Hoenig is a former vice chairman of the Federal Deposit Insurance Corporation, and I stumbled across an odd little note about him or by him recently here, which does not seem to have an official publisher or date of publication. Anyway, he makes an interesting point, so I thought I’d reproduce it here (particularly since its not having an official publisher means it could disappear from the internet at some point).
I’ve reproduced it in green below and also taken a screen shot of it in GIF form (see below). If you click on the GIF image, save it, and then open it, you’ll find it’s legible, but only just. At least that’s how it worked out on my PC.
His basic point is that deposit insurance is ipso facto a subsidy for banks in that it means those who fund banks, depositors in particular, are backed by an insurer with an infinitely deep pocket, whereas other lenders (of which there are many types) do not enjoy that luxury.
Those other lenders include mutual funds, unit trusts, pension funds and wealthy individuals who lend to corporations when they buy corporate bonds. Plus there are millions of people who lend to small businesses run by friends and relatives.
One of the main excuses for deposit insurance is that it results in private banks’ home made money being a totally secure form of money (as distinct from where there is no deposit insurance, in which case so called deposits are to some extent a form of equity in that depositors stand to lose money if their bank makes a mess of things.)
But that excuse is a trifle feeble, in that CENTRAL BANKS have for decades if not centuries provided anyone who wants it with a very safe form of money. First there are physical £10 notes, $100 bills etc, and second there are accounts at state run savings banks (like “National Savings and Investments” in the UK). The latter accounts amount to something not vastly different to “Central Bank Digital Currency”.
So…. given that everyone ALREADY HAS a totally safe form of money available to them, arguably we do not need deposit insurance which (as mentioned above) results in a non level playing field as between different types of lender (banks versus other types of lender, to be exact).
I actually expand on the latter point in a forthcoming article, but that’s all I’ll say on that point for the moment: the main point of this post, to repeat, is to reproduce Hoenig’s ideas.
Hoenig’s “note” is as follows…
The government safety net of deposit insurance, central bank loans, and ultimately taxpayer support provides a multibillion dollar subsidy to firms that engage in both commercial and investment banking. This government backstop means that they have cheaper access to funding and face less discipline from the market. The subsidy, in turn, creates incentives to take excessive risk directly through risky investments and greater leverage. For example, they can cover – and even double-down -- on their trading positions by using insured deposits or central bank credit that comes with the commercial bank charter. Their competitors that don’t affiliate with a commercial bank have no such access to the safety net and its subsidy, and thus no such staying power, putting them at an enormous competitive disadvantage and eventually leading to consolidation. While trading and investment banking activities are important to the success of an economy, there is no legitimate reason to subsidize them with access to the safety net. Furthermore, the excessive risk and greater industry consolidation that is brought about by the subsidy has created a more fragile economy and, therefore, greater risk for the American taxpayer.
The safety net’s protection should be limited primarily to those commercial banking activities for which it was originally intended: stabilizing the payments system and the intermediation process between short term lenders and long-term borrowers. That is, it should be confined to protecting activities essential to a well-functioning economy.
Vice Chairman Hoenig is calling for statutory changes to place noncore financial activities such as proprietary trading, market making, and derivatives outside of the commercial bank – and thus outside of the safety net. Broker-dealers would be free engage in these activities where they would be subject to the forces of market discipline and have greater incentives to innovate and thrive.
None of these reforms would be effective unless the shadow banking system is also removed from the safety net. Therefore, Vice Chairman Hoenig is calling for requiring that money funds represent themselves for what they are: uninsured investments, the value of which changes daily. And he is calling for disciplining the repo market by subjecting repo lenders that accept mortgage-related collateral to the same bankruptcy laws as other secured creditors.
Confining the safety-net to what it was intended will not eliminate crises. But it will allow the economic system to handle them, and it will return the financial services industry to a simpler, more competitive and pro-growth footing.
The GIF:
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