Laurence Kotlikoff lays out his ideas for reform of the banking system.
There is a simple, quick way to restore integrity to the system — Limited Purpose Banking (LPB). It makes banks, insurance companies and all other financial corporations operate as mutual fund companies (unit trusts) called LPB banks. Mutual funds don’t borrow short and lend long. They don’t borrow at all. They take in funds on a 100 per cent equity basis (they sell shares) and use these proceeds either to make loans by purchasing mortgages, commercial paper (short-term IOUs from companies) and corporate and government bonds or to buy stocks.
Just because you\’ve changed it to equity you\’ve not stopped the possibility of runs.
For the secondary market in equity is still liquid and immediate. But the assets owned by the LPB are still long term and illiquid. People start to panic and you\’ve still got the possibility of mass selling of the shares.
If it\’s like a mutual find or unit trust, where you don\’t in fact sell them on the secondary market, you present them to the LPB for redemption, you\’ve in fact just recreated the very bank run problem you\’re trying to avoid.
Once the mutual fund has run through the limited amount of cash it has available to cover redemptions it has to dump longer dated assets at fire sale prices to cover further redemptions.
For, you see, the problem is inherent in any system which allows short term redemption of savings which are invested in long term assets. Calling them deposits or calling them equity shares doesn\’t change this very basic problem.
Just not going to work, d\’ye see?
I’m puzzled. what do deposit-takers do with their deposits if they can’t lend? Do they buy equity in mortgage-granting LPB’s?
And how you issue a credit card in this construct, I have no idea.
He’s on the right track. Having separating banks into “vaults” which charge a storage fee, do not lend your money and do not pay interest; and “investors”, which take title to your money and promise to give it back on a particular day plus interest; would be a good start. Getting rid of two people having simultaneous title to the same money (“fractional reserve banking”) and getting rid of instant availability accounts that pay interest (“maturity transformation”/”borrowing short/lending long”) would indeed make bank runs impossible.
Interest should be proportional to the time your money is tied up for. If you can get your money out at any time, interest should be zero.
In the U.S., we have institutions which are called “banks” very commonly but are actually “S & Ls” (savings and loan associations) and are, effectively, mutual funds selling dollar-denominated shares (at the constant “price” of $1
each). Though customers of such (very popular)
institutions pay little heed to the difference, they are not actually “depositors” (creditors) of the institution but shareholders receiving dividends in the form of “interest.” Such institutions are granted the right to pay higher (1/2%, I believe) rates than commercial banks but are precluded from certain types of lending activity. They may not be subject to some of the same kind of abuses
as ordianry banks but have similar ones of their own (and went through a crisis back in the late ’80s).
Significantly, the S & Ls experienced the same type of pressure for profit performance as did the banks in the latest fiasco–just arising from “mission creep” from original single-unit mortgages to financing of the developers and even of commercial projects (and where such larger, potentially profitable applicants may have acted to corrupt loan officers’ decisions). What is not mentioned currently aboput that crisis is that, in one respect, it set a precedent (and was, thus, a forerunner) for the latest: the then-President, George (Herbert walker) Bush “bailed out” the industry by making the depositors (actually shareholders) whole (even for those whose accounts exceeded the portion–$100,000–that was “insured” by the FSLIC). With that precedent in mind, it’s a little more understandable how so many in discretionary positions exercised so little discretion in the latest go-round.
At the time, opponents of a bailout expressed (in addition to other objections) that it would simply lead to a bigger bust in the future: they were right.