Thursday, July 11, 2013

The Financial Times struggles with bank leverage.

Today’s FT second leader entitled “Restraining Banks” advocates better bank leverage but ends by warning that even if better leverage is imposed, banks will still be tempted to “load up on the riskiest assets available..”.
Well wakey wakey FT: that problem has been solved by Laurence Kotlikoff, Positive Money and others. The solution is to make depositors who want their bank to lend on or invest their money be FAIRLY SPECIFIC as to what is done with that money, and to make those depositors carry the downside risk where there actually is a significant risk.
That way, depositors can get whatever they want. E.g. if they want near 100% safety, their money could for example just be lodged at the central bank or invested in short term government debt. And government could provide a guarantee of those deposits.
There’d by next to no subsidy or taxpayer exposure there because the money is as good as 100% safe ANYWAY.
As to something slightly more risky, depositors could choose to fund mortgages where the householder had a minimum equity stake of say 30%. That again would as near 100% safe as makes no difference. And perhaps taxpayers could guarantee that sort of investment as well, or perhaps government would undertake to foot the bill for only half of any losses.
As to anything more risky which pays fancy rates of interest, government should steer well clear of that. Depositors are on their own.
And the beauty of all that is that banks would be forced to charge realist rates to risky borrowers.
In other words no longer would banks be able to grab grandma’s savings (which pays grandma a miserable 2%) and use the money to bet on dodgy derivatives yielding the bank 20%.
The only way a bank would be able to get hold of money to bet on dodgy derivatives would be to get money from depositors who had specifically asked to have their money fund dodgy derivative bets. And those depositors would want a good 15% for taking that risk. And that in turn would severely limit banks’ freedom to behave irresponsibly.

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