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?