| Federal Reserve Bank of Dallas President Richard Fisher extended his long-running effort to break up the biggest banks Wednesday at a time when the idea is gaining currency with policymakers on both sides of the aisle.
Long a critic of letting financial firms grow "too big to fail," Mr. Fisher detailed in a prepared speech Wednesday an approach he said would prevent banking firms from growing so large and complex that their failure could undermine the entire financial system. The Dallas Fed chief spoke to the Committee for the Republic at the National Press Club. |
Fed's Fisher: Limit Government Aid to Traditional Bank Unit
Kristina Peterson and Victoria McGrane
(h/t Ryan Harris in the comments)
Forgive me for banging on about full reserve banking (FRB) again, but Fisher is fumbling his way towards FRB. He wants to split the banking industry into two halves (as do advocates of FRB). Plus he says that banks’ “insurance or brokerage units wouldn't be able to rely on the federal safety net. Customers of these unprotected businesses would have to sign a disclosure acknowledging this risk.” Agreed: FRB opposes any sort of subsidy or “safety net” for commercial activity.
ReplyDeleteHowever I don’t agree when he says in relation to banks: “the biggest financial companies would be restructured, with only their commercial banking units able to rely on federal deposit insurance or to access the Fed's discount window.” FDIC for smaller banks is a GENUINE self-funding scheme, so advocates of FRB have no objections to it. But if “federal deposit insurance” means billion dollar bail outs for large and supposedly “commercial” banks, then I object. Plus the discount window is arguably a form of artificial preference for banks vis a vis other sectors of the economy.
The solution is to offer no safety net for depositors who want their bank to lend on or invest their money, which means that depositors become very similar to bank shareholders. As to depositors who want 100% safety: fine – they can have it. Everyone is entitled to a 100% bank account. But they cannot at the same time ask to have their money put at risk by having it loaned on or invested.
As Mervyn King, governor of the Bank of England put it, “If there is a need for genuinely safe deposits the only way they can be provided, while ensuring costs and benefits are fully aligned, is to insist such deposits do not coexist with risky assets.”
The above split (unlike Fisher’s split) makes breaking up large banks unnecessary. That is, if a large bank gets into trouble, the value of its shares fall, as does the value of the stake held by quasi-shareholders, i.e. depositors. And a decline in equity values is nowhere near as harmful as bank runs or failures. Mervyn King again:
“We saw in 1987 and again in the early 2000s, that a sharp fall in equity values did not cause the same damage as did the banking crisis. Equity markets provide a natural safety valve…”
'The solution is to offer no safety net for depositors who want their bank to lend on or invest their money'
ReplyDeleteIf certain banks were to offer no safety net for high yield accounts, those banks might need to temporarily suspend withdrawals when depositors periodically panic?
Hi Ryan,
ReplyDeleteThere is no need for any sort of artificial suspension of withdrawls in a panic. If there is a panic, all that happens is that the value of depositors’ stake in the bank falls as does the stake held by shareholders. General Motors does not face imminent insolvency when there is a stock market "panic" and its shares fall 20%, or nor would banks under FRB.
The exact way in which “depositors’ stake” is organised differs slightly as between different advocates of FRB. E.g. Laurence Kotlikoff’s system involves having the money that depositors want invested or loaned on to be put into mutual funds. In that case, given a mass withdrawal, the value of the fund falls which dissuades others from withdrawing. But more importantly, there is no need for those mutual funds to call in loans they’ve made.
That doesn’t solve the problem that given a flight from risk there is a deflationary effect. But at least there wouldn’t be actual bank failures.
In contrast, a work by Prof. Richard Werner and others restricts the speed of withdrawal by investing only money that’s been put into term or deposit accounts. Plus depositors have to take a hair cut if the underlying loans or investments go wrong. See:
http://www.positivemoney.org.uk/wp-content/uploads/2010/11/NEF-Southampton-Positive-Money-ICB-Submission.pdf
Finally, Messers Diamond and Dybvig advocate restricting withdrawals in a panic. But Messers DD are strangely enough opponents of FRB. I conclude that possibly they’re a bit schizophrenic. For more, see:
http://ralphanomics.blogspot.co.uk/2013/01/do-diamond-and-dybvig-oppose-full.html
The fundamental problem is that no country is going to allow its financial system to fail or result in a depression. There is no sense putting a reformed system in place that can lead to this eventuality because it is certain that when mass failures begin to take place, either institutions or depositors, government will be compelled politically to step forward with a rescue. It's always happened in the past, and "everyone knows" it will happen again in the future if circumstances force it, enen though most may pretend otherwise.
ReplyDelete