Monday, 3 September 2012

The false logic behind Glass-Stegall.

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.


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.


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.



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?

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