Banking on Failure: An Introduction …

When Problems comes, if you seek well, you'll can find the Solutions easily ;) High resolution render, 3D Image generated with the best quality settings. Out of focus is created on a rendered layer, with a specific plug-in that simulate many lens focus Joe Pimbley, Columnist & Featured Contributor[message type=”custom” width=”100%” start_color=”#F0F0F0 ” end_color=”#F0F0F0 ” border=”#BBBBBB” color=”#333333″]Editor’s Note: This if the first Article in a new Series by Joe, as excerpted from his Book; “Banking on Failure” co-authored by Laurel McDevitt. [/message]

[su_dropcap style=”flat”]W[/su_dropcap]HAT’S WITH BANKING? The news since 2008 has been full of failures and near-failures of firms such as Bear Stearns, Lehman Brothers, Fannie Mae, Freddie Mac, Washington Mutual, IndyMac, Dexia, Royal Bank of Scotland, Lloyd’s Banking Group, Northern Rock, three Icelandic banks, and Banco Espirito Santo. The U.S. Treasury Secretary and the Chairman of the Federal Reserve rocked the world in late 2008 with a $700 billion “Troubled Asset Relief Program” (TARP) to bail out U.S. banks that hadn’t yet failed. Still in panic mode, the government guaranteed everything with a financial pulse: Fannie and Freddie mortgages; money market mutual funds; larger deposits in the banks; the insurance company AIG; and bonds of banks and companies like GE Capital. General Motors and Chrysler even drove into this bailout frenzy somehow. Europe and others suffered similar convulsions.

Was all of this expensive chaos necessary? Will it happen again? The governments warned that all banks might fail without “taxpayer assistance.” Why is it we never worry that all farms will fail? Or that all electricity providers will fail? Or all retail stores? Why are banks different?

We’ve neBanking on Failurever heard a President or comparable political leader of any country explain why banks are different. We’ve never heard such an explanation from a Treasury secretary or central bank chairman. All these people seem to dislike bailing out and otherwise supporting banks and bankers. At times these politicians will make brave statements or even propose and pass legislation to say the bailouts will never happen again. Unfortunately, the people and statements are not credible on Main Street or on Wall Street.

But why? Why bail out the banks? Why not just let banks fail – like “ordinary companies” – if they cannot honor their obligations? There’s a reason … and it’s surprising. By virtue of history, political bargains, and past government actions, banks are part of government. We demonstrate this point in a later chapter but we don’t dwell on it. Rather, our focus is the discovery of what banking is now and the proposal for effective banking reform.

The most fascinating aspect of this entire study is that one cannot simply investigate banking in its current form, find problems, and suggest improvements. Much as we hate to say it, banking is complex. To ponder banks, one must also delve into corporations, governments, central banks, bank regulators, the nature of money, the commodities gold and silver, borrowing and lending, inflation and deflation, and the relationships and histories among all these subjects. It’s work and it’s fun. What we find in the end is a plan to make both banking and the government management of the money supply simpler, fairer, and far safer than what we have in the current world.

Chapters 2-11 lay the groundwork in gradually increasing level of content. Chapter 12 pulls all this background together to discuss various proposals to reform banking: current legislation in the United States and Europe (including the Basel Committee on Banking Supervision); innovative proposals of A. Admati, M. Hellwig, C. Calomiris, S. Haber, L. Kotlikoff, and others; and our specific recommendation. In addition to banking reform, we propose a larger monetary system reform in this chapter 12 that fits and accommodates the simultaneous banking reform.

We begin in chapter 2 with the topic of “business failure.” Just as the civil engineer who designs bridges must be an expert in bridge failure, we seek expertise in business failure in order to understand healthy businesses. Banking is, or at least should be, just one type of business. Chapter 3 discusses the “business of banking.”

Chapter 4 broaches the critically important question of why banks seem different from non-bank businesses. Are banks really different? If so, why? It is in this discussion that we find, among other observations, that banks are part of government.

Chapter 5 provides a deeper analysis of banks at the level of financial experts. We use the word “expert” somewhat loosely since one conclusion (from an expert!) is that “nobody really understands banks.”

At this point we digress somewhat to tackle history. If we were writing here about the business models of Facebook or Twitter, then there would be no chapters on “history.” The only comment to make about history for some subjects is that “history doesn’t matter.” With banking, however, history is (almost) everything. Chapters 6, 7, and 8, then, cover the histories of banking, money and gold, and central banks.

Chapter 9 speaks to the (government) regulation of banks to convey the “standard thoughts,” conventions, and operating guidelines of the banking world as well as to flesh out the relationships among banks, bank regulators, and governments.

Chapter 10 is critically important to banking and monetary reform proposals since it defines the nexus of money, lending, and inflation. Borrowing from an earlier discussion, Chapter 11 emphasizes the observation that banks are “junk” (have high risk of failure) in the absence of government guarantees. We raise the question again of why society cannot simply “let banks fail” and conclude with conventional and new thoughts on “systemic risk.”

Chapter 12 is the culmination in which we review both mainstream and innovative bank reform proposals of others. We also propose our plan of full reserve banking. This concept of full reserve banking is not at all novel … and that’s an advantage! We cite prior proposals and explain our variant. Given earlier discussion of the link between money supply and inflation, we realize that full reserve banking will produce deflation without further action. We discuss alternative techniques to manage such deflation. Our strong preference is to marry full reserve banking with a full reserve gold standard to produce stable monetary policy. We explain in some detail how this would work.

The reform is striking! Life in the financial world will change tremendously for the better. There will be no more “bank runs.” Banks that encounter difficulty can fail, just like “ordinary companies,” with no necessity of government bailout. Banks will no longer be part of government. Governments adopting these reforms will be unable to impose “the inflation tax” – a levy that harms the financially unsophisticated citizens most.

More to come…


Joe Pimbley
Joe Pimbley
Joe is Principal of Maxwell Consulting, a firm he founded in 2010. Joe is expert in complex financial instruments, financial risk management (certified as FRM by the Global Association of Risk Professionals), valuation, structured products, derivatives, and quantitative algorithms. His recent and current engagements include financial risk management advisory, valuation and credit underwriting for structured and other financial instruments, and litigation testimony and consultation. In a prominent engagement from 2009 to 2010, Joe served as a lead investigator for the Examiner appointed by the Lehman bankruptcy court to resolve numerous issues pertaining to history’s largest bankruptcy. Joe and his colleagues discovered Repo 105 and also reported the critical importance of pledged collateral mishaps and mischaracterizations to the Lehman failure. Joe holds a Ph.D. in Theoretical Physics and is a co-author of Banking on Failure (2014), Simple Money (2013), and Advanced CMOS Process Technology (1989). He serves on several corporate and academic Boards, has written more than thirty finance articles, presented more than sixty finance seminars, and holds numerous patents for engineering inventions.

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