I like this cynical take on Basle regulators. It’s a couple of paragraphs (abbreviated by me) from John Kay’s article in today’s Financial Times.
“At the recent Jackson Hole conference Andrew Haldane reminded policy makers of a central truth. The capital ratios calculated according to the Basle Committee on Banking Supervisions had no value in predicting the probability that a bank would fail. But a simple measure of the bank’s leverage, which anyone with a calculator could compute did. The world’s financial policy makers nodded in admiration of Mr Haldane’s analysis. Then they continued as before, congratulating the Basle Committee on its excellent work. To expect otherwise would be to miss the point of these conclaves. Their purpose is not to discover the root causes of instability. Their purpose is to give politicians and the public a sense that “something is being done”. Few processes meet this requirement for irrelevant busyness as well as meetings of the Basle Committee.”
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This is a strange article. It’s by Michel Bauwens (founder of the P2P Foundation).
He claims:
“If you ask for interest in a static pre-modern society and you need to repay more than you have borrowed, then you can only take it from someone else, thereby destroying the social fabric of non-growing societies.”
What – so a country’s legal and educational systems collapse because someone pays interest to someone else? I’m baffled. Anyway, the next sentence reads:
“This is why interest is forbidden in Islam . . . . Indeed, the only way you can pay back more than that you borrow without taking it directly from others, is by endlessly growing the economy.”
I’m baffled (for a second time).
In a “non-growing” economy, as long as interest earners spend the money they get from interest, that money just keeps circulating. I.e. a non-growing economy is perfectly compatible with interest.
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Bank regulation of the Basle, Vickers and Dodd-Frank type is getting nowhere.
The complexity of the regulations suggested by the above three is ridiculous, as pointed out by Andrew Haldane in his introduction, and John Kay (p. 9-10) and by Sebastian Mallaby in the Financial Times, and by Kenneth Rogoff. Also the need for simplification is referred to in the preface of a paper by Jan Kregel.
Moreover, the proposed changes to bank regulations do not even look like making the banking system much safer. As Mervyn King said, “Basel III on its own will not prevent another crisis…”. Or as Kenneth Rogoff put it, “Legislation and regulation produced in the wake of the crisis have mostly served as a patch to preserve the status quo.”
The solution: outlaw banks’ false prospectus.
The root problem, not spotted by regulators, is that the basic set of activities carried out by banks in their current form is fraudulent: it’s a false prospectus. This set of activities is, 1, to accept deposits, 2, to put depositors’ money in less than 100% safe loans and investments, and 3, to promise depositors their money back.
Well that just doesn’t add up: sooner or later any bank is bound to make a series of bad loans and investments, and when it does, depositors JUST DON’T GET THEIR MONEY BACK. That has happened hundreds of times in every country in the world over the centuries. And it just flies in the face of the facts and of history for regulators to claim they can prevent it happening again. The regulators have not spotted the elephant in the room.
The only occasion on which depositors DO GET their money back, given a bank failure, is when the taxpayer stands behind deposits. But that amounts to a subsidy of the bank industry: an industry which is supposed to stand on its own two feet - an industry which is supposed to be commercially viable.
To summarise, the bank industry as currently set up is quite simply in check mate: it is guaranteed at some point to fail, while the only way of preventing failure is an unjustified taxpayer funded subsidy.
Let’s outlaw the false prospectus.
The solution to the above problem is to bar banks from promising depositors their money back WHERE DEPOSITORS CHOOSE TO HAVE THEIR MONEY USED IN A COMMERCIAL FASHION. I’ll explain.
Where a bank pays interest to a depositor, the bank can only fund that interest by placing the depositor’s money in a less than 100% safe loan or investment. I.e. any depositor who wants interest on their money is acting in a commercial fashion. And it is not normal practice to have taxpayer backing for commerce. Thus where a loan or investment made by a bank goes wrong, the relevant depositors should foot the bill.
And that in turn means that “interest demanding” depositors cannot have INSTANT ACCESS to their money. That is, they can only have their money back when the underlying assets have been sold, in exactly the same way as you cannot get the money you’ve put into shares back till the shares have been sold.
In contrast, where depositors want instant access and 100% safety, they are certainly entitled to it. In fact it is arguably a basic human right to have access to a 100% safe bank account. But the only way of ensuring 100% safety is NOT TO INVEST the money. Thus no interest will be earned. So those who want complete safety must forgo interest.
That way, it’s almost impossible for a bank to go bust. The worst that can happen is a series of bad investments and loans made by banks, which in turn results in “interest demanding” depositors losing out. The net effect would be no worse than a stock market set back. As Mervyn King put it, “…we saw in 1987 and again in the early 2000s, that a sharp fall in equity values did not cause the same damage as did the banking crisis.”
In fact a system of very much the latter sort has been advocated first by Richard Werner, Positive Money and the New Economics Foundation, and secondly by Laurence Kotlikoff.
The above set of rules or regulations is of course VASTLY SIMPLER than anything dreamed up by Basle, Vickers, etc.
Money creation and loans.
The criminals, fraudsters and incompetents running our existing banking industry will of course produce a string of objections to the above idea. One is that if bank lending is constrained as above, the effect will be deflationary. Well the simple answer to that is that the government / central bank machine can counter that deflationary effect by printing and spending extra money into the economy (as pointed out by Werner and Kotlikoff).
The net result would be an economy where firms and households have a bigger stock of cash and would thus need to borrow less. The bank industry has expanded no less than TEN FOLD in the UK over the last fifty years relative to GDP. (See p.3 of this paper by Mervyn King). Anyone know what the big advantage of this has been – apart from the credit crunch and catastrophic unemployment levels? A CONTRACTION of the bank industry would probably do no harm at all.
Moreover, loans do not need to come from institutions which have made the absurd promise to their creditors that the latter are guaranteed their money back. For example if someone lends to a non-bank corporation by buying its bonds, the corporation does guarantee bond holders their money back. And if someone lends to a small business run by a friend, the lender knows perfectly well they may not get their money back.
Another objection which the above criminals, fraudsters and incompetents will raise is that there is no need for 100% of loans and investments made by banks to be covered by loss absorbing creditors (whether those loss absorbers are shareholders, bondholders or interest demanding depositors is pretty immaterial). That is (as Martin Wolf has suggested) a DECENT LEVEL of loss absorbing buffer would do the trick.
The answer to that is, first, that as soon as loss absorbing is at less than the 100% level, the criminals, fraudsters and incompetents will lobby and bribe politicians into having the level progressively reduced till there is practically no loss absorbing capability left – apart from the taxpayer, of course. (Criminals, fraudsters and incompetents in Britain spend £92million a year lobbying politicians). And the criminals, fraudsters and incompetents are ALL FOR taxpayers rescuing them when things go wrong.
I.e. the 100% level is a clear line in the sand.
Second, it is fair enough to criticise a very high level of safety IF THERE ARE SIGNIFICANT COSTS INVOLVED IN ACHIEVING THAT LEVEL OF SAFETY. But Martin Wolf in the above mentioned article failed to specify what those costs were. And if someone of Martin Wolf’s intellectual calibre cannot argue a particular point, the criminals, fraudsters and incompetents certainly won’t be able to do so.
Full reserve banking.
A final twist to this tale is that the system advocated above actually amounts to full reserve banking (that’s a system where just the central bank creates money, not private banks). Reasons are thus.
Under our existing banking set up a bank can accept a deposit of £X and lend it on while still allowing the depositor access to their £X. Thus both the depositor and borrower now have £X in the bank: an extra £X has appeared from nowhere.
In contrast, under the set up advocated above, banks cannot do this. That is “interest demanding” depositors can only get access to their money when a chunk of the underlying assets have been sold. Thus the relevant bank does no create any money out of thin air.
As to depositors who want 100% safety, their money is not invested. Nothing is done with their money, so no “private bank money creation” takes place there either.
We should all be grateful to James Dorn, Editor of the Cato Journal, for his inspiring letter in the Financial Times on 4th September. This explained something that no one had hitherto worked out, namely that excessive money printing a la Mugabwe leads to inflation. He deserves a Nobel Prize for that.
Of course another explanation for the above letter is that the Cato Institute is a mouthpiece for the Koch brothers: the latter have donated $30m to the institute over the years. And rich people just cannot stand the idea of government printing money and distributing it to poor people so as to raise demand and revive the economy. Oh, but I'm being too cynical.
My sources in the Cato Institute tell me that this institute will shortly be making two further state of the art, paradigm changing revelations. One is that water is wet. And the other is that grass is green.
Don’t you just love American right wing crazies?
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Glass-Stegall is commonly associated with the separation of commercial or High Street banks from investment bank type operations.
G-S has imitators like the proposals put by Britain’s Independent Commission on Banking in 2011 and the proposals by the Financial Times economics commentator, John Kay. (See his page 51-2 in particular. And if you think his ideas are vague and muddled, that is not much different to Vickers, which in turn is not much different to G-S, as is shown below.)
G-S type provisions separate banks into two groups: the RELATIVELY risky, where depositors and other stake-holders are not backed by taxpayers, and the RELATIVELY safe, where depositors often get taxpayer backing.
Unfortunately, SOME OF the activities carried out by the supposedly safe group still involve risk (as indeed is implied by the above word “relatively”). For example Northern Rock was a standard high street bank: it did not engage in investment bank type activity (except that it funded itself from wholesale money markets to a greater extent than other banks). But Northern Rock clearly indulged in risk taking.
Plus, Northern Rock has now reverted to offering 100% mortgages: exactly the sort of behaviour that caused its down fall. And it did not even take much lobbying of politicians by bankers to enable this risky behaviour because Northern Rock is nationalised.
And not only do “relatively” safe banks (or bank divisions) involve risk: the above mentioned taxpayer backing constitutes an implicit subsidy of COMMERCE: e.g. loans by high street banks to small businesses and to mortgagors. And there is no excuse for subsidising commerce.
This is clearly a mess.
100% safe accounts.
One reason for trying to separate the safe from the unsafe is to provide 100% safe bank accounts for households while not using taxpayers’ money to back deposits by or loans to commercial organisations, particularly the investment banking type. And quite right: there is no excuse for subsidising commerce in any way. But G-S fails in this regard.
That is, when anyone deposits money at a high street bank and the bank uses the money to make loans to or investments in commercial entities, or lends to mortgagors, then commerce is being subsidised because the latter deposit is taxpayer backed.
To illustrate, if I invest in corporation X, Y and Z (or in a small business), I get no taxpayer backing, and quite right. But if I deposit money in a bank, which in turn lends to or invests in corporation X, Y and Z (or small businesses) and those corporations / businesses fail and bring the bank down with it, I get rescued by the taxpayer.
THAT IS PURE UNADULTERATED FALSE LOGIC. IT’S BARMY.
Where to draw the line.
So rather than draw the line between TYPES OF BANK, the line should be drawn between sums of money or bank accounts that DEPOSITORS want invested or loaned on by their bank and which get no taxpayer backing, and in contrast, sums / accounts that DEPOSITORS want to be 100% safe and which do get taxpayer backing. The former can earn interest reflecting the fact that the relevant money has been invested, while the latter accounts CANNOT earn interest: reflecting the fact that no risk is taken with the money as it’s supposed to be 100% safe.
If that is done, then NO COMMERCIAL ACTIVITY IS SUBSIDISED.
Full reserve banking.
Now bizarre as it might seem, the above sort of separation by TYPE OF ACCOUNT is pretty much an inherent characteristic of full reserve banking. (This is better than reconciling general relativity with quantum mechanics!!)
Under full reserve, commercial banks cannot create money, as they currently do. That is when making a loan under full reserve, the bank must find a depositor willing to relinquish access to their money for the period of the loan, or at least for some minimum period.
Without the latter provision, money creation takes place. To illustrate, if I deposit £X in a bank under our current fractional reserve system, and the bank lends on the £X, then both the borrower and I have £X in the bank. £X has been turned into £2X.
But we obviously cannot have depositors losing instant access to all monies deposited at banks. Therefor instant access accounts are required. But to ensure that no money creation takes place, money in instant access accounts cannot be loaned on.
Now who is going to decide whether a particular sum deposited in a bank is to be loaned on or whether it’s to be instant access? Well, just as is currently the case with deposit accounts and current accounts, the depositor decides. That is, depositors CURRENTLY have a choice at most banks as to how much of their money to put into current or “checking” accounts (U.S. parlance), and how much to put into term accounts. We can’t for example have banks or governments laying down the law as to what proportion of everybody’s money will be instant access.
So under full reserve / the ideal alternative to Glass-Stegal, the line between the safe and riskier banking activities is taken by depositors.
Conclusion.
Glass-Stegall is illogical. What WOULD MAKE SENSE is a few alterations to practice already adopted by many banks, and as follows.
1. Money in current or checking accounts cannot be loaned on, and hence it earns no interest, but it does get taxpayer backing.
2. Money in term accounts can be loaned on or invested, and such money can earn interest. But it gets no taxpayer backing because the depositor is acting in a commercial manner.
Moreover, that way it’s near impossible for a bank to go bust: if a bank makes a series of bad loans or investments, then depositors who have decided to act in a commercial manner (i.e. who want interest on their money) take a hair-cut. If that happens big time to a SERIES OF banks, then the effect is not entirely problem free. However, it’s no worse than a stock market crash, and that does not imply the destruction of the economy’s basic money transfer or payments system, nor are trillion dollar bank bail outs needed.
The above full reserve / alternative to G-S arrangement might easily result in bank loans being harder to come by, but that can easily be made up for by having government / central bank create and spend more money into the economy.
If someone who wants a new laptop can pay cash for it instead of having to borrow the money to buy it, is that a problem?
I always had a low opinion of Martin Feldstein, but this article of his is rock bottom. (hat tip to Frances Coppola)
Both he (and apparently the Fed) think that private banks can be dissuaded from lending their excess reserves by having the Fed raise the interest paid on reserves. Feldstein and the Fed need to Google the phrase “banks do not lend reserves”. They’ll find plenty of articles to put them straight on that one.
When the private bank system sees a series of profitable lending opportunities, it creates money out of thin air and lends it out. The Fed can pay 8%, 18% or 28% on reserves: it won’t have the slightest effect given the large excess stock of reserves that private banks currently have.
If the Fed wants to pay 28% on reserves, it can. Private banks will just – laugh all the way to be bank. Or put it another way, they’ll just be helping themselves to even more billions of taxpayers’ money than hitherto.
As to when reserves drop to their minimum level relative to deposits at private banks (10% for large banks in the U.S. as I understand it), that’s a slightly different scenario. That is a QUANTITATIVE control. But assuming private banks continue to see profitable lending opportunities, the result will just be a rise in interest rates.
The Fed at that point could of course say “this has gone far enough – it’s time to raise interest rates”. But given the 10% reserve requirement and continued profitable lending opportunities, interest rates would (to repeat) rise anyway. Which makes the Fed’s interest rate adjustments look somewhat irrelevant.
And indeed they are. As suggested above, the fundamental point is aggregate demand which in turn determines the amount of profitable lending opportunities.
Of course lending itself influences demand. But the basic cause effect runs from demand to profitable lending opportunities. So how about abandoning interest rate adjustments as a means of regulating the economy – or at least demoting interest rate adjustments to a regulatory tool to be used only occasionally and in emergencies? That’s the policy advocated on p.10 here.
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Supposedly august economics institutions continue to repeat a popular bit of nonsense on the subject of fiscal consolidation.
The nonsense is nicely encapsulated by a passage written by John Plender in the Financial Times. He refers to “The unbearable tension between the short-term requirement to lift the economy and the longer-term need for fiscal consolidation..”
If you don’t immediately see the nonsense there, then I suggest you’re not up to speed on deficits, national debts, consolidation, etc.
Much the same nonsense appears in the National Institute Economic Review. They say, “…it is clearly the case that over the medium to long term fiscal consolidation is essential for debt sustainability . . . . In this paper we assess the impact of the scale and timing of this fiscal consolidation programme on output and unemployment in the UK.” (That publication is produced by the National Institute of Economic and Social Research (NIESR)).
You’ll have no trouble finding other articles and papers that repeat the “Plender / NIESR consolidation” nonsense. E.g. see the passage starting, “The calculations do not take into account…” in this OECD paper.
The flaw in the above quotes is thus. (Incidentally it’s just monetarily sovereign countries like the U.S., Japan or the U.K. considered here. Individual Eurozone countries have a very different set of problems.)
The above quotes imply that a country with a national debt that is expanding relative to GDP as a result of its deficit must at some point put the process into reverse, or at least bring the debt expansion to a halt. But – shock horror – reversing the process will hit the recovery, or at least be deflationary.
And that gives rise the $64k allegedly difficult question as to WHEN TO REVERSE the process and by how much, a question which keeps hundreds of so called economists employed at the taxpayers’ expense.
Deficits no not necessitate rising debts.
The first bit of nonsense in the Plender / NIESR idea is the assumption that a deficit means an expanding debt. As both Keynes and Milton Friedman (and numerous other economists) have pointed out:
DEFICITS CAN ACCUMULATE AS EXTRA MONETARY BASE RATHER THAN AS EXTRA DEBT.
Thought I’d put that in capitals and in colour for the benefit of NIESR and OECD staff have never heard of Keynes or Friedman.
Oooh la la, but money printing is inflationary, isn’t it?
A possible response from the above is that having a deficit accumulate as monetary base equals money printing or “monetising the debt”, the effect of which is inflationary.
Well David Hume answered the latter point 250 years ago. As he pointed out, a money supply increase only has an effect on inflation to the extent that it is SPENT.
To be more accurate, given significant spare capacity, a money supply increase, EVEN IF IT IS SPENT, will initially just affect demand rather than inflation. And that’s exactly the effect required! Raising demand gets us out of the recession.
(Provisional conclusion: the NIESR, the OECD etc are 250 years behind the times.)
Why monetisation makes sense.
To repeat, Keyes and Friedman pointed out that a deficit can accumulate as DEBT OR BASE. When it accumulates as debt, the effect (surprise surprise) is to expand the amount of debt held by traditional holders of debt: wealthy individuals, pension funds, etc.
However, the continued recession is being caused to a far greater extent by reluctance by households, particularly underwater households to spend rather than by reluctance of wealthy individuals or pension funds to spend. Thus we’d probably get a lot more “bang per buck” for what that’s worth from having the deficit accumulate as base, and channelling that extra base into the pockets of ordinary households rather than channelling extra debt into the pockets of the wealthy and pension funds.
Let’s assume no monetisation.
However, let’s assume no monetisation, i.e. let’s assume the standard “deficit expands the debt” scenario.
The Plender / NIESR / OECD argument, to repeat, is that the expansion of the debt must come to a halt or be reversed at some stage, therefor we might as well start thinking about how and when to “halt / reverse” even if the effect hits economic growth a bit.
The REALITY is that national debt is an ASSET as viewed by the private sector entities holding that debt, and those entities will not continue expanding their holding of said assets indefinitely. That is, a point must come at which they start trying to spend or divest themselves of those assets. In particular, debt holders receiving cash for debt that reaches maturity will not re-invest the cash in new government debt: they’ll try to spend the cash. And when that happens, demand rises: the recession comes to an end.
I’ll put that in more graphic form for the benefit of the NIESR, OECD, etc. If you steadily increase the bank balance of a household, what's the household likely to do? Just continue to let the balance increase ad infinitum?
Anyone with a grain of common sense appreciates that the effect is to increase the household’s spending. What do people or households do when they get a tax rebate or win money on a lottery?
Difficult one that, isnt’t it? Um . . . er . . . THEY SPEND SOME OF THE RELEVANT MONEY!!!!! Doh.
In short, the fact that at some point the expansion of the debt will have to be stopped is not an argument for stopping it BEFORE it looks like the recession has ended. That is, the point at which to stop the debt expanding is when the private sector starts spending at a rate that brings full employment.
And taking the point even further, the point at which to run a surplus and contract the debt is when the private sector gets too confident, or goes into “irrational exuberance” mode, and starts spending at a rate that looks likely to exacerbate inflation in a serious way.
The NIESR gets it right in the end.
But credit where credit is due: the NIESR article does come to the right conclusion in the end (after spending probably tens of thousands of taxpayers’ money in the process). But they needn’t have bothered. The conclusion is intuitively obvious to anyone with a grasp of economics.
MMT speak.
To put the above point in “Modern Monetary Theory speak”, a monetarily sovereign government does not need to tax or borrow because it can print money anytime. Therefor tax and borrowing must have some other purpose.
The purpose of tax is to counteract the inflationary effect that would arise from a simple “print and spend” operation. And the purpose of borrowing is to provide the private sector with a stock of net financial assets such that the private sector spends at a rate that brings full employment (though quite what the point of issuing INTEREST PAYING debt is, rather than NON-INTEREST PAYING DEBT (i.e. cash) is, is a mystery). Milton Friedman advocated the abolition of interest paying debt.
