Commentaries (some of them cheeky or provocative) on economic topics by Ralph Musgrave. This site is dedicated to Abba Lerner. I disagree with several claims made by Lerner, and made by his intellectual descendants, that is advocates of Modern Monetary Theory (MMT). But I regard MMT on balance as being a breath of fresh air for economics.
Sunday 29 November 2015
Why do governments rescue banks but not widget makers?
When a widget maker fails, government doesn’t rescue of those who funded the widget maker, and quite right. Bankruptcy of widget makers indicates resources should probably be allocated to something else. But if a bank fails, government rescues those who funded the bank, i.e. relevant depositors. Bank failures probably indicate that too much borrowing and lending is taking place, i.e. that there’s too much debt. Deposit insurance thus helps ensure that that misallocation of resources continues.
Governments only have a motive for the above nonsense where two of the basic activities of banks can be combined, namely first lending, and second, accepting deposits which are supposed to be totally safe. Banks force governments to assist the first activity by forcing them to underwrite or insure the second.
The alternative and better option is to separate lending from deposit accepting. Under that arrangement, only deposits made at the central bank or put into government debt are insured by government. Plus under that “separation” arrangement lending is funded (as in any normal corporation) by shareholders, bondholders and the like (who can lose their money). There again, there is no need for state organised insurance.
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Ralph> The alternative and better option is to separate lending from deposit accepting. Under that arrangement, only deposits made at the central bank or put into government debt are insured by government.
ReplyDeletePractical issue: such arrangement requires a sufficiently fine-mazed network, since one can't expect the whole country to present themselves in person at the central bank. Such networks don't operate free of cost (employees, offices etc). I take for granted that a subsidised network ought to be excluded. Do you have an estimate for what it would cost to risk-averse depositors to deposit and redeem their savings via the network to/from the central bank? How would these costs be charged? A fixed fee per transaction and/or negative interest on deposits?
Re costs, assuming some of the safe money goes into government debt, as I suggested above (and as suggested by Milton Friedman), then interest on that would cover some or all the costs.
DeleteRe everyone having an account at the central bank, that option is in effect already in operation in that some countries have state run savings banks (e.g. National Savings and Investments in the UK where millions of people have an account).
An alternative is for existing commercial banks to act as agents for the central bank, and charge enough to cover costs if the above interest doesn’t cover costs. Also, current / checking accounts where customers have to pay is nothing new: I pay about £12 a month for my Lloyds bank current / checking account and get sweet nothing by way of interest. Doubtless I could do better if I shopped around!
It seems to me that once we used to have such a system in Holland. It was called the postgiro, operated by the postal services. Worked like a charm.
DeleteBetter than anything the banks could offer on the transfer of money.
As the bulk of the money never left the system, it was just circulating amongst customers, therefore a huge part of it was loaned to the government. Interest payed made the system cost free to its users.
As the banks obviously didn't like the competition from the giro system they lobbied to privatize it It took of course a social democrat to sell it of and ever since we all are paying bank charges.
Very recently in Holland a new banking license has been given to somebody who has created a money transfer system using smartphone.
The idea behind it, if there is a system that allows you to send messages (whatsapp) why no a system that allows you to transfer money?
The fine mazed network you are talking about is already a thing from the past. Within a couple of years we are debiting each other accounts by the central bank (or one of its agents) by smartphone.
And for most people, the ability to transfer money is the only thing they need banks for.
https://www.youtube.com/watch?v=j84auNVGoJk&list=RDj84auNVGoJk#t=15
Oops wrong video, this is what John Cleese had to say about Giroblauw.
DeleteChris,
DeleteBankers twisting the arms of politicians and bribing them so as to get rid of any state competition for private banks has been going on for a long time. Private banks played some very dirty tricks on Abraham Lincoln (or some US president of that period) in an attempt to get rid of state created money (greenbacks).
Re smartphones (which I agree will take over big chunks of bank business very soon), I don’t think that renders the arguments in my above article obsolete because there is still the question as to who issues money: central bank or private banks.
As usual, Ralph is hot on the ball in his criticisms of bank subsidies.
ReplyDeleteTwo comments:
(a) Semantic point: "deposits made at the central bank or put into government debt" are NOT " insured by government" since there is no insurance policy. You could say they are very safe because of legal obligations of the government.
(b) It is hard to understand why you mention one of the unnecessary and very weird "cranky"proposals of Positive Money and William F Hummel, namely their proposals that all bank deposits would be outlawed except those deposited at the Central Bank. Under PM's proposal, banks (other than the CB) would merely act as agents for the CB.
PM's Andrew Jackson says "the positive money system is not a full reserve system – people don’t own bank deposits which are then backed 100% by central bank reserves, instead they actually own the ‘reserves’ themselves".
- http://clintballinger.edublogs.org/2012/12/25/can-full-reserve-banking-actually-even-stop-credit-money-creation-the-chicago-plan-v-positive-money/
No other proposals for Full Reserve banking suggest that all deposits should become liabilities of the CB.
It is is particularly strange that that you mention this weird feature of PM because you criticise it (in the blog just referenced) as being "unnecessarily bureaucratic".
PM attempted justification is the claim that Full Reserve banking "doesn’t necessarily stop banks creating money", whereas the PM proposal "does not suffer from this problem".
Actually the reverse is the case, depending on how the proposals are implemented.
Re a), government’s monopoly powers are doubtless also relevant.
DeleteRe b), the system I favour is the same as the system Andrew Jackson favours. All we seem to disagree on is the meaning of the phrase “full reserve”. He distinguishes between a system where people actually own reserves, and in contrast a system where people are owed money by a private bank, all of such money being backed by base money / reserves. I can’t see any effective difference between the two!
“No other proposals for Full Reserve banking suggest that all deposits should become liabilities of the CB.” I suggest Milton Friedman and Lawrence Kotlikoff’s versions have that characteristic. To quote from Ch3, of Friedman’s “A Program for Monetary Stability”….
He says the bank industry is split in two and one half “would be a pure depository institution, a literal warehouse for money. It would accept deposits payable on demand or transferable by check. For every dollar of deposit liabilities, it would be required to have a dollar of high-powered money among its assets in the form, say, either of Fed notes or Fed deposits.” (“High powered money” is just another name for base money.)
The other half “would be an investment trust or brokerage firm. It would acquire capital by selling shares or debentures, and would use the capital to make loans….”.
Thus it’s only the first half which accepts deposits and all those deposits are backed by or consist of base money / sovereign money / high powered money. (Why we have to have at least half a dozen names for the same thing, God knows!).
Maybe we should distinguish 4 broad types of banking reform proposals:
ReplyDelete1. The Existing System with stricter regulations, capital requirements etc.
- Bank deposits remain liabilities of private commercial banks.
- Deposits are not fully backed by safe liquid assets (or only by small reserve requirements).
- Deposit insurance continues as today, either provided commercially or provided by the Government (subsidised).
- During financial crises the Government provides "lender of last resort" loans at below market rates to banks (another form of subsidy).
- During financial crises the Government effects bailouts of "too big to fail banks" (another form of subsidy).
2. Full Reserve Banking (Chicago Plan, Fisher, Friedman, Kotlikoff, Allais etc.)
- Bank deposits remain liabilities of private commercial banks.
- Deposits are required to be 100% backed by reserves at the CB or by very safe short-term assets.
- Loans from investment banks continue to be available, financed by equity (including mutual funds) and longer term loans, but not by deposits.
- There is no threat to the payments mechanism during financial crises:
No need for any deposit insurance.
No need for any "lender of last resort" loans at below market rates to banks.
No need for any bailouts/takeovers of failing banks.
3. Zero Reserve Banking (Positive Money, Huber)
- Same as 2 (Full Reserve Banking) except that all bank deposits become liabilities of the Central Bank.
- Private commercial banks have zero reserve requirements to back deposits because they become merely the agents/contractors of the CB in the operation of the payments system.
4. Bank nationalisation (Bill Mitchell, other left wingers)
- Same as 3 (Zero Reserve Banking) except that private commercial banks are taken into Government ownership.
KK,
DeleteI agree your “1” is the existing system and that your “2” is a what’s called full reserve (sometimes called 100% reserve system).
Re 3, I don’t see the effective difference between 2 and 3. Under 2, you say “Bank deposits remain liabilities of private commercial banks.” That is, where a bank customer has £X in their account, the bank must transfer up to £X to someone else or produce up to £X in cash at ATM’s when the customer makes that request.
In contrast, under 3 you say “all bank deposits become liabilities of the Central Bank. Private commercial banks have zero reserve requirements to back deposits because they become merely the agents/contractors of the CB”. But under that scenario, private banks are obliged to do exactly the same: transfer money and produce physical cash on demand.
Even though banks continue to operate the payments system under proposal 3 (Positive Money), it is radically different because the banks don't need any reserves or other assets to back bank deposits. It is illogical to refer to this proposal as "Full reserve". It isn't. PM themselves saytheir proposal is different (see the Andrew Jackson quote I gave earlier). And PM argue (mistakenly) that their proposal 3 is superior to full reserve proposals 2.
DeleteKK,
Delete“…banks don't need any reserves or other assets to back bank deposits.” I assume that by “deposits” you mean current / checking account money: what PM calls “transaction” accounts. In that case under the PM system, banks certainly do need to match what’s in current / transaction accounts pound for pound with reserves.
The PM submission to Vickers (link below) says “This risk--‐free central bank digital money, when held in a Transaction Account, will be owned by the customer.”
Re Andrew Jackson’s distinction in the passage you refer to between full reserve and the PM system, that’s just a legalistic irrelevance I think. He says “This is why the positive money system is not a full reserve system – people don’t own bank deposits which are then backed 100% by central bank reserves, instead they actually own the ‘reserves’ themselves..”.
Far as I’m concerned, “ownership” is defined as “complete or near complete control” over something. In a system where current accounts must be fully backed by reserves, a bank customer with £X in a current account has complete control over £X of reserves, even though those reserves are technically owned by the relevant private bank.
In contrast, PM’s system has those current accounts off balance sheet in some sort of trust, with bank customers having legal ownership of reserves.
I can’t see the effective difference between those two set ups.
http://b.3cdn.net/nefoundation/3a4f0c195967cb202b_p2m6beqpy.pdf
I'm not very familiar with banking in the UK... thx for reference to National Savings & Investments.
ReplyDeleteInsofar I found, it's a state-owned bank, with all deposits fully covered by HM Treasury. Thus it's compatible with the full-reserve concept, and in particular the "deposit collection" half. I find nothing about NSI lending to non-govt parties, so I assume that NSI indeed keeps the deposits in reserve.
http://www.nsandi.com/
https://en.wikipedia.org/wiki/National_Savings_and_Investments
I see on the website that, for instance, an interest rate of 1.10% gross is offered in the Direct Saver formula, with straightforward "no notice, no penalty" access.
http://www.nsandi.com/direct-saver
Now at present "the state" (BoE) charges about 0.50% interest on loans it makes to the commercial banks ("reverse repo rate"), and "the state" (Treasury) borrows (short term) at roughly the same 0.50% ("bank rate"). At the same time "the state" (NSI) is willing to pay 1.10% interest to depositors, 0.60% more than needed and 0.60% more than what can be charged. Thus it appears to me that this 0.60% interest difference, -plus- all NSI operational costs (employees, offices, telecom, computers etc) are essentially financial aid to a financial institution covered by the state, i.e. -state subsidy-.
Is there anything wrong in this logic?
Can such a (quite high and systematic) subsidy to a state bank be justified, and how?
Erikdesonville,
DeleteYou make some interesting points. Thanks. Re your first two paras, NSI does transfer account holders’ money to OTHER BANKS, but it doesn’t issue debit cards or cheque books, so it’s not quite as flexible as a normal bank. I.e. it doesn’t perform all the functions required of a deposit acceptor under full reserve. But having the NSI offer debit cards and cheque books obviously wouldn’t be difficult.
Re interest rates, the NSI has actually paid much more than 1.1% in the recent past in that it offered inflation proofed accounts which paid interest as well (1 or 2% as I remember it). That was a boon for depositors when inflation was around 4% about 4 years ago, but obviously that inflation proofing element is worth less just at the moment.
Re your final sentence (question as to whether such a subsidy can be justified), my answer is “no”. However, I wasn’t trying to justify every aspect of NSI in the above article. I was just making the point that the NSI proves that having a state run savings bank accept deposits and transfer money as requested by account holders isn't difficult.
Ralph> Re your final sentence (question as to whether such a subsidy can be justified), my answer is “no”. However, I wasn’t trying to justify every aspect of NSI in the above article.
ReplyDeleteOkay, that clarifies your point of view.
Ralph> I was just making the point that the NSI proves that having a state run savings bank accept deposits and transfer money as requested by account holders isn't difficult.
Indeed it can be done, in several countries there have been and there still are similar state-run institutions, that are all subsidised one way or another (e.g. by piggy-backing the service onto another state-run network such as the mail system).
The real challenge, I think, is to work out a viable business model for the full-reserve deposit-collection activity -without- overt or hidden subsidies, or at least not higher than what is blamed on fractional-reserve banking. I'm rather skeptical whether that's possible at all. Frankly, this leads me to consider the full-reserve concept in its various incarnations as interesting theoretical thought experiments and just that (even though my opinion isn't carved in stone).
I can’t see the big problem in setting up a state run bank which stores and transfers money in a totally safe fashion. As far as funding the operation goes, one option (suggested by Milton Friedman) is to let the bank invest in government debt, as that’s about as safe as you can get. That would earn a bit of interest which would help fund the operation. Indeed, that’s exactly what NSI does.
DeleteIt’s also what some money market mutual funds in the US will be forced to do soon. That is, where an MMMF wants to promise depositors total safety (i.e. $X back for every $X deposited), they’ll be restricted to simply lodging the money at the Fed or buying US Treasuries.
Also, if the above interest doesn’t cover costs, then those “safe banks” will just have to charge account holders a monthly fee, and/or make a charge per cheque or per debit card transaction. But commercial high street banks already do that. So all in all, the problems are non-existent, far as I can see.
Ralph> I can’t see the big problem in setting up a state run bank which stores and transfers money in a totally safe fashion.
ReplyDeleteThere's no conceptual problem if the costs can be covered one way or another. There can be practical problems, though: former Finance Minister Varoufakis investigated plans for doing exactly that, piggy-backed on the tax revenue service in Greece, as a back-up for Greece's banking system under stress. But his boss killed the plans because too risky (politically), too difficult (technically), and too expensive (financially).
Ralph> As far as funding the operation goes, one option (suggested by Milton Friedman) is to let the bank invest in government debt, as that’s about as safe as you can get. That would earn a bit of interest which would help fund the operation. Indeed, that’s exactly what NSI does.
It's indeed as I understand it too, but that's getting difficult near the zero bound, with nominal interest rates close to zero, because John Doe doesn't like negative nominal interest or fees on his deposits. The alternative is to fall back on taxpayer coverage for the operational costs, an alternative you don't like.
Ralph> It’s also what some money market mutual funds in the US will be forced to do soon. That is, where an MMMF wants to promise depositors total safety (i.e. $X back for every $X deposited), they’ll be restricted to simply lodging the money at the Fed or buying US Treasuries.
Okay. There already are mutual funds that invest only or mostly in high-grade sovereign debt such as A and above (with correspondingly rather low return). However, since there are many thousands of mutual funds on the market (cfr e.g. Morningstar), it's a bit problematic for John Doe to sort it all out and understand what is what.
Ralph> Also, if the above interest doesn’t cover costs, then those “safe banks” will just have to charge account holders a monthly fee, and/or make a charge per cheque or per debit card transaction. But commercial high street banks already do that.
Yes. They're forced to do so to cover costs, even though many John Doe's don't like it. (It used to be "free" in the times of old, when the world was different. But there's no such thing as free, in the sense of free beer, because ultimately the costs must somehow be covered by somebody).
Ralph> So all in all, the problems are non-existent, far as I can see.
There's always a way to "word" difficult problems into non-existence. I rarely see balance sheets or numbers on your blog. But the devil is in the numbers. The challenge for finance professionals in the real word is to find viable -numbered- business models in a context of risk, competitive pressure, and the pressure of legal compliance.