Adair Turner’s main objection to full reserve banking.

Chapter 12 of Turner’s recently published book, “Between Debt and the Devil” claims that full reserve banking (FR) is flawed. I dealt with what I think are some weaknesses in Turner’s criticisms of FR here yesterday.

What he calls his “most fundamental” reservation about FR is that “..there may be some positive benefits to private rather than public creation of purchasing power.”

He continues, “..it could still be true that not only debt contracts but also banks can play a useful role in mobilizing capital investment that would not otherwise occur.”

Well the answer to that is that under FR, banks “mobilize capital investment” just as they do under the existing system. That is, under FR, banks collect the savings of millions of savers and lend them out to borrowers. All that changes is the EXACT WAY banks do that job.


Maturity transformation.

Turner’s next sentence reads, “Maturity-transforming banks enable long-term investments to be funded with short-term savings: that might seem like an illusion, a sort of confidence trick, but it may be a useful one. Inevitably it creates instability risks, but some instability may be the inevitable and reasonable price to pay to gain the benefits of investment mobilization and thus economic growth.”

Well there is more than one flaw in that sentence. First, if by “investment” Turner means industrial and commercial investment, the bulk of that is funded by equity and bonds. I.e. bank loans play a relatively small part, at least in the UK.

Second, maturity transformation (i.e. “borrow short and lend long”) is a mirage, and for the following reasons.

Assume an economy where maturity transformation (MT) is not allowed, and assume the economy is at capacity, i.e. at the full employment level.

You might think that where MT is banned, private money creation is necessarily also banned or at least severely curtailed, and hence the economy couldn’t possibly attain full employment. In fact if private banks don’t issue enough money, central banks can easily issue whatever amount of money is needed to keep the economy at full employment. Indeed, as Robert Mugabe so ably demonstrated, the state or central banks can take that process too far and cause hyperinflation.

Also assume that in our hypothetical economy, everyone has the assortment of assets they want, liquid and illiquid assets in particular.  Next, assume the law on banking is changed and MT is allowed. The effect will be to turn a proportion of savers’ relatively ILLIQUID assets into much more liquid assets, if not into actual money.

But that will cause savers to try to spend away their surplus stock of money / liquid assets. Thus demand rises. But a rise in demand is not permissible because the economy is already at capacity. Thus government will need to raise taxes and confiscate a proportion of the private sector’s stock of cash, or impose some other deflationary measure. In short, little or no extra investment spending takes place!


Subsidies.

Another problem with Turner’s theory has to do with the “instability” to which he refers. As he rightly says, MT involves risks. And how have we dealt with that risk (at least in the UK over recent decades)? Well government, out of the kindness of its heart (i.e. the long suffering taxpayer) has had to foot the bill when banks collapse. In short, any extra investment that may have come about as a result of MT has been gratis a SUBSIDY. And subsidies not make economic sense (except where there is a good social case for them, as there doubtless is in the case for example of kid’s education).

In short, subsidies reduce GDP, thus the idea that “MT plus subsidies” promotes growth is very questionable.


FDIC type insurance.

Of course instead of blatant subsidies, depositors can be safeguarded by some sort of FDIC type insurance. And assuming that’s on a self-funding or commercially viable basis, then there is no subsidy.

But that idea has weaknesses as well which I dealt with in detail here. One weakness is that if bank shareholders and the FDIC insurer both gauge the risk correctly, they’ll charge the same for bearing the risk. Thus in theory there shouldn’t be any difference as between funding a bank by depositors protected by FDIC type insurance on the one hand, and via shareholders on the other. (A bank funded just by shareholders does not of course do any MT).

Incidentally, I was using the word “shareholder” in a loose sense just above. That is, under some versions of FR, those who want their money to be loaned on would buy into a unit trust / mutual fund of their choice. But mutual fund stakeholders are effectively shareholders.

Another problem with FDIC type insurance which a “shareholder funded” bank (i.e. an FR bank) does not have: it’s that bankers will never stop lobbying politicians to have the state insure banks at an unrealistically cheap rate. To date (as pointed out above), bankers have been very successful in that regard.

Yet another problem is that if you are insured by some FDIC type third party rather than going for self-insurance as per FR, there’s a temptation to take excessive risk and keep the profits when that works, and in the knowledge that the insurer will foot the bill when the risks don’t work out. And that phenomenon partly explained the 2007/8 crisis.


Conclusion.

The pros and cons of MT are complicated. Turner’s analysis is too simple. The analysis in the above paragraphs is hopefully better, and those paragraphs indicate that the merits of MT are largely or entirely an illusion.

Adair Turner’s flawed criticisms of full reserve banking.

Adair Turner is a former head of the UK’s Financial Services Authority. I agree with much of the thrust of his recently published book “Between Debt and the Devil.” But his criticisms of full reserve banking (in his Chapter 12) leave room for improvement to put it politely. 

The paragraphs below deal just with that Chapter 12, and one of Turner’s criticisms of full reserve (FR) runs as follows.

“Moreover, any risks of private credit creation need to be balanced against the risks that would arise if we instead relied entirely, as the Chicago Plan proposed, on fiat money creation to increase nominal demand. For if we allow governments to run money-financed fiscal deficits, there is a danger that they will do so in excess or will allocate the spending power inefficiently for short-term political advantage.”
 
What – so politicians never boost demand before elections under the EXISTING system? The phrase “pull the other one” springs to mind.



Near monies.

A second criticism Turner makes of FR is that even if money creation by private banks is banned, “..near-money equivalents and new credit and purchasing power can be created outside banks. If promissory notes are believed to be low risk, they can be used as a money equivalent…”.

Well the first answer to that that is that advocates of FR don’t advocate a complete ban on non-state issued money. For example, most supporters of FR in my experience have no objections to local currencies like the Bristol pound.

Second, what FR advocates do propose is that money creation by the ten or twenty largest banks (regular banks AND shadow banks) should be banned, and that represents a HUGE CUT in the amount of private money creation.

Third, money is defined in economics dictionaries as something like “anything widely accepted in payment for goods and services”. Now every high street shop accepts central bank notes (e.g. Bank of England £10 notes) and credit and debit cards issued by well-known private banks and card issuers.

However, high street shops certainly won’t accept Turner’s “promissory notes”. And those promissory notes are no use when buying a car or house.

Thus while Turner’s promissory notes arguably count as a form of money in financial centres, like the City of London, they’re not much use anywhere else in the country. Thus those notes are not a fully fledged type of money.


Shadow banks.

A third criticism that Turner makes of FR is thus.

“…the development of shadow banking illustrates the remarkable ability of innovative financial systems to replicate banklike maturity transformation and thus the creation of near-money equivalents outside the formal banking system. The challenge of constraining credit and money creation would not be wholly resolved by requiring the formal banking sector to hold 100% reserves.”

That point is partially answered above: i.e. while promissory notes are a form of “near-money”, they certainly are not what might be called “100% proof” or “genuine” money.

Another answer was spelled out very eloquently by Turner himself when he said in reference to shadow banks which up to now have avoided some of the regulations that apply to regular banks,  “If it looks like a bank and quacks like a bank, it has got to be subject to bank-like safeguards…”.

If some drug is deemed harmful, then it makes no difference who makes or sells it – a lone individual or a multinational corporation – any such manufacture or sale should be banned.

However, in a sense, stopping private money creation is easier than stopping dangerous drug production. That is, dangerous drugs are indeed produced by individuals and families, and it’s clearly difficult to keep tabs on all those small producers. In contrast (to repeat), the smaller the organisation that tries to issue money, the less money-like is its so called money.

Indeed, someone who lends £10 to his next door neighbour is acting like a bank. There is clearly no need to regulate that sort of lender.


Debt jubilees.

A fourth criticism of FR made by Turner relates to debt jubilees. That is, Turner casts doubt the idea put by Messers Benes and Kumhoff, namely that some sort of debt jubilee should be or has to be implemented when FR is first set up. That idea is indeed nonsense: there may be arguments for debt jubilees, but there is no need whatever to lump the introduction of FR and debt jubilees together. Plus I don’t know of any other advocates of FR who agree with that “lump together” idea.

Thus that weakness in Benes and Kumhoff’s argument is not a weakness in the overall argument for FR.


Maturity transformation.

Turner also backs the existing bank system because of the maturity transformation it involves. As he puts it, “…banks can play a useful role in mobilizing capital investment that would not otherwise occur. Maturity-transforming banks enable long-term investments to be funded with short-term savings..”

I’ll deal with that point in a separate post in a day or two because this post is already long enough, plus the maturity transformation point is complicated.


Full reserve reduces debts.

A final irony about Turner’s criticisms of FR is that (as the title of his book more or less implies) he argues that one of the causes of the crisis was excessive private debts. As the opening sentence of Part II of his book puts it, “The most important reason the 2008 crisis was followed by such a deep recession and weak recovery was excessive private credit creation in the preceding decades.”

But one of the effects of FR is to REDUCE DEBTS! Indeed, the world is awash with people who deplore the size of private sector debts in one breath, and in the next, they advocate lots of lovely bank lending (which funds investments that “would not otherwise occur”) because that allegedly promotes economic growth.

FR forces banks to fund loans just from equity or equity like liabilities rather than from deposits. To the extent that that disposes of bank subsidies, that will clearly raise the cost of loans. The result will be a rise in interest rates and hence a reduction in loans and debts.

However, there is no reason to assume any reduction in aggregate demand or numbers employed because of any cut in demand stemming from FR. Any such cut can easily be countered with standard stimulatory measures:  the stimulatory measure preferred by several FR advocates being to simply have the state print money and spend it into the private sector (and/or cut taxes). Plus the removal of unjustified subsides ought to increase GDP, not reduce it.

As for any idea that a rise in interest rates is some sort of problem, mortgagors in the 1980s were paying up to THREE TIMES the rate of interest that they pay nowadays. I don’t remember that being a huge problem.

Base money is free. So why do we have privately created money which we have to rent?

Why are we renting our money supply from the banks that conjure it from nothing? https://t.co/cSiRRTDhuf pic.twitter.com/601XtWHV5z

— Positive Money (@PositiveMoneyUK) November 12, 2015

The idea that we rent our (privately created) money supply could be questioned on the following grounds.

People who want to borrow from banks certainly pay what might be called a “rent”. That is, they pay interest plus they pay for the administration costs involved in setting up a loan (e.g. checking up on the value of the collateral deposited in exchange for the loan).

But it could be argued that that rent is simply what any borrower would pay to any lender, including those who borrow from a non-bank entity of some sort. Moreover, what might be called the “outright owners of money”, i.e. those with a positive balance at their bank, don’t pay any rent. Indeed, if anything it’s the reverse: the bank pays interest to the depositor.

The answer to the above criticisms of the “we rent our money” argument is as follows.

In the real world (as intimated above) LENDING gets very mixed up with money creation. But in order to separate the two, let’s assume a hypothetical country where no one wanted to borrow or lend, but people DID WANT a money supply.

In that scenario, everyone or most people would, 1, deposit collateral at some bank, 2, have the bank open accounts, and 3, have those banks credit each person’s account with whatever float or day to day spending money each person thought they needed to tide them over from one payday to the next. Or perhaps most people would want a bit more money than that, but that’s a minor technicality.
Now people would clearly have to pay for the administration costs incurred by banks in supplying that above money. So the conclusion is that we do in fact hire the money supplied by private banks, irrespective of any lending that those banks do.

In contrast, supplying the economy with base money is almost costless.


How private money displaces base money.

If base money is costless and privately issued money does cost a significant amount to produce, it is legitimate to ask why about 95% of our money is private rather than public / base money. Put another way, how does private money manage to displace public money?

George Selgin provides an explanation here (see in particualar his 5th paragraph). It’s an explanation which I think is “the truth, but not the whole truth”. I.e. he misses out a step in the argument. (Incidentally, Selgin does not favour a “base money only” system)

After assuming a base money only economy, he says:

“Suppose next that fractional reserve banking is legalized and that…. it becomes so popular that all the old warehouse banks embrace it. Will inflation result? Of course it will—but only for a time. As fractionally-backed notes (or deposit credits) take the place of their 100-percent reserve predecessors, the demand for monetary gold, and hence the demand for gold in general, declines, causing the value of gold to decline with it. Because prices are expressed in terms of an (unchanged) gold unit, the price level has to rise.”

My explanation, for what it’s worth, is thus.

Assume a fractional reserve bank or banks set up in an FR or “base money only” economy, and the bank wants to lend. It could of course attract deposits and pay interest to depositors. But why bother? The bank can simply create money out of thin air and charge interest to those borrowing that freshly produced money.

The result (as Selgin points out) is inflation. But why would those new fractional reserve banks be bothered by that inflation? If you can effectively print money, and hire it out at interest, the fact that that money loses value at a significant rate won’t bother you.

Thus the conclusion is that even though privately issued money is inherently more expensive to produce than publicly issued money, the interest that private banks get from the money they print and hire out more than compensates.

The Economist says Japan’s high debt might make it “insolvent”. Sigh.

The Economist trotts out the old myth that a country that issues its own currency can go insolvent because of a relatively high national debt. As they put it “As more Japanese workers retire, domestic saving is falling and spending on the old soaring. Even a modest rise in borrowing costs could bring insolvency.”

I’ve demolished this sort of nonsense several times over the years. So what do I do apart from demolish it yet again? Darned if I know. So here goes.

First, the point about “spending on the old soaring” is only of marginal relevance. If that spending increase does take place, then it helps solve the problem which the Economist article addresses, namely how to raise demand in Japan! So that’s that minor point dealt with.

As to what would happen if holders of Japanese debt demand a higher rate of interest, the first point to note is that only becomes a problem (if indeed there is a problem) as debt becomes due for rollover: at which point the Japanese government (JG) faces the prospect of paying more interest.

One option is to pay the interest and send the bill to Japanese taxpayers. No “insolvency” there.  But I don’t favour governments paying a rate of interest much above zero. So that’s not my preferred option. Thus what does the Japanese government do if it doesn’t want to pay a higher rate of interest? Well it’s easy: pay off creditors on “rollover day” and tell them to get lost. That would mean in effect that as regards relevant government bonds, interest paid by JG would drop from a miserable 0.5% (which is about what it pays at the moment) to zero percent.

The only possible and minor problem is that printing money and paying off creditors (which are nearly all Japanese nationals by the way) has a slight stimulatory and/or inflationary effect. That is, QE is stimulatory.

But seems from experience in the West that the stimulatory / inflationary effect is pretty feeble. Plus to the extent that there is a stimulatory effect, that again helps solve the very problem that the Economist article addresses, namely how to raise demand in Japan.

And the REASON why the stimulatory effect is feeble is that government debt paying around 0.5% interest and cash are much the same thing. Both are (at least in theory) government liabilities, but one pays a very slightly higher rate of interest than the other.

As Martin Wolf, chief economics commentator at the Financial Times put it, “Central-bank money can also be thought of as non-interest-bearing, irredeemable government debt. But 10-year Japanese Government Bonds yield less than 0.5 per cent. So the difference between the two forms of government “debt” is tiny, particularly since the BoJ intends to reverse its monetary expansion at some point.”

As to what to do if the stimulatory effect is too much, that’s easy: all JG has to do is to grab money off the Japanese private sector. Governments (revelation of the century this) do have the power to expropriate any amount of money they like any time from their citizens.

That expropriation should deal with any excessive and hence inflationary spending by the Japanese private sector.


Why stabilise the debt?

Later, the Economist article says “Other studies are less dire, but nonetheless suggest that far bolder measures than anything under consideration will be needed to stabilise the debt.”

Hang on: why is there any need to stabilise the debt at any particular level? If Japanese households want to hold $50,000 each of Japanese government bonds, the Japanese government should let them, and pay them virtually no interest.

In fact if JG doesn’t issue that debt, households will just cut their spending so as to acquire the stock of savings they want. As a result, unemployment will rise. In short, governments really don’t have any option but to supply the private sector with the stock of savings or paper assets that the private sector wants.

Bloomberg publishes an article on 100% reserve banking.

And it’s hopeless. I’ll run through the arguments, most of which I’ve seen a dozen times before.

First, the author (Leonid Bershidsky) describes the change to 100% reserve with the emotive word “cataclysmic”.  That’s in stark contrast to what Milton Friedman said on the subject. He said “There is no technical problem in achieving a transition from our present system to 100% reserves easily, fairly speedily, and without any serious repercussions on financial or economic markets.” (That’s from Ch3 of Friedman’s book “A Program for Monetary Stability).

Next, even if a change is “cataclysmic”, that is not a good argument against the change. The change from the feudal regime in Europe of the Middle Ages to present day democracy was arguably “cataclysmic”. The changes brought by the industrial revolution were arguably “cataclysmic”.  That’s not an argument against democracy or industrialisation.

Next, Bershidsky says “a process whereby banks would gradually repay the central bank for the 100 percent reserves, would be immensely complicated.”

The first answer to that point is much the same as the answer to the above “cataclysmic” point. That is, if a change is complicated, that’s irrelevant: the important point is how the ULTIMATE BENEFITS stack up against the cost or “complexity” of the change. I’m 99% sure that Bill Gate’s found his first operating system “complicated” to set up. The ultimate benefits have been ASTRONOMIC.

Second, the above “repayment” system far from being complicated is simplicity itself. All that happens is that the central bank takes over some of the assets of existing banks (e.g. mortgages) and collects interest and capital repayments for the next 20 years or so. Where’s the “complexity” is there?

There would of course scope for argument as to what a mortgage is worth in the case of dodgy NINJA mortgages. But a few hours haggling would sort that out. As to bog standard UK mortgages, they aren’t in the NINJA category. That is the value of those mortgages will be within 1% of book value.


100% reserve is deflationary?

Next, Bershidsky makes a claim I’ve seen a dozen times before. As he puts it: “Then, if banks are only allowed to lend money they have made from commissions and interest, borrowed from the central bank or from depositors, they will probably provide less funding to the economy than they are providing now.”

Well they wouldn’t “probably provide less funding”: they’d DEFINITELY provide less funding. Reason is that under 100% reserve, banks can only lend on money that relevant depositors are prepared to put at risk. That’s  as distinct from the existing system under which banks can lend on money which is insured by governments (i.e. taxpayers). That featherbedding of the “borrow and lend” process is wholly unjustified.

As the cut in demand that would result from less bank funding, that’s easily dealt with by standard stimulatory measures. Moreover, less “bank funding” means less debt, and half the world is having a nervous breakdown over the size of private sector debts. Assuming those nervous breakdowns are justified, then less debt won’t do any harm.

Next, Bershidsky makes the bizarre claim that having just the central bank create money is “a tiny step removed from central planning”.

Central planning actually consists of government bureaucrats, rather than market forces, deciding the amount of almost every product to be produced in the next five years or whatever. That includes the amount of steel, aluminium, sulphuric acid and ten thousand other items.

In contrast, there isn't one single advocate of 100% reserve banking I know of who proposes anything remotely like that. In particular, it would be very odd of the arch proponent of free markets, Milton Friedman, advocated 100% reserve (which he did) if 100% reserve bore any resemblance to central planning.

The only “centralising” that takes place under 100% reserve is that the state decides how much new money to issue with a view to determining how much stimulus should be implemented. But the state (i.e. central bank and government) ALREADY DECIDE how much stimulus to put into effect. It’s just that they do it in a slightly different way under the existing system.

Thus it is debatable as to whether 100% reserve would give us any more “centralising” than we already have.

A brief guide to why government borrowing is pointless.

First, let’s consider current as opposed to capital spending. Should government borrow so as to fund current spending? Clearly not. This year’s current spending should be paid for out of this year’s tax.

Now for borrowing to fund capital spending.

One reason to borrow is that if a capital investment is significant compared to any entity’s annual income or turnover, it will suffer a significant drop in consumption if the investment is paid for out of one year’s income. E.g. if you paid for a new car out this year’s salary, that might severely reduce your standard of living this year.

But that point does not apply to governments. The cost of a large bridge or a hundred miles of new road is a minute proportion of total government spending.


Generations.

Another popular excuse for government borrowing is that it allegedly spreads the cost of capital items across the generations that will benefit from relevant capital items (e.g. bridges). The problem with that argument is that it involves time travel. That is, it just ain’t possible for people in 2030 to sacrifice time, labour, effort etc so as to produce the concrete and steel needed to build a bridge in 2015.

Steel consumed in 2015, unless I misunderstand the laws of Physics, must be produced in 2015 or earlier.


Cash.

A third reason why microeconomic entities like firms and households borrow so as to fund capital spending is that they just don’t have the necessary cash to fund the capital spending. But that point does not apply to governments. Governments have access to near infinite amounts of cash: first they can grab near limitless amounts off taxpayers, and second, they can print the stuff.


Anti cyclical matters.

A forth reason for government borrowing is to cool down an overheating economy. But if that’s the objective, why concentrate on just ONE sector of the economy, i.e. the “borrow and lend” sector? That is, why not cut a broader range of types of spending by raising taxes and cutting public spending?

To increase government borrowing so as to cut aggregate demand is a bit like placing an extra tax just on restaurants and garages so as to cut demand.

Moreover, if government wants to borrow more so as to cut demand, what it needs to do is to borrow money and do nothing with the money. That’s not borrowing in the normal sense of the word, which is use REAL RESOURCES belonging to someone else and on a temporary basis: the intention being to return those resources to the owner at some stage.


Conclusion.

Government borrowing (in the normal sense of the word borrow) is pointless.

Matthew Klein’s flawed criticisms of full reserve banking.

Klein in this Financial Times article says he supports full reserve (FR) banking. His actual words were “….proponents have included Milton Friedman, James Tobin, researchers at the International Monetary Fund, John Cochrane, and Martin Wolf. (And me.)”

However, Klein does make some criticisms of FR. In relation to Iceland’s proposed FR system his first criticism is thus:

“Sigurjonsson’s report makes a convincing case that private lenders aren’t the best judges of how much money the economy needs to sustainably grow. Why should central bankers and politicians be any better?”

The answer to that is that it’s widely accepted that lending by private banks is pro-cyclical. That fact stares you in the face from any money supply chart.  The chart below shows the steep rise in private bank lending prior to the 2007/8 crisis.

 

But quite apart from that, WE ALREADY HAVE “central banks and politicians” attempting to iron out fluctuations in GDP, unemployment levels and so on. Indeed, if government and central bank don’t do that job, then no matter how inefficiently, who else does do it?  Thus having “central banks and politicians” trying to counteract cycles is not a peculiarity of FR. FR simply advocates a slightly different way implementing those anti-cyclical efforts.


Klein advocates full blown monetarism?

Shortly after that, Klein says “If Iceland were successful in centralizing the control of nominal purchasing power, the appeal of policymaker discretion should vanish and a simple money-growth target would suffice.”

Well a fixed annual increase in the money supply was what Milton Friedman advocated and that didn’t work too well. In defence of Friedman, his idea is not completely daft: i.e. anyone can be forgiven for thinking that a fixed and small annual money supply would work. But the fact is that it didn’t work too well. So that’s that.

If Klein now thinks that monetarism a la Friedman is actually desirable, most economists would regard that as a joke. But I’m broad minded: I’m happy to listen to explanations from Klein that support his pro-monetarist belief.


Investment accounts.

Next, in the paragraph starting “Those are minor criticisms.” (and subsequent paragraphs), Klein argues that the FR system Iceland envisages would be as liable to runs as the existing system. As he puts it, “banks would be almost exactly as vulnerable to runs as they are in today’s system”. To explain Klein’s concerns, it is necessary to delve into the detail’s of Iceland’s proposed system.

Iceland’s proposed system (far as I can see) is a direct copy of Positive Money’s FR system. And under that system, those who want a bank to lend on their money put their money into so called “Investment Accounts”. Those accounts are not protected by taxpayers, plus instant withdrawal of fund is not allowed: depositors have to wait a few months to withdraw. And therein lies the first weakness in Klein’s claim that those accounts would be subject to runs. Runs occur where depositors have a right to INSTANT ACCESS to their accounts. So when there’s a suspicion that a bank is in trouble, queues appear outside relevant bank branches (as at Northern Rock). The queues consist of people demanding instant access.

In contrast, with investment accounts, a run would be a slow motion affair, and that gives the bank time to find alternative sources of funding. Thus Klein is clearly wrong to claim that FR banks would be as subject to runs as existing banks.

Moreover, there’d be nothing to stop the terms governing those investment accounts including a clause to the effect that in the event of the bank having problems, depositors’ access to their money can be extended by the bank. After all: those depositors have absolutely no cast iron guarantee they’ll get any of their money back at all, given that there is not government backing for those accounts. So they’d be daft to object to having access to their money delayed: that delay might enable them to eventually get their money back.


Milton Friedman and Lawrence Kotlikoff.

Next, the above “run problem” to which Klein refers is not actually a weakness in FR as a whole: it’s a peculiarity and weakness in the Positive Money / Iceland version of FR.

That is, in other versions of FR, in particular Milton Friedman and Lawrence Kotlikoff’s versions, those who want their money loaned on buy what are essentially shares in a unit trust (“mutual fund” in US parlance). Under that arrangement, insolvency of the investment department of a bank (i.e. those mutual funds) is plain impossible.

To illustrate, if 90% of relevant borrowers turn out to be dud (which is about as likely as being hit by a meteorite), all that would happen is that the value of the mutual fund shares would drop to 10% of their book value.

If you have a SHARE in a corporation as distinct from a FIXED VALUE claim on the corporation, there is no point in running, as John Cochrane explains.


Interest rates.

Next, Klein claims that in the event of a number of bank failures (i.e. failures of the lending or investment department of banks) “you could expect a sudden spike in the cost of borrowing.”

True, but what’s wrong with that? If there were a series of failures in the food retailing industry, that would indicate that the industry had overestimated the size of the potential market and had pitched its prices too low. If market forces were working properly, the result would be that a number of retailers would go out of business, and the remainder would raise prices.

That’s in contrast to the existing and barmy set up where when there’s a series of bank failures, or near failures, government comes riding to the rescue with the result that excessive lending and excessive debts get back to where they were before the problem exploded.

The world is awash with people (mainly politicians and economics commentators) who advocate more bank lending in one breath so as to promote “growth”, while in the next breath they deplore the rise in private sector debts (caused by those bank loans).