A Banking System We Can Trust

May 3, 2009 6:03 AM

Limited Purpose Banking -- for lending, investing, etc. -- Turn all financial firms into mutual funds: "All mutual funds would break the buck with one exception: cash mutual funds. These funds would strictly hold cash and be valued at $1 per share. Owners of these funds would write checks against their balances and never have to worry about a bank run. Fractional reserve banking and the FDIC would be history." [previously]

also see The Credit Crisis and Cycle Proof Regulation, Raghuram Rajan (cf. 1 2 3 4) on preventing/regulating 'cyclical euphoria' among financial institutions...

and btw Fixing bankrupt systems is just the beginning, viz.

posted by kliuless (15 comments total)

So would this eliminate all principal transactions? Banks would hold nothing on their own books?
posted by leotrotsky at 7:30 AM on May 3, 2009

Genesis of the debt disaster ~ FT's Gillian Tett
posted by SeizeTheDay at 8:05 AM on May 3, 2009

Sounds like an interesting op ed, but can someone explain it in words I can understand?
posted by NekulturnY at 8:32 AM on May 3, 2009

tett has been taking quite an anthropological lens (or micro-level cultural analysis) to the whole thing...

...in words I can understand?

as with many things it's worth listening to clay shirky :P

cheers!
posted by kliuless at 8:54 AM on May 3, 2009

Is Limited Purpose Banking a serious proposal?
My only experience is through managing my own investments so it may be that I am missing some salient points, but this proposal seems to have some deeper issues that aren't too clear to me.
For starters these two quotes:

The system was supposed to channel our hard-earned savings into the best real investments ... And it was supposed to correctly price our assets. It did neither.

We need a financial sector but not one like this. Nor do we need Wall Street hitting us up for its gambling debts. What we need is Limited Purpose Banking (LPB)

The article seems to be conflating banking and investing, at least how I view them. Investing is trying to guess what things are going to be more valuable over time and putting money in those things. Banking is about saving money. This conflation may be on purpose, in fact, the article only really makes sense in that view. But, and here's my issue, I don't want my banking and investments conflated. I want the money I put in the bank to be there when I need/want it. I like that fact that it's insured. I accept the fact that there will be little to no interest gains on those savings, because the flip side is that there is very little chance of losing the money. I also want to be able to invest in things that I feel will grow in the future, I may be wrong, and if I'm wrong then I will lose money.

Under LPB, people, not companies, bear risk as their mutual funds do well or poorly.

I don't understand this point. By "companies" do they mean banks? Or are all companies prohibited from using a bank? I understand investors bearing the risk, but I don't see how investors are limited to people and excludes companies.

A new Federal Financial Authority (FFA)--would rate, verify, supervise custody, disclose and clear all securities purchased, held and sold by LPB mutual funds

This seems like the lynch-pin to the whole scheme, and that our trust shifts from the financial system/banks to this organization. This may be a good thing, but there's not enough detail to explain the mechanisms that would make an FFA organization better than the private enterprises that do these functions today.

cash mutual funds. These funds would strictly hold cash and be valued at $1 per share. Owners of these funds would write checks against their balances and never have to worry about a bank run. Fractional reserve banking and the FDIC would be history.

I don't follow. How does a cash mutual fund differ from a bank account? Because the bank isn't holding any assets? Who controls the mutual fund? Shouldn't I be worried about them?

I understand the basics of the proposal, I think. The banks would not hold any financial assets, rather they would have relationships with mutual funds. These relationships would be regulated through a new FFA organization. However, this seems to add a layer between me and my money/investments and the only benefit I seem to get out of it is that I don't have to worry about my bank failing. But if you take away all the reasons a bank could fail and distribute them elsewhere in the system, of course I'm not going to worry about the bank failing ... I'm worried about the rest of the system that I understand even less now.
posted by forforf at 9:07 AM on May 3, 2009

Investing is trying to guess what things are going to be more valuable over time and putting money in those things. Banking is about saving money.

In a perfect world, yes, that is a reasonable distinction. The problem, though, is that, over the last, oh, 30+ years or so, banks have increasingly steered their depositors away from traditional savings programs toward investment-based/backed products, because that's where the higher profit was.
posted by Thorzdad at 9:25 AM on May 3, 2009

I definitely don't have the financial acumen to seriously evaluate this, but it certainly sounds suspicious, like Billy Mays insisting that society should switch to all airplanes being held together with his super adhesive putty stuff.
posted by XMLicious at 10:16 AM on May 3, 2009

The article seems to be conflating banking and investing, at least how I view them. Investing is trying to guess what things are going to be more valuable over time and putting money in those things. Banking is about saving money.

No, banking is about "borrowing short, and lending long" In other words, banks borrow money from lots of people for a short time (when you deposit money into your savings account, you're lending them money). Then banks the sum of all those deposits, which should be a lot of money all the time, and lend it out for people to buy houses and stuff. Rather then investing in equities which can go bad if the investment goes south, they make loans which should be paid back as long as the borrower can make the payments.

Banks have always been about investing, just not investing on your behalf. If you want to 'cut out the middle man' you could buy a fund like MBB which invests directly in mortgage backed securities, but then you take on the risk yourself. When you deposit money in the bank, you're guaranteed a percentage back (or some perk like free checking) and you have protection from the FDIC. If you invest directly in bonds or loan someone money for a house your money is tied up directly and you might not get paid back. (MBB and mutual funds are a little more liquid, though, but their prices can go up and down)
posted by delmoi at 12:07 PM on May 3, 2009 [1 favorite]

The article seems to be conflating banking and investing, at least how I view them. Investing is trying to guess what things are going to be more valuable over time and putting money in those things. Banking is about saving money.

I don't think banking was ever about saving money. I think it is supposed to be about borrowing money. A lot of the problems developed because it became about investing--or maybe even gambling--in broader markets.
posted by Chuckles at 12:11 PM on May 3, 2009

Oh and anyway, this idea is terrible. What he's saying is we could put all our money under our mattresses. Or rather have one big mattress where everyone puts their money, and we have some security guards and provide normal 'banking' services, but all the money stays under the mattress.

How would people get mortgages then? How would business get money to grow and employ people?

Also, rather then earning interest you would have to lose some of your money each month in order to pay for the "giant mattress"s upkeep: security guards, servers, check processors, etc that the "bank" needs to function.

I wrote a comment a while ago about what it would be like if we got rid of the lending. I think it was on askme, but I can't seem to find it now. I thought it would be mostly the same. Rather then "banks" we'd have "cash collectives" that stored our money, and we all would have to pay fees to maintain them. There would also be super-safe equity vehicles that would give low returns and low risk that operated just like FDIC-Insured bank accounts.
posted by delmoi at 12:18 PM on May 3, 2009

I wrote a comment a while ago about what it would be like if we got rid of the lending. I think it was on askme, but I can't seem to find it now. I thought it would be mostly the same. Rather then "banks" we'd have "cash collectives" that stored our money, and we all would have to pay fees to maintain them.

I think you're dead on there, since my impression is that Islamic banking seems to have simply used loopholes and clever interpretations to provide all the same services non-Islamic banks have. I should think at the core it's all some unified mathematical risk management mechanism and financial services will find isomorphisms or euphemistic descriptions of their products to get around almost any strictures. It's like trying to design an impenetrable bank vault that not even a shape-shifting supercriminal who can ooze through cracks can get into. (Though Islamic banking does involve lending, I believe, so it's not quite equivalent to what you're talking about.)
posted by XMLicious at 12:32 PM on May 3, 2009

speaking of mattresses (or tarps) the fed has the biggest of them all...
posted by kliuless at 12:37 PM on May 3, 2009

Banks Are Prevailing in a Tug of War
posted by ornate insect at 9:20 PM on May 3, 2009

Repeat after me:

Full reserve banking =\= No lending allowed.

There. You feel better?

Full reserve banking would just mean that lending becomes more explicit rather than the implicit "every dollar is up for grabs" attitude that banks currently have towards their reserves. If you want to borrow money a bank would setup a loan between yourself and a long term investor looking to make a fair amount of money over 30 years rather than lending it from their own reserves. They'd then take a fee or a margin off the top of the loan.

As much as I think the Austrian School are a bunch of gold foil hat wearing nutjobs I do personally think that fractional reserve banking is responsible for at least some of the chaos in today's economy. You can pull only so much money out of the magic fractional reserve hat before someone realises there's ten times as much on the books as there is in the vault and you're up a certain creek of excrement without any form of manual propulsion.
posted by Talez at 9:39 PM on May 3, 2009 [1 favorite]

From the "fractional reserve banking" link: What this thought-experiment tells you is that, if you believe in maturity transformation, you believe it's good public policy for the government to print money and lend it

As a matter of fact, I don't just think it's good public policy, I think it's the only possible public policy, unless we plan to go back to bartering. Because as far as I can tell, money has to be printed at some point or else there simply isn't any, bringing all commerce to a stop--and I'm pretty sure it's a federal crime to print our own.

I mean, seriously, think this through: What's the alternative? Let's say we're starting on day one, with a clean slate. Now should the treasury just print a few million $1 bills, and then completely shutter the works, leaving it to "the market" to make sure we all get a fair share of that pie?

What happens down the road when we've got most of that money stuffed under our mattresses, and our children enter the workforce? Where does the money to pay their salaries come from? We've got the same amount of cash in circulation, but more people to spread it around to. So the value of a dollar increases, which makes a dollar even harder to come by.

We could crank out more exports to bring foreign dollars into our economy. But then, assuming all those countries are following similarly sound fiscal policy, they only have so many of their own dollars to spare. Even if we drained every other country dry, we'd eventually hit a wall: there'd be no money left for doing anything else. No new stores, no new products, no new jobs--nothing.

Bottom line: A dollar is nothing more than an IOU--a chit that denotes a unit of value. You get it from someone who thinks they owe you something, and you give it to someone you owe something to. As long as the person spending the dollar gets something they consider to be valuable in return, and the person on the receiving end is willing to deliver their goods or services for that dollar, there's no problem...

Now let's say on the other hand, we decide we don't want to set ourselves up for economic paralysis. How do we decide when the treasury gets to print more money and how much? And who gets it? Those are the real questions that everyone would like to avoid. Currently, the banks effectively make these decisions, in a round about way, extracting generous fees for themselves in the process.
posted by saulgoodman at 8:21 AM on May 4, 2009