John Cochrane advocates full reserve banking, sort of.

John Cochrane (economics prof in Chicago) more or less advocates full reserve banking (FR). In line with Milton Friedman, James Tobin, Laurence Kotlikoff and other advocates of FR he advocates that institutions that advertise their deposit accepting facilities as being totally safe should invest depositors’ money only in base money or short term government debt.

As to entities / banks which lend to mortgagors, businesses etc Cochrane suggests a 30% capital ratio rather than the 100% ratio favoured by Friedman, Tobin etc. Certainly the REALLY BIG improvement in bank safety comes from upping the ratio from the ridiculous pre-crisis 3% to 30%, while relatively little improvement is gained from taking that right up to 100%. However there are some good arguments for the 100% ratio, which are briefly as follows.

1. The 100% ratio costs nothing because of Modigliani Miller.

2. As long as there is ANY SORT of bank subsidy or guarantee offered by government (deposit insurance, lender of last resort at favourable rates of interest, etc) then private banks are being subsidised, and subsidies misallocate resources and reduce GDP.

Now what sort of capital ratio would induce governments to make it clear that NO SORT OF backing for commercial banks is available? 30%? 50%?

Say it’s 50%. But there’s a catch: in that scenario if anything DID GO seriously wrong with a bank, then depositors and bondholders might be in for a hair cut. That is, they’d be shareholders of a sort. So why not just cut all the shilly-shally and make it 100%?

3. 100% is a nice simple number: it’s a clear line in the sand. Anything less than 100%, and you can bet that over the years bankster-liars will bribe and cajole politicians and regulators into cutting the percentage down to 3% or so. Roll on the next crisis.