How much does Sir John Vickers know about banking?

I’ve just stumbled across a discussion paper written in 2012 by John Vickers. He was chairman of the UK’s “Independent Commission on Banking”, which was the official UK government enquiry into what to do about banks in the wake of the 2007/8 bank crisis. Title of John Vickers’s paper is “Some Economics of Banking Reform”.

Starting on his page 15, he makes three criticisms of Narrow Banking. He starts (to quote): “First, as the crisis has underlined, even government bonds are not necessarily safe liquid assets.”

Whaaaaat? So has the UK government reneged on its debt any time in the last century? Not that I know of! And same goes for numerous other relatively well run countries: the US, Canada, etc.

Of course there are the Zimbabwes and Argentinas of this world, and anyone living there should be free and indeed is free to stock up on other assets. E.g. the US dollar circulated widely in Zimbabwe when Mugabe ran the country.

But John Vickers doesn’t bother distinguishing between the UK, the country he is supposed to be concerned with, and the Zimbabwes and Argentinas.

Conclusion: John Vickers claim that government bonds might not be safe is a joke.


Vickers’s second alleged “problem”.

This runs, to quote, as follows. “Second, despite large government debts, there might not be enough government bonds to back retail deposits, especially of short-to medium-term maturity.”

Well the simple answer to that is that if depositors thought they were short of deposits under narrow banking, they’d try to save money so as to acquire their desired stock, and that would show up as Keynes’s “paradox of thrift” unemployment. Hence the state (i.e. government and central bank) would simply create and spend more base money into the private sector, thus supplying all and sundry with the stock of base money they wanted. Problem solved!

Indeed, that “short of state supplied paper assets” phenomenon occurs under the EXISTING system.

I have of course assumed just above there that it is base money at the central bank which backs retail deposits rather than government debt. But as Warren Mosler explained, there is precious little difference between the two. That is, government debt is simply base money that has been deposited with government for a period and on which interest is earned.

Indeed, the relative size of the stock of base money and government debt is entirely within the control of the state (government and central bank). That is, if the state offers a more generous rate of interest on government debt, clearly the private sector will convert some of its stock of money to government bonds.

But the decision as to what that relative size should be has precious little to do with the above points about the TOTAL size of the two stocks and the paradox of thrift point. (MMTers actually sometimes refer to the sum of those two stocks as “Private Sector Net Financial Assets”.



Vickers’s third alleged problem.

This starts: “Third, narrow banking could lead to a very inefficient misallocation of resources.  Natural holders of government bonds such as pension funds would find them in short supply, while credit in the economy was deprived of a prime funding source –deposits.”

Well that point has already been answered above: to repeat, if the private sector, or specific sections of the private sector are short of base money / government debt, they will save so as to acquire their desired stock. That would raise unemployment, which would induce the state to supply more of those state issued paper assets.

So . . . . problem solved! John Vickers’s “problem” vanishes into thin air.

There is, it could be argued, one remaining problem, namely that in a very low interest rate environment, pension funds are short of what they really want, namely government bonds which yield a decent rate of interest. Well the answer to that is: “tough”. None of us who have a credit balance at our high street banks are getting as much interest as we did twenty years ago. But what of it? Does that mean the sky falls in? And do those who have stashed away a large pile of money (pensioners or not) have any sort of God given right to a generous rate of interest on that money? No it doesn’t.

And the final part of Vickers’s above alleged “problem” is that “ credit in the economy” is “deprived of a prime funding source –deposits.”

Well unfortunately the fact that one source of X, Y or Z declines does not prove other sources won’t jump in to fill the gap or at least largely fill it. Borrowers have NUMEROUS sources of credit: 1, trade credit, 2 peer to peer lenders, 3, unit trusts and mutual funds lend in that they buy bonds issued by corporations, cities etc, 4, pension funds do the same. I could go on. And the total amount loaned via the latter lenders rivals the amount loaned by banks.

Second, under narrow banking, bank loans do not dry up: it’s just that those who fund loans carry the risks, unlike under the present system where risks are carried by taxpayers (via taxpayer backed deposit insurance and billion dollar bailouts for banks in trouble).

But the latter privileges for banks, as should be obvious, amounts to a subsidy of banks, as I explain in more detail here. And subsidies for particular firms, or sets of firms, results in those firms competing on a non level playing field basis with other firms. And it is widely accepted in economics that subsidies / non level playing fields do not result in GDP being maximised.

https://mpra.ub.uni-muenchen.de/99989/1/MPRA_paper_99989.pdf


Ooh la la. We all love “synergies” don’t we?

Vickers’s final sentence of his third objection reads “Narrow banking would also lose the natural synergy that exists between deposit-taking and the provision of overdraft facilities.”

Well unfortunately the simple fact of a synergy existing does not justify the synergy. Doubtless I could l find “synergies” in the world of illegal drug dealing, murder, crime in general, dealing in firearms and so on. I rather doubt the mere existence of any synergies there would JUSTIFY the synergies.

 
Vickers’s fourth point.

This is that, to quote, “Fourth, deposit-taking and payments systems are not the only banking services for which continuous provision is essential; the same is true of some credit supply, which would happen outside the narrow bank.”

Well true. But there's no chance of “credit supply” disappearing just because we move to narrow banking. As just explained above, there are numerous sources of credit other than banks.

It is however true that if one source of credit (or anything else) gets more difficult, then the market price for the item concerned will rise – in this case, interest rates would probably be higher under narrow banking than under the existing bank system.

But what of it? Interest rates are now at a record fifty year low, and the consequences of that record low are not entirely beneficial. As a Bank of England study shows (and as is indeed no more than common sense) the decline in interest rates over the last two decades is one of the major causes of the rise in house prices: that is, given a fall in interest rates, borrowers will pretty obviously run out and borrow more with a view to buying a bigger house.

In addition, a fall in interest rates tends to cause a rise in GENERAL indebtedness, and if there’s one thing the great and good like wittering on about, it’s the alleged horror of the latter general rise in debt.

So this all raises a big question: what is the OPTIMUM rate of interest, or will narrow banking rather than the existing bank system tend to give us an optimum or GDP maximising rate of interest?

Well a simple answer to that is that the default assumption in economics is that free markets maxmise GDP, except where it can be shown that markets do not work well.

In the case of the narrow banking versus existing bank system argument, under the existing system, banks get preferential treatment relative to the other above mentioned lenders (peer to peer lenders, trade credit lenders etc) in that banks are backed by taxpayers (billion dollar bail outs etc). And that is not a genuine free market. It is not a level playing field as between banks and other lenders and that non level playing field does not maximise GDP.

The conclusion is therefore that, despite the rise in interest rates that narrow banking might bring, the rise in interest rates would be a rise to something nearer a genuine free market rate of interest. Ergo narrow banking would result in a higher GDP and output per hour than the existing bank system. And for more on that point, see this MPRA article entitled “The Crucial Flaw in the Bank System.”


Conclusion.

It would seem that Sir John Vickers is rather a long way short of being clued up on banks.