Laurence Kotlikoff's latest book.

This book is a scathing indictment of the U.K.’s Vickers commission report on banking, and with good reason. The opening sentence of the Executive Summary reads:

“The Independent British Banking Commission, the Vickers Commission was charged with keeping the British economy safe from another major failure of its banking system – a failure from which the UK economy is still reeling. Unfortunately, it’s done nothing of the kind.”

And later in the summary, Kotlikoff says,

“Instead of fixing the real problems with banking - opacity and leverage – the Vickers Commission Report pretends to fix banking by re-arranging the deck chairs.”

The book is short: roughly 25,000 words. But quality is more important than quantity.

The Vickers commission proposes splitting banking into two categories (in a similar way to Glass-Steagall). There are “High Street / retail” banks (or bank subsidiaries), and in contrast “casino / investment” banks (or bank subsidiaries), and the two are allegedly separated by a “ring-fence”.

Some basic points made by Kotlikoff are as follows.

1. Vickers HINTS that it would let investment banks go bust. But as is obvious from the demise of Lehmans, it is very doubtful as to whether that was a good idea. The consequences were disastrous. So would Vickers let investments banks go bust? They aren’t clear on that one.

2. Vickers proposals would not have saved Lehmans.

3. Several crucial decisions as to what needs to be done to effect the much vaunted ring fence are just not taken by Vickers. That is, the Vickers report leaves those decisions to “the regulators”. (That’s the folk with a proven inability to regulate banks.) As Kotlikoff says in his conclusion, “The Commission’s proposals are a full employment act for regulators.”

Incidentally, Kotlikoff missed a trick here. One of decisions you might think Vickers would have taken in relation to it’s “ring-fence” is the decision as to whether ring-fenced banks can lend to large corporations. But they shy away from that decision (top of p.12 of the Vickers report).

4. Vickers fails to deal with the central problem with banking in its present form. This is that banks can promise to return £X to depositors for every £X deposited at the same time as investing or lending on that money in ways that are nowhere near 100% safe. And as soon as those investments / loans turn out to be worth significantly less than their face value, the bank is bust. How many European banks are currently bust in all but name? We don’t know.

The solution is to bar banks from taking the above risk: that is, it’s depositors who have to take the risk. Under Kotlikoff’s “narrow banking” proposals, a depositor can let their bank do anything they like with their money. If a depositor wants their money invested in for example the chemical industry, the money goes into a chemical industry mutual fund (unit trust in the UK). And the value of those funds / trusts rises and falls in line with the performance of the underlying assets.

As to depositors who want instant access to their money and 100% safety, they put their money into cash mutual funds. I.e. the money in effect is not invested or loaned on at all.

That way, depositors can certainly lose out on their fund/trust investments (cash funds apart), but it’s almost impossible for the bank to go bust.

5. As to Vicker’s reaction to narrow banking, it is obvious they just didn’t understand the concept. Vickers deals with narrow banking in paragraphs 3.20 to 3.24. And this section has the bizarre heading “Should credit provision to individuals and SMEs be prohibited?”: the implication being that narrow banks don’t lend to individuals and SMEs (Small and Medium Size Enterprises). The suggestion is of course complete nonsense. Narrow banks would offer, for example, mortgages to households just as banks currently do. It’s just that the lending is done (under the Kotlikoff model) via mutual funds.

There is actually plenty of nonsense in this section NOT DEALT WITH by Kotlikoff, which I’ll deal with here in a week or two.

6. Another curiosity to which Kotlikoff draws attention (Ch.5) is the way in which British establishment figures have on the face of it changed their minds on narrow banking. Both Martin Wolf and Mervyn King expressed approval of the idea a few years ago, but now disown the idea, and for reasons which are not clear. Possibly knighthoods and lordships have been offered by David Cameron to those concerned as long as they don’t interfere with the Tory Party’s source of funds: the criminals and fraudsters who run banks.

Or possibly the British establishment when they are in disarray (e.g. haven’t a clue as to how to organise banks) cling together under some very conventional and conservative set of ideas.

7. Kotlikoff rightly draws attention to another basic point that Vickers & Co didn’t understand, which is thus. Vickers was much concerned about restrictions to liquidity that might flow from restricting bank activities. The answer, as Kotlikoff rightly points out (Ch.5, p.61) is that the government / central bank machine can supply any amount of liquidity any time (inflation permitting) simply by printing money and spending it into the economy.

Put another way, do we want the nation’s money supplied to us by spivs, criminals and fraudsters or by government?

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