Tuesday, 19 March 2013

Bank regulators fail to deal with building societies – but full reserve banking does.

In relation to building societies (“savings and loan” in the US), Mervyn King said recently “There is a separate issue about mutuals and building societies in general, which has never been resolved. It is how you ensure that there is an adequate loss-absorbing capacity before the depositors are called upon to bear losses, given that in a mutual organisation they are, in effect, the shareholders.”  (See question 4510).
The big problem with mutuals is that, as King rightly points out, depositors are in effect shareholders, yet when the assets of a mutual exceed its liabilities, the “depositor / shareholders” don’t have a piece of paper that actually records those assets.  That is, the statements that depositors get from mutual are misleading.
Worse still, if a mutual’s liabilities were to exceed its assets, the piece of paper or statements possessed by depositor / shareholders would actually be fraudulent. That is, they would claim a depositor had assets of £X when in fact the depositor’s assets in the mutual were LESS THAN £X.
The solution to this problem is simply to outlaw the misleading or fraudulent nature of mutuals. Mutuals need to “come clean”. Put another way, the statements they issue to depositor / shareholders should state the truth. Now that’s a novel idea, isn’t it?

Full reserve.
The latter “statement of the truth” occurs automatically under full reserve. The basic rule under full reserve is that depositors can choose between two types of account: safe and investment accounts. (See previous post for more on this.)
A depositor who opts for a safe account and lodges £X is guaranteed to get £X back. The bank or building society owes the depositor £X – not a penny more and not a penny less.
In contrast, where a depositor opts to have their money loaned on, they get an “investment” account. And the value of their holding (at least under the full reserve system advocated by Laurence Kotlikoff) varies with the value of the underlying loans or investments.
So that solves the problem that Mervyn King and the regulators apparently cannot solve: “…how you ensure that there is an adequate loss-absorbing capacity before the depositors are called upon to bear losses”.
Indeed, the answer to the problem was almost spelled out by King himself. That is, as he rightly said, in a mutual, depositors are in effect shareholders. So why not just come clean and admit that – er – “depositors are shareholders”?
And when sending statements to those with investment accounts, why not just be honest and print in black and white and ACTUAL VALUE of the stake that such depositors have in the mutual?
As to King’s idea that you can somehow have “adequate loss-absorbing capacity before the depositors are called upon to bear losses..”, well that’s pure fantasy. The REALITY is that in a mutual, there is NO ONE to bear losses before depositor / shareholders bear losses. You cannot have someone bear a loss (or take a profit) when that person doesn’t exist!!!
Problem solved.


  1. Not quite sure why you and Merv are beating up the building societies. I don't think it is they who have been the cause of most of the problems in the financial sector in the last 5 years or so.

  2. Fair point. Merv made his point in passing, rather than making a song and dance about it. But his point is valid: the way current attempts at bank regulation deal with building societies is logically inconsistent with the way banks are treated. Or should I say that’s one of the many pieces of false logic in current proposals for bank regulation.


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