LIBOR settings.

Desperate to bring US interest rates down for domestic borrowers, the Federal Reserve resorted to a very high risk policy of advancing unlimited, functionally unsecured, lines of credit called ‘swap lines’ to several foreign central banks. These loans were advanced at the Federal Reserve’s low target rate, with the hope that the foreign central banks would lend these funds to their member banks at the low rates, and thereby bring down the LIBOR settings and the cost of borrowing for US households and businesses.

There is no way for the Federal Reserve to collect a loan from a foreign central bank that elects not to pay it back. If, instead of contracting based on LIBOR settings, US banks had been linking their loan rates and lines of credit to the US Federal Funds rate, this problem would have been avoided. The rates paid by US borrowers, including homeowners and businesses, would have come down as the Federal Reserve intended when it cut the target rate.

3. Insured depository institutions should not be allowed to have subsidiaries of any kind. No public purpose is served by allowing banks to hold any assets such as CDOs ‘off balance sheet.’ These off balance sheet entities are also much more difficult for bank examiners to properly analyze and risk-weigh, since their values can be derived from any number of financial outcomes that occur both in and out of the banking system.

4. Insured depository institutions should not be allowed to make margin loans or accept financial assets as collateral for loans. Lending against financial assets is not an appropriate role for the insured banking system because it exposes it to systemic and market risk, which can then jeopardize the public purpose of a stable national lending platform. Lending against financial assets is a role for capital market entities such as private investment banks and hedge funds, which do not benefit from the subsidies of deposit insurance and unlimited Federal Funds. No public purpose is served by creating financial leverage within the banking system. This would also refocus the banking system on its original public purpose of lending against real productive assets.

5. Insured depository institutions should not be allowed to lend offshore. No public purpose is served by allowing them to lend for foreign purposes. Foreign lending only exposes the US banking system to risks that often fall outside the purview of prudential regulators.

6. Insured depository institutions should not be allowed to buy or sell credit default insurance. The public purpose of banking as a public/private partnership is to allow the nongovernment to price risk, rather than have the public sector pricing risk through public banks. If an insured depository institution relies on credit default insurance, it is transferring that pricing of risk to a third party outside the banking system, which defeats the whole purpose of having an insured banking system.

7. Insured depository institutions should not be allowed to engage in proprietary trading or any profit making ventures beyond basic credit creation. Net interest margins should be the main source of income for insured depository institutions. If the public sector wants to venture out of banking for some presumed public purpose it can be done through other outlets. All other financial activities should be done outside of the insured, Federal Reserve banking system.

8. Insured depository institutions should utilize FDIC approved credit models for evaluation of bank assets. Marking banks assets to market is not appropriate, since the process of lending itself is not market dependent. In fact, if there is a valid argument to marking a particular bank asset to market prices, that likely means that asset should not be a permissible asset of an insured depository institution in the first place. Therefore, marking to market rather than evaluation by credit analysis exposes banks to market crises, serves no further public purpose, and subverts the existing public purpose of providing a stable national platform for credit creation.

9. Every American citizen should have a legal right to access the payment system at no charge (as defined by Regulation DD/Truth in Savings.) It is no more acceptable that 40 million Americans do not have full, direct access to the payment system than if they did not have access to the water, sewer, or phone systems. Like those systems, the payment system is a utility function necessary for modern life. Therefore, any citizen who applies for a checking and savings account would be provided one at no cost, either at an insured depository institution or at a US Post Office. This would cut down on check cashing fees, loss or theft of cash, and the volatility and fraud associated with nonbank payment and storage systems.

Currently, the Community Reinvestment Act (CRA) gives regulators a few mild tools, both sticks and carrots, to incentivize banks to serve the communities in which they are located. However, the CRA covers only lending activity, which is only half of the public purpose of the banking system. The CRA, and its implementing regulations and guidance documents that bank examiners use, should be updated to include incentives and penalties for achieving universal access to checking and savings accounts.

10. Credit unions should not face regulatory asset limits on member business lending. Since credit unions, like community banks, tend to be smaller institutions with localized footprint and community ties, they are well suited for local business lending. Since the large national banks are increasingly retreating from small business lending, this would allow credit unions to fill in some of the gap.

11. In order to help smaller depository institutions, the Fed should loan unsecured Federal Funds in unlimited quantities to all insured depository institutions, regardless of size. This step would clearly establish banks as the credit allocation utilities that they already are, and eliminate public confusion that banks are merely intermediaries between savers and borrowers.

The regulators should then drop all requirements that a certain percentage of bank funding be ‘retail’ deposits. Small banks and credit unions are currently at a competitive disadvantage because the marginal cost of funds is too high. The true marginal cost of funds for small institutions is probably at least 2% over the Federal Funds rate. This is keeping their minimum lending rates at least that much higher, which also works to exclude borrowers who need that much more income to service their borrowings, all else equal.

The primary reason for the high cost of funds is the regulatory requirement for ‘retail deposits’, which causes these institutions to compete for a finite amount of available deposits in this ‘category.’ While, operationally, loans create deposits, and there are always exactly enough deposits to fund all loans, there are some leakages. These include cash in circulation, the fact that some banks, particularly large, money center banks, have excess retail deposits, and a few other ‘operating factors.’ This causes small institutions to bid up the price of retail deposits in the broker CD markets and raise the cost of funds for all of them, with any institution considered even remotely ‘weak’ paying even higher rates, even though its deposits are fully FDIC insured. Additionally, small institution are driven to open expensive physical branches that can add over 1% to a bank’s true marginal cost of funds. So by driving small institutions to compete for a limited and difficult to access source of funding the regulators have effectively raised the cost of funds for them.

Proposals for the Federal Reserve System

1. As above, the Federal Reserve should lend reserves unsecured to member banks, and in unlimited quantities at its target Federal Funds rate. There is no reason to do otherwise. Currently the Federal Reserve will only loan to its banks through the discount window on a fully collateralized basis, which is both redundant and disruptive. Reserve banks demanding collateral when they lend is redundant because all bank assets are already fully regulated by Federal prudential regulators. It is the job of the regulators to make sure that all FDIC insured deposits are ‘safe’ and the Deposit Insurance Fund is not at risk from losses that exceed the available private capital. Therefore, the FDIC has already determined that funds loaned by the Federal Reserve to a bank can only be invested in ‘legal’ assets and that the bank is adequately capitalized as required by law.

There is no room for funding from the Federal Reserve to be ‘misused’ as banks already can obtain virtually unlimited funding by FDIC insured deposits (except for institutional size discrepancy, as described in #11 above.) The only difference between banks funding with FDIC insured deposits and funding directly from the Federal Reserve might be the interest rate the bank may have to pay; however it’s the further purpose of the Federal Reserve’s monetary policy to target the Federal Reserve funds rate. The Federal Reserve also tends to set quantity limits when it lends to its member banks, when there is every reason to instead lend in unlimited quantities.

Bank credit creation is not reserve constrained, so attempting to constrain it via reserve supply does not work. What constraining reserves does is alter the Federal Funds rate, which is the rate banks pay for reserves. So the only way the Federal Reserve can fully stabilize the Federal Funds rate at its target rate is to simply offer to provide unlimited funds at that rate as well as offer to accept Federal Funds deposits at that same target rate (currently called Interest on Reserves, accomplished by the establishment of Excess Balances Accounts). With no monetary risk or adverse economic consequences for lending unlimited quantities at its target rate there is no reason not to do this.

Another benefit of this policy would be to entirely eliminate the interbank Federal Reserve funds market. There is no public purpose served by banks trading Federal Reserve funds with each other when they can do it directly with the Federal Reserve. To eliminate the interbank markets entirely the Federal Reserve has the further option to provide funding with an entire term structure of rates to its member institutions, to both target those rates and also eliminate the need for any interbank trading. This could be accomplished through expansion of the Term Deposit Facility and Repo trading.

2. The federal funds rate should be dropped permanently to zero. There is no reason to set an arbitrary cost for banks to obtain what is an unfixed, free-floating, fiat currency. This zero rate minimizes cost pressures on output, including investment, and thereby helps to stabilize prices. It also minimizes rentier incomes, thereby encouraging higher labor force participation and increased real output. Additionally, because the non-government sectors are net savers of financial assets, this policy hurts savers more than it aids borrowers, so a fiscal adjustment such as a tax cut or spending increase would be appropriate to offset this loss of interest income.

Implementing a zero rate policy would also ease regulatory burdens on the banking system. Although many of the burdens placed by regulators on the banking system are useful, the need to mitigate interest rate risk is not. In recent years, fears of the Federal Reserve raising its overnight interest rate target have led prudential examiners to increasingly focus on interest rate risk, among the many other new requirements under Dodd-Frank. In the current variable rate environment, banks have to constantly monitor the maturities on the balance sheets for exposure to interest rate risk, and often mitigate these risks by entering into interest rate derivative contracts. A permanent zero rate policy would therefore reduce the need for many of the derivative tools currently used in the banking system, which remain inadequately regulated and supervised by the CFTC and SEC.

Additionally, several consumer protection regulations are based around rate spread, that is the difference between the 30-year Treasury and 30-year mortgages. For example, HMDA requires lenders to report mortgages that are originated above a certain spread, so when the long end of the yield curve changes as a result of Fed policy, the amount of mortgages that must be reported under HMDA changes. Consumer protections under HOEPA also kick in based on the basis point spread between certain mortgage products and and the prime rate, which itself is based off of the Federal Funds Rate. When the Fed changes the Funds Rate, all these spreads also change, which makes compliance with these regulations unnecessarily difficult for banks and credit unions.

3. All Federal Reserve bank examiners and supervisory staff should be employees of the Federal Reserve Board of Governors. Currently, examiners are employees of the Reserve banks, which have supervised entities as shareholders and board members. Without necessarily changing the work stations of exam/supervisory staff, shifting their employment to the Board would remove the potential for regulatory capture or conflict of interest (whether real or imagined).

4. Require Presidential nomination and Senate confirmation of the President of the Federal Reserve Bank of New York. The FRBNY is the closest to the Board of Governors in power and responsibility, and it should be overseen as such. Since the FRBNY executes the directives of the FOMC and supervises many of the largest bank holding companies in the world, its responsibilities are far higher than any other Reserve bank.

Proposals for the FDIC (Federal Deposit Insurance Corporation)

1. Remove the $250,000 cap on deposit insurance. The public purpose behind the cap is to help small banks attract deposits, under the theory that if there were no cap, large depositors would gravitate towards the larger money center banks. However, this cap drives deposits into the uninsured and unsupervised money markets, which played a large part in funding the mortgage bubble of the 2000’s. However, once the Federal Reserve is directed to trade in the Federal Funds markets with all member banks, in unlimited amounts, the issue of available funding becomes moot. This would also help eliminate the cost discrepancy problem for small banks described in #3 below.

2. Insured depository institutions should not be funding the FDIC’s operations through taxes or fees. As with the proposal for the OCC and SEC, the FDIC’s operations should be entirely funded through the Federal Reserve System. Taxes on solvent banks should not be on the basis of the funding needs of the FDIC. Taxes on banks have ramifications that can either serve or conflict with the larger public purposes presumably served by government participation in the banking system. These include sustaining the payments system and credit creation based on credit analysis. Any tax on banks should be judged entirely by how that tax serves or doesn’t serve public purpose.

3. The FDIC, whether through regulation, guidance, or supervisory discretion, should not be requiring well-capitalized institutions to fund themselves through any particular mix of core retail or brokered deposits. Requiring institutions to fund themselves through a certain percentage of retail deposits raises the marginal cost of funds for community banks, which have limited branch networks and areas of operation. This forces them to bid up the price of retail deposits within their operating region, which puts them at a competitive disadvantage to banks with national reach. Any liquidity risks posed by larger reliance on wholesale funding would be eliminated by the above proposal to allow the Federal Reserve to trade unlimited Federal Funds directly with all depository institutions.

3. The FDIC should operate without direct assistance from Treasury (apart from guaranteeing the full faith and credit of the Deposit Insurance Fund). The FDIC is charged with taking over any bank it deems insolvent, and then either selling that bank, selling the bank’s assets, reorganizing the bank, or any other similar action that serves the public purpose government participation in the banking system. The TARP program was at least partially established to allow the US Treasury to buy equity in specific banks to keep them from being declared insolvent by the FDIC, and to allow them to have sufficient capital to continue to lend.

Normally, once a bank incurs losses in excess of its private capital, further losses are covered by the FDIC. However, if the Treasury ‘injects capital’ into a bank, all that happens is that once losses exceed the same amount of private capital, the US Treasury, also an arm of the US government, is next in line for any losses to the extent of its capital contribution, with the FDIC covering any losses beyond that.

So what is changed by Treasury purchases of bank equity? After the private capital is lost, the losses are taken by the US Treasury instead of the FDIC. It makes no true difference for the US government and the ‘taxpayers’ whether the Treasury covers the loss indirectly when backing up the DI Fund, or directly after ‘injecting capital’ into a bank. All that was needed to accomplish the same end as the TARP program (to allow banks to continue to function and acquire FDIC insured deposits) was for the FDIC to either make Prompt Corrective Actions against undercapitalized banks, or directly reduce capital requirements. Instead, both the Obama and Bush administrations burned through substantial quantities of political capital to get the legislative authority to allow the Treasury to buy equity positions in dozens of banks. And, to make matters worse, it was all accounted for as additional federal deficit spending.

While this would not have mattered if Congress and the administrations understood the monetary system, the fact is they didn’t, and so TARP therefore restricted their inclination to make further fiscal adjustments to restore employment and output. Ironically, this persistently tight fiscal policy continues to contribute to the rising delinquency and default rate for bank loans, which continues to impede the desired growth of bank capital. This backwards view of finance permeates every level of the policymaking community and has significantly reduced national output and standards of living.

Proposal for the CFTC, SEC and OCC

The CFTC, SEC and OCC should not be funded by any fees, assessments, taxes, or appropriations. In order to preserve agency independence and remove any potential conflicts of interest, these agencies should be funded entirely as part of the Federal Reserve System, as the Consumer Financial Protection Bureau is currently. This would allow the agencies to grow their staff to appropriate levels, and offer competitive compensation to attract and retain public servants of the highest integrity.

Along with the FDIC, at most, this would reduce Fed remittances to Treasury by $8 billion, a fraction of the current amount.

SEC FY2015 Budget Request: ~$3 billion
OCC FY2015 Budget authority: ~$1.06 billion
CFPB FY2015 Budget authority: ~$582 million
FDIC FY2015 operating budget: $2.3 billion
CFTC FY2015 Budget request: $280 million

Further, since a great deal of financial activity now occurs in the capital/derivatives markets outside the banking system, the resources and responsibilities of the SEC and CFTC, the two federal nonbank regulators, need to be significantly increased. While both agencies do currently have supervisory roles, they should have the resources to develop examination and supervision corps that are on par with those of the prudential regulators.

Proposals for CFPB

The Consumer Financial Protection Bureau should use its exemption authority to exempt all credit unions from coverage under the Mortgage Servicing, Loan Originator Compensation, and Escrow Rules. Credit Unions are democratically operated, nonprofit financial cooperatives that exist only to serve their members not make a profit. All credit union customers are also members, so the profit centered, client relationship of the for-profit banking world does not apply.

The problems that the Servicing, Originator Compensation, and Escrow rules are intended to prevent, all stem from the profit motive which does not exist in credit unions. The potential for consumer harm is minimal when consumers are also voting members of the institution. However the Ability-to-Pay/QM Rule should continue to apply to all credit unions, in its current form. There is good macroeconomic reasoning to cover all US creditors with the same underwriting requirements, in order to prevent credit growth from shifting into entities with weaker underwriting practices.

The Bureau should also be given clear legal authority to regulate and supervise all auto lending activities, whether by insured depository institutions, auto dealers, or otherwise. This is a notoriously opaque and often abusive business which has shamefully operated in the shadows for too long.

Proposals for the Treasury

1. Cease all issuance of long term Treasury securities, and allow Treasury to only issue paper with maturities of three year or less. This would provide adequate safe assets to build bank capital and meet pension fund investment obligations, without artificially raising the term structure of interest rates. The Treasury Borrowing Advisory Committee (TBAC) could continue to provide guidance on maturity issuances of three years or less.

No public purpose is served by the issuance of long-term Treasury securities with a non-convertible fiat currency and floating exchange rates. Issuing such securities only serves to support the term structure of interest rates at higher levels than would otherwise be the case. Since these long term rates serve as the benchmark for trillions of dollars of investment, higher long term rates only serve to adversely raise the price structure of all goods and services. Any long-term asset price support that may be deemed necessary could be achieved by Federal Reserve Banks auctioning term deposits, which are functionally the same as US Treasuries, but don't count as "national debt."

This change, which seems dramatic, would in reality have no effect on fiscal policy or public finance. At the most basic operation level, federal spending simply adds deposits to reserve accounts at the Federal Reserve. Whether these deposits are swapped to securities accounts is irrelevant to anything except interest rates and asset prices, as securities accounts are available to the public and reserve accounts are not.

Further, since there is no operational difference between direct reserve creation and security issuance, there is no inflation risk involved (which would not be the case for nations on a fixed-exchange rate). For nations like the US, it makes no difference whether “financing” is executed by the treasury or central bank, since both constitute government, that is, the state using its monopoly power to create currency (ask yourself: what is the difference between overnight federal reserves, and say, a two-day treasury note). The only financial difference is payments of interest, which are simply fiscal additions like any other that increase non-government net financial assets. Since all this spending is simply the issuance of tax credits and the state is the monopoly issuer of tax credits, which it accepts alone in payment of the financial obligations it imposes, there is no financial limit on the amount that the state can create.

2. Treasury should not be allowed to purchase financial assets, including bank equity. This would also limit the activities of Treasury’s Exchange Stabilization Fund to only dealing in foreign exchange. Government purchasing of financial assets should be done only by the Federal Reserve, as has traditionally been the case. When the Treasury buys financial assets (ie TARP) instead of the Federal Reserve, all that changes is the reaction of the President, Congress, economists, and the media, as they misread the Treasury purchases of financial assets as federal spending (increasing the dreaded “deficit”), which ends up limiting future fiscal options.

Conclusion

These proposals will serve to clearly bifurcate the banking system into its two important roles: providing full access to the payment system and safe savings, and granting credit based on credit analysis. These two functions should be operated distinctly, since history has demonstrated that trying to control credit through the price, quantity, or availability of liquidity has never worked. While operationally, it is already the case that credit creation is not constrained by quantities of liquidity, these proposals would make this absolutely clear to both bankers and regulators. This would free up regulatory resources to focus on the public necessity of sound underwriting, which should be the main focus of banking policy.

These proposals will quickly restore the US economy to positive growth, full employment, and establish a banking system that will promote public purpose and require less regulation while substantially reducing the systemic risk inherent in our current institutional arrangements. This is not nationalization. This is not socialism. This is not an attempt to politicize the credit creation process. It is completely possible, completely constitutional, and firmly rooted in the successful American banking system we built decades ago. This leaner, simplified system does not threaten private enterprise. It actually strengthens private enterprise by reducing the massive rent-seeking operations that our bloated financial sector has devised, which suck efficiency and demand out of our real, nonfinancial economy. Capital formation is not a magical process. It is not something that requires a great deal of complexity or intelligence.

So these reforms go far beyond Dodd-Frank and even Glass-Steagall. They will restore our banking system to the simple, boring utility system that existed in the four decades when our nation was most prosperous and our middle class most robust. If bankers want to continue to think of themselves as businessmen, they are free to do so. But the basic functions of banking will no longer be conducted under the false premise of private, competitive, market activity.

1 comment:

  1. Would it be OK if I cross-posted this article to WriterBeat.com? I'll be sure to give you complete credit as the author. There is no fee, I'm simply trying to add more content diversity for our community and I liked what you wrote. If "OK" please respond via email.

    Autumn
    AutumnCote@WriterBeat.com

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