Banks are junk. Such is one conclusion of the previous chapter. We also note that a government’s guarantee of its banks is expensive precisely because the underlying banks are junk. One way or another, the taxpayers and citizens bear the large expense of the government guarantee for banks. Yet it would be disastrous for a country to lose its payment system.
Editor’s Note: This is the next in a Continuing Series of Articles by Joe, as excerpted from his Book; “Banking on Failure” co-authored by Laurel McDevitt.
Though not a “solution,” the obvious premise for a solution is that banks should have much lower dependence on the government guarantee. That is, underlying bank risk should not be “junk.” To the extent that banks have very low risk of failure on a stand-alone basis, they would have low risk of government bailout which is, presumably, what all parties desire. (This point should strike all of us as obvious, but we will encounter in this chapter an entrenched attitude that the measures that reduce bank default risk are somehow harmful to society.)
We divide proposals for “fixing banking” into three categories. We label these proposals as “Nibble the Edges,” “Dramatic Change Inside the Box,” and “Banking Re-Boot into Safe Mode.” All three have advantages and disadvantages. The first option is easiest to implement and is the current course of global governments and regulators. Unlike this first option, the second proposal would be highly effective. While straightforward to implement, this option #2 is controversial and requires an old-fashioned political battle that could go either way. Finally, we consider the third option to be the “right answer.” Being right and winning arguments are not the same thing. Just as virtue is its own reward, we will press the case enthusiastically for “full reserve banking.”
Surprisingly at first glance, fixing banks requires no consideration of the monetary system. Individual banks must play by the rules. Money either has an anchor in substance such as gold or silver or it has “anchor” in government fiat only. In 2016 we live in a fiat-currency world. Banks can thrive or fail regardless of currency anchor. But the financial system needs substance for its money. This chapter ultimately proposes a full reserve gold standard to remove the greatest threat of global ruin.
Option #1: Nibble the Edges
When human organizations confront failure and must take remedial action, the prevailing attitude is often to make as few changes as possible. The failure demonstrates the imperative for change. Yet all organizations have vested interests that abhor change. The result is that such institutions grudgingly concede only the incremental modifications that will supposedly eradicate future failures.
Global governments, bank regulators, and bankers constitute the large “human organization” that must address the failure of government policy, bank regulation, and banking of 2008 to the present. True to form, this organization has enacted and proposed minimal change to banking operation. Beyond the small number of significant banks (such as IndyMac, Washington Mutual, Lehman Brothers, and Laiki Bank) that governments permitted to fail without bailouts for all creditors, almost all players remain the same. Leading politicians, regulatory heads and staff, bank executives – they’re all the same people. Banks still remain part of government as we described in chapter 4. It is not an exaggeration to say that the only reactions to the Credit Crisis are moderately higher capital requirements, the possibility of improved bank liquidity, a potential loose and discretionary limit on simple balance sheet leverage, and central banks’ administration of “stress tests.”[1]
The great advantage of “nibbling the edges” in this manner is that the changes are politically achievable. Political leaders can show that “they did something.” Regulators get more apparent control over banks, larger budgets, and a longer checklist of activities. Bankers retain their lucrative careers in exchange for following a modified set of rules. It stands to reason that increasing capital requirements will lead to some beneficial reduction of bank default risk. Thus, this edge nibbling should have a positive near-term impact if one ignores the increased and incalculable inefficiencies of the new regulation.
The glaring disadvantage of this approach is simply that there is no real change. With the eraser at the end of the pencil, regulators are removing old capital requirement values and writing in some new and higher values. The direction is right, but there’s no rhyme or reason to the old or new numbers other than what emerges from a global political agreement. As a further criticism of the solution, there is not even a cogent statement of the problem. That is, regulators and politicians do not state a goal of a target bank default probability or expected loss to taxpayers. Without a clear problem statement, there can be no solution and no intelligent discussion of a solution.
The next excerpt for Chapter 12 will discuss a stronger option for the reform of banks.
