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Tuesday, April 30, 2013

Clint Balinger — Question for Mosler/Mitchell/MMT: Bank Reform, Assets or Liabilities?

Warren Mosler, in his excellent recommendations for bank reform (similar to Bill Mitchell’s proposals 
and others) focuses on the asset side of banks, and writes: 
“The hard lesson of banking history is that the liability side of banking is not the place for
market discipline.”
Mosler doesn’t discuss this history or reasoning any further though. Can anyone elaborate on this banking history? And how it shows that disciplining the liability side of banking is not a good idea?

The asset side of a bank's balance sheet records the loans. Banks loan using the five "C"s of credit: character (usually based on credit history), capacity (ability to service the obligation from income), capital (net worth), collateral (assets that secure the debt), and conditions (state of the economy and borrower's role in it). Generally, it is assumed that banks will act prudently overall in extending credit, since their capital is being placed at risk. However, with the moral hazard created by, e.g., deposit guarantees, banks may fail to follow best practices. Therefore, government acting through its agencies impose regulations designed to offset this hazard. Often such regulations are imposed on the liability side, e.g., reserves or capital requirements. 

However, the problem arises with the quality of the loans that are extended, and these show up on the asset side. Thus, government can address the asset side by regulating how credit is extended, e.g., down payment, and quality of collateral. 

For example, the housing crisis developed out of imprudent credit extension, and the financial crisis grew out of the overvaluation of collateral. So a lot of loans got extended at a much higher value than was proper under best practices. 

Government could have intervened with rules regarding the valuation of collateral when it was clear that the run-up in valuation was exceeding the ability to recover based on the underling collateral. Regulators should also have been sharper-eyed about the collusion of mortgage brokers and appraisers, especially after the FBI warned of rampant irregularities in the mortgage business as early as 2004.

LIfted from the comments:

Scott Fullwiler points out: "There's certainly some rationale for regulating the liability side in MMT, though not necessarily the way most people think. See this by Randy: The Lender of Last Resort: A Critical Analysis of the Federal Reserve’s Unprecedented Intervention after 2007 (April 2013)

15 comments:

  1. Hi Tom

    There's certainly some rationale for regulating the liability side in MMT, though not necessarily the way most people think. See this by Randy:

    http://www.levyinstitute.org/publications/?docid=1739

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  2. Thanks, Scott. I added that to the post.

    The way I interpret Warren (and Bill Black) is that if the asset side had been properly regulated, there would have been no housing crisis (due to imprudent and predatory lending, and also fraud) and the ensuing financial crisis (due to securitization and fraud) in the first place.

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  3. BTW, Dr. Housing Bubble has been pointing out that the housing bubble is beginning again in CA with buyers bidding up prices well over the asking price, and non-standard mortgages being written, even interest only.

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  4. Bank Reserves are bank assets.

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  5. Thanks all. As far as banking history, it seems like limiting banking in the way positivemoney and similar proposals (Kotlikoff etc.) argue for has never been done, so there is not much history to judge the proposals by.

    The closest historical examples I have heard of are mentioned in Benes and Kumhof, on the St Simonians in France, and Pre-WWI Germany, where credit-money was not so much the basis for the money supply (?) I haven't had time to look into it.

    I certainly agree with Mosler's proposals. (Ultimately, I think nationalizing the banks and PM type proposals amount to about the same thing, arrived at from opposite directions). I just think the type of limits PM and similar ask for have not been considered fully; that's why I was wondering what "hard lessons" Warren was referring to.

    If anyone knows any more historical examples of trying to limit the liability side in the way PM proposes, or any details on German and French and other European narrow banking systems, would be great to hear them.
    Kind regards,
    Clint

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  6. On a side note - I found this interesting tidbit, published in 1919:

    “In America, we are accustomed to the doctrine that deposits grow out of loans, in very large degree.”

    (1919 p. 27)

    EFFECTS OF THE WAR ON MONEY, CREDIT AND BANKING IN FRANCE AND THE UNITED STATES BY B. M. ANDERSON, JR.. 1919

    How did economists forget this?

    ``````````````````
    Back to the discussion on banking systems more limited on the liability side than modern systems, the above work from about the page just mentioned (27)has some interesting details, sort of related

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  7. Bank Reserves are bank assets.

    Right, and as we know, Warren's proposal is to eliminate reserve requirements, set the rate to zero, and provide unlimited liquidity to solvent banks. No regulation from the aspect of reserves.

    With no separate money policy, no need for a politically independent cb, so formally consolidate the cb and Treasury into a single agency under Treasury and handle the payments system automatically.

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  8. Capitalism is based on a private financial system that handles finance capital and provides markets for financial instruments. The whole concept of capitalism would have to change to go to government money. That is unlikely to happen without an overhaul of the entire economy. Virtually all vested interests would strongly oppose this.

    The problem with banking now is that plain vanilla banking is not very profitable, which is why we are were we are. Bankers lobbied strongly to expand the purview of banking into other aspects of finance in order to increase profits.

    The world is not going to go back to small, local, plain vanilla banks for the simple reason that there is no real money in it. Again, for banking to change, it will require an overhaul of the system that moves the ball forward rather than backward.

    There is no clear vision yet of what moving forward would look like and to the contrary, finance capital is now exercising transnational global hegemony. Getting a leash on that is proving to be impossible politically.

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  9. "Bank Reserves are bank assets

    As I have written before, PM and similar proposals are concerned with private credit-money creation, not reserves; I don't know why anyone (pro or con) uses the term "full reserves" to describe what they want, it is misleading. The PM proposal is a "no reserves" system; the proposals just want 1) an option for a narrow banking system for the public and 2) the rest of the system to put risk in the right place - money that earns interest is also exposed to risk, with no public backstop.

    New money is created and spent into the economy to the maximum extent possible barring inflation, and in accordance to functional finance and as close to full employment as possible (again, short of inflation).

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  10. (the new money - it is created greenback or platinum coin style - I forgot to clarify)

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  11. Tom - capitalism is often described as the private ownership of the factors of production (capital, land, and labor).

    But the money supply itself can still be a public monopoly; money itself is not a factor of production.

    And of course the world, including the US, is already run by mixed socialist systems, and arguably the more socialized systems (N & W Europe) outperform (as measured by material well-being) all other systems anyway.



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  12. 1) an option for a narrow banking system for the public

    Already exists as credit unions, which can be accessed online if none in area.

    and 2) the rest of the system to put risk in the right place - money that earns interest is also exposed to risk, with no public backstop.

    FDIC limit is 250K which includes most small depositors and hugely exposes large ones, mostly firms, which are already at risk.

    What the government backstops is the financial sector, as it must. But just recently word went out that bail-outs are out and bail-ins are in.

    But the money supply itself can still be a public monopoly; money itself is not a factor of production.

    That's true but neoliberals, who are in charge, will never agree to it unless they are sure that they can control government without having to be concerned with a political revolt through democracy.

    Neoliberalism is fundamentally opposed to democracy, which neoliberals view as the rule of the rabble.

    And as Minsky observed and Keen is again pointing out, capitalism is inherently instable.

    So politically this is explosive.

    And of course the world, including the US, is already run by mixed socialist systems, and arguably the more socialized systems (N & W Europe) outperform (as measured by material well-being) all other systems anyway.

    And the direction even there is toward neoliberalism. See Sweden, for instance.

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  13. a few notes

    not to defend private banking, but the Fed is a public bank, as is the federal home loan bank and other govt lending 'agents', student loans, etc. nuff said?

    as to hard lessons, closing down 4000 of 8000 US banks in 1933? the gold standard is a policy to regulate the liability side of banking, for example.

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  14. “closing down 4000 of 8000 US banks in 1933”

    Warren - I am not clear on the connection here – the PM type proposals are designed precisely to avoid the early 1930s situation.

    “the gold standard is a policy to regulate the liability side of banking, for example”

    Mitchell also associated PM type proposals with the gold standard. But there is a fundamental difference – the Gold standard limits the money supply. PM proposals do not at all – sovereign currency issuers can issue as much money as needed (unlike the gold standard, of course) and thus can do all the things a sovereign non-convertible floating currency issuer is capable of (a job guarantee etc).

    PM proposals are not at all like a gold standard; the sovereign issuer can issue as much currency needed to achieve fiscal policy goals, limited chiefly by inflation, of course.

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  15. (For more recent readers, some context to my question is here Towards a Pure State Theory of Money )

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