Tuesday, 28 May 2013

Making banks work

BANKI think it is probably time to outline how I would reconfigure the banking sector in the UK.

To do that first you have to understand what a bank is and what the point of them are from the perspective of an economic system. For this I refer to Minsky's work on What Banks Should Do.

And that is very simple - promote the capital development of the economy.

About the only reason we should pay bankers to do anything is if they can demonstrate the skill of underwriting capital projects against a prospective income stream.

In simple terms this means somebody going into a bank with a proposal that requires a certain amount of money. The bank staff considers whether the prospective income stream proposed to repay that money is adequate to repay the loan and pay the wages and costs of the bank - including a reasonable return to whatever risk capital underpins the bank.

Note that there is no asset collateral involved in this process.

This underwriting process is of great benefit to all of us as it helps to ensure that we all have jobs and output. And that is why the state stands behind the banking business - helping to make sure that the cost of lending is low - in the hope of promoting that process.

The other reason might be less clear. Banking helps prevent the concentration of equity in society. If I want to start a business and the bank won't lend, then I have to find a rich person and sell them most of my business to get the money necessary to get it going. That turns me from an entrepreneur with ownership into an unpaid lackey dancing to the tune of the Vulture Capitalist class. As Felix Dennis puts it in How To Make Money
All Faustian pacts in the raising of start-up capital should be avoided ... No founder of a business who surrenders control in exchange for capital is ever likely to retrieve control of their business. Their financial destiny is in the hands of others and the entrepreneur has lost their way on the narrow road.
Several of the proposals to narrow banking propose to restrict bank lending far further than is necessary or socially sensible - putting up the cost of lending far too high.

Lending


When I was 17 and was looking to start my first business I went to see an old grizzled business advisor. And about the first thing he said was that British Banks don't do their job. That job is the distribution of new state backed money to those who can make use of it to develop the capital of the country. The problem of getting lending to businesses has been around for a very long time.

The lending banks we need are the ones that can lend development capital effectively and stick to doing just that. If we are to have private lending banks, then they need to be able to make a decent profit doing development capital lending.

The way I would narrow banks is to offer them an incentive - an unlimited cost free overdraft at the Bank of England. 0% funding costs. In return they must drop all the side businesses and just do capital development lending on an uncollateralised basis - probably in the form of simple overdrafts. In other words they become an agency businesses delivering state money to those that require it.

I'm not even sure a capital buffer is required here. Losing your lending licence if your underwriting isn't that good should be sufficient incentive to run a tight ship. Backing off the entire thing to the central bank reduces the barriers to entry in lending - making self-employed, highly dispersed and, importantly, locally focussed underwriters a possibility (the 'Provi Model').

Any lending businesses that doesn't want to take the oath, then has to fully fund their lending on a maturity matched basis Zopa style. No deposit insurance, no access to the Bank of England, and losses absorbed by those doing the lending. This then becomes the fate of the shadow banking system - the building societies and money funds.

So that sets state funded lending against fully match-funded lending in competitive tension. State funding will likely be conservative but actually injects extra net financial assets into the non-government sector economy. Fully funded lending is just patient man helping impatient man for a fee in return for the risk.

Now narrowing banking in any way will put the cost of lending up markedly - particularly if you de-collateralise to get away from asset bubble spirals. With the current level of loans that is likely to cause fun and games. So you have to get the total amount of lending down at the same time as the narrowing is put in place.

Probably the quickest way to do that is via a debt jubilee, where everybody gets a set amount of money from the state to set against a loan. That way loan amounts, property values and the level of lending all go down at the same time, and those currently without loans get the cash as compensation for loss of asset value.

So with complete disintermediation by the central bank you can have several models - from a fully nationalised state bank with employed underwriters, through the 'Provi Model' where you have self-employed lenders and collectors, to the normal bank with employed bank managers.

The amount of state money injected is limited by demand - as determined by a highly distributed set of underwriters locally on the ground varying interest rates to suit local conditions and their own profitability vs the competition from fully match funded lenders.

That is a flexible system that can respond rapidly to changes in circumstances and is infinitely superior to a cabal of the elite sat in luxurious surroundings in London trying to work out how much the economy requires by applying the Wisdom of Solomon that they don't really have.

A National Bank Transaction System


The retail bank transaction system is the circulation of our economy - interruptions can prove dangerous and perhaps fatal.  As Cypriots recently found, most of us can only operate for a few days without access to a cash-point or online banking transaction service.  

Transaction banking services are a national dependency, just as our body depends on the circulation system to pump blood around the system.  This dependency is currently held entirely within the hands of privately-owned, dubiously managed, mixed-market banking organisations.  Any threat to their monopolies or their bonuses, and the transaction banking system gets it.  The Government, fearing a Cypriot-style crisis or queues at the Northern Rock, capitulates, and Osborne goes to Brussels to argue for bigger banker bonuses.

Even the wildest free-marketeers would hesitate to place our entire road network in private hands, so banking transactions should be protected in the same way.

There is no such thing as 'cash in the bank' if you're beyond the central bank's deposit insurance limit (note I didn't say "state's insurance limit" - only the central bank can provide reliable deposit insurance). At that point you're a risk investor in the bank as many in Cyprus have recently found out.

The transaction system is clearly being used as a hostage by the banks to get whatever they want out of the government and the central bank. Do as we say or we shoot the transaction system!

The transaction system has to continue to function in the event of a bank failure.  Funds held in transactional accounts should be unaffected by that bank failure. The bank illusion of money in the vault has to be replaced with the reality of money in the vault. It can never be allowed to be shattered otherwise you get a sudden shift in expectations at best and cascade failure of businesses at worst.

But that can't be done by simply propping up banks no matter how ridiculous they behave. Capitalism without losses is like Catholicism without hell-fire. It no longer works as a concept. Bad lenders have to be allowed to fail.

Additionally the transaction system is a massive cost overhead to banks and they hate it. Every bank has a unique system, they are fundamental incompatible and that means the duplication between banks is colossal. I've done quite a bit of work on bank transaction systems over the years and the scale dis-economies are quite spectacular. And so they follow management fads - like outsourcing and offshoring - that do little more that shuffle the costs around the business. The recent failure of the RBS transaction system is a case in point.

The banks can do things together. APACS (now UKPA) and LINK show what can be done with mutual co-operation. That needs to be taken one step further, with the transaction system incorporated into a similar body.

There are lots of ways of designing a mutual transaction system. But at its core is one concept - that transactions operate on the balance sheet of the central bank, not the individual banks. So you would have a Transaction Department at the Bank of England (alongside the Issue and Banking Departments) and current and savings account ultimately represent liabilities on that balance sheet.

The functional aspects are less important - existing bank accounts could be held in trust by the current banks, run as separate subsidiaries companies and a myriad of different other options. But the key point is that the operational entity is acting as agent and the legal ownership and responsibility is always at the central bank. That makes anything recorded in the transaction system exactly the same as holding cash. You have a receipt for liabilities at the central bank.

However that makes the individual banks short of deposits and balancing liabilites. The replacement on the individual bank's balance sheets is of course an overdraft from the central bank - as mentioned in the section on lending. Existing banks would then have to get the match funding to free themselves from the central bank lending restrictions, conform to requirements or just enter run-off.

The transaction system is like the road or rail infrastructure and is a common good required by all. Inevitably the state will have to fund its existence - because there is no money in running it. I see the state providing a 'white box' system that anybody authorised can put a marketing veneer on. Done correctly it would mean that you can literally operate your bank accounts through any of the competing front ends. Account numbers would stay the same whoever you are notionally with.

Shadow banks would just have an account on the transaction system like everybody else and would lend by advance - paying money from their account into somebody else's. Overdrafts would be authorised by the underwriters for state funds. All that does is lower the limit at which transactions are refused to somewhere below zero. You could have a combined savings/transaction account by allowing the customer to increase the limit at which transactions are refused above zero.

This design maintains the mutual elements of the UK banking system - our common cash machine system and payments infrastructure as well as the 'free banking' transaction system, it frees the lenders from a crippling cost obligation and it ensures that everybody can rely on 'cash in the bank' being there - regardless of the turmoil in the lending institutions.

The one casualty is interest on deposits. To have interest on deposits in a private system there has to be income from somewhere else to pay that interest. Therefore in this system it becomes a line item of government spending - likely via interest bearing accounts for individuals at National Savings. Paying interest on deposits in this way is then really just the same as paying coupons on Gilts. Gilts, of course, would cease to be issued under any rational government.

Summary


Much of this is an amalgam of ideas from all over the place. There's nothing new as such - perhaps just a slightly different arrangement.

There are some key points though:

  • People who put money in the banks believe they are storing an asset safely. It's important that the reality reflects that belief. The bank illusion must be maintained at all times - whether individual institutions fail or not.
  • We can keep the free banking and mutual nature of our cash machines and payments system. It's a good thing to have a freely available rapid transaction system just like it is a good thing to have freely available banknotes and coins.
  • Lenders have to be allowed to go bust. Constant forbearance is a bad thing in a capitalist system. Failures must fail and the costs borne by those funding those operations. The state's job is to mitigate the effects of failures in the private capitalist system.
  • Lending of state money is a valuable way of dynamically increasing and shrinking the money supply. It's automatic and distributed. It helps the capital development of the economy and helps to dilute the ownership of equity. But the nature of that lending has to be tightly controlled.
  • Getting the state to lend directly via agents in the field would lower the barrier to entry in lending.

48 comments:

Ralph Musgrave said...

As to what the “point” of a bank is, “promoting the capital development of the economy” is certainly not the only basic objective as far as a VERY LARGE number of bank customers are concerned: DEPOSITORS. They’re after a variety of services provided by banks – the most important and obvious being somewhere to store money, and a money transfer system (cheque books, debit cards, etc).

Second, banks are essentially fraudulent institutions: they borrow specific sums of money from depositors, and promise to return those specific sums, while investing or lending on that money in ways that are not 100% safe. That works out 9 years out of ten, but sooner or later it’s a promise that is bound to go wrong, the bank goes bust.

It’s happened over and over and over and over and over thru history. And the solution we adopt? It’s to have taxpayers bail out banks when it goes wrong. Completely daft.

Even more daft is that everyone complains about bank subsidies, while SPECIFICALLY ASKING FOR a banking regime that makes those subsidies inevitable.


Clint Ballinger said...

Nice post Neil, a clear explanation of the issues at stake and good solutions. I think there is finally some much needed convergence on bank reform, and it all fits in nicely with MMT as well.

Basically, 1) make sure there is a safe narrow banking system for those who want it (which will be a large part of the medium to poor) 2) let lending partly be by completely risk free (to society) maturity-matched loans to the extent there is demand for this and 3) let operatives loan out state money for profit to meet additional demand for loans as long as they do so responsibly, which can be ensured by limiting the asset side and revoking licenses liberally.

Not far off from my conclusions here( Towards a Pure State Theory of Money )just arrived at differently.
My post needs to be developed further, but Neil’s post says some of the same things I would have anyway.

Neil Wilson said...

"They’re after a variety of services provided by banks"

Currently provided by banks. There is no reason they have to provide them any more than there is a need for private banks to print notes.

What banks do that is special is offer loans. That is where the skill is and is the essence of their operation.

What I propose above separates out the essence of a bank from the peripheral operations it is using as a 'human shield' to gain inappropriate state protection.

Banks have to be allowed to go bust. If they are regulated and have access to the central bank then it is appropriate that the central bank takes the hit - for failure to regulate effectively.

If they are not regulated then the bank has to have maturity matched funding - Zopa style. Then the investors take the hit for failing to pick the winners.

Jamie_Griff said...

Hi Neil,

Over on golemxiv.co.uk you criticise Positive Money's proposed reforms as being liable to concentrate equity in the hands of a small elite.

To my untutored eye though it seems that your proposals are almost identical.

Could you possibly explain the differences? And elaborate on your criticism of PM's proposals?

Clint Ballinger said...

"putting up the cost of lending far too high"

Isn't the cost of lending the interest rate, and the government can control the interest rate (with ZIRP being sensible)?
So how is the cost of lending raised?

Neil Wilson said...

"Isn't the cost of lending the interest rate, and the government can control the interest rate (with ZIRP being sensible)?"

Not with matched money it isn't. It's set by the requirements of depositors/investors.

The cost of lending can only be controlled by the central bank if the lending banks have the option of borrowing from the central bank. Remove that and a load of middlemen start adding their cut to the price of money.

The interest rate in our current system is set by the combination of the base rate and the scope of the discount window.

You'll notice that interest rates have come down since the BoE widened the discount window with the Funding for Lending Scheme - even though they didn't touch the interest rate.

Neil Wilson said...

"Could you possibly explain the differences?"

The difference is that the central bank lends pretty much directly to the entrepreneur dynamically on demand. That cuts out all the rich middlemen completely, forces the price of money to a particular level and ensures there is never a shortage of funds at the current price of money.

Additionally the level of government spending is determined by parliament and parliament alone in a democratic manner.

The government of the day always gets the Finance Bill it can get approved by the Commons. Remember that even the House of Lords never stands in the way of such a Bill.

That way the buck stops with the Government and if they screw up we can at least throw them out at the next election.

You'll note that Mervyn King has only just stepped down as Governor of the BoE and many individuals are still on the MPC five years after this mess started. Why are they still there making the same mistakes?

Cabals of the Elite make decisions that favour the Elite. It's only natural that the do so, because they are only human.

Mark Pawelek said...

What is to guard against fraudulent loans, NINJAS, etc. apart from 1) due diligence by the lender, 2) the central bank rationing the amount of free money issued to lenders.

Will there still be inflation targets set by the central bank?

Will the individual lenders be restricted to some maximum size? What's that maximum size as a fraction of national GDP?

The fundamental issue I have with this is that our banking system is an outgrowth of capitalism. The capitalists made it that way for a reason. They are not going to change things just because you have a more rational system. It's the 'politics' in the political economy that will, likely as not, stop this.

Neil Wilson said...

"What is to guard against fraudulent loans, NINJAS, etc. apart from 1) due diligence by the lender, 2) the central bank rationing the amount of free money issued to lenders."

Parliament checking that the central bank is doing its job.

All control systems have points of weakness. The trick is to come up with one that is good enough. Here the central bank is 'in the bank'. So if things go wrong the central bank takes the loss immediately and questions get asked.

"Will there still be inflation targets set by the central bank?"

The control, which is likely to be leverage ratios, is determined by parliament. The central bank executes the will of parliament.

"Will the individual lenders be restricted to some maximum size? What's that maximum size as a fraction of national GDP?"

They will be capital restricted by regulation, or fully equity backed depending upon the model they choose. Lenders can then fail via the bankruptcy and administration mechanism.

"The fundamental issue I have with this is that our banking system is an outgrowth of capitalism."

Yes, and if we're to 'fix capitalism', then we need to move away from Financial Capitalism to a more Managed Capitalism like we had just after the war.

Capitalism is like a uranium reaction. It can provide immense power, but has to be contained effectively and have efficient control rods.

And it has to be designed to fail cold so you don't get a melt down.

Malcolm Henry said...

Neil,

I came to this article via your comment on Golem's blog about PM's Modernising Money book.

Your comment expresses concern about Positive Money's proposed method of managing the continuous flow of new money into the economy.

In PM's system the rate of flow is decided by calculation and the government decides where it gets spent. In your version the market decides both the flow rate and the application.

Both versions concentrate the application of new money into favoured areas of the economy, leaving the rest of the population out in the cold, which is very much what we have with our existing system (hot spots of government spending and bank lending versus the rest).

Both you and PM appear to accept that a continuous (if variable) flow of new money is inevitable, hence the need for a method of creating and allocating it.

We only need a continuous flow of new money because of our cultural obsession with using money as a proxy for wealth. The more money we get, the more we hoard because it makes us feel rich.

In my book I argue for a mechanism that discourages the hoarding of money and encourages using it for investment in productive activities (as opposed to gambling on assets).

This means that the quantity of money in the economy can remain approximately constant while the mechanism can adjust the velocity.

The need for a system to manage a continuous flow of new money into the economy disappears.

Neil Wilson said...

"In PM's system the rate of flow is decided by calculation"

No - it's decided by unelected committee and that's the problem.

In the MMT proposal it is decided by the government - who set the lending policy for the banks and gets its budget through parliament.

In other words properly democratically.

Any other approach requires that you effectively ban financial savings - which is simply not going to happen.

Anonymous said...

I say we abolish banks altogether and go full communist. Cash issued to a populace with the intention of making profit for the bank, and a populace who use cash to make profit for themselves, seems to inherently lead to poverty, even if it also inherently leads to "value" being created.

Terry Hall said...

Neil,

Where can I find more information about the Provi Model you refer to? A quick google search yielded nothing.

Thanks

Neil Wilson said...

It's the system used by Provident Financial - which is to use a large number of local agents who are self-employed and have the authority to make loans and collect payments within very small areas on a face-to-face basis.

Very similar to old insurance agents who sold insurance products door-to-door and once used by companies like Prudential, or Pearl Assurance.

jake said...

Neil,
I think these ideas are great. One possible alternative to the status quo.
I would however be interested to hear what you make of the following:
http://australia4mpe.wordpress.com/category/mpe-for-dummies/
It´s called mpe and involves an Accounting Common monetary Infrastructure.
As I understand it, people can essential underwrite their own credit by issuing their own "unexploited promissory obligations" without a bank to underwrite the credit and charge interest. Only the principle has to be repaid and retired out of circulation.
Ta

Neil Wilson said...

That's essentially a 0% interest loan from a public bank dressed up in fancy language and lots of hand waving.

There's far too many of that sort of thing - normally involving some amazingly separate Solomon like organisation that maintains the True Path God like, unwavering and without any mistakes.

And particularly without any 'politicians'.

The Right Libertarians have the same nonsense maintaining the inviolability of property laws - like they were handed down from Mount Sinai.

Unfortunately it all falls foul of the usual "Who watches the watchers" critique - also known as the Solomon Fallacy.

I really don't understand why people want to try and create perfect barter, try and create perfect fixed exchange rates or try and create perfect loanable funds. All rather than accept the system and human beings for what they are and work with that.

It's like trying to 'cure' homosexuality with electroconvulsive therapy. Endogeneity is innate and you can't make it go away. We create debts with each other all the time and swap them for other debts we prefer. That's how stuff gets done.

jake said...

Yeah good points. Mind you I suppose any system will require an army of forensic accountants to mitigate against any abuses.

I do not think their understanding of the economy acknowledges Vertical or Government money. As a result they are overly concerned with National debts. For them all money is horizontal debt money.

I do think they make some good points about the role of interest increasing debts beyond an economies ability to pay. Michael Hudson (no relation to the mob we are discussing) wrote about how in the ancient near east kings dished out 50 year debt jubilee in order to maintain equality and reverse the concentration of property ownership. The Babylonians recognised that debt increased exponentially whilst the real economy tapers off in an S curve. It only takes 30 years for a debt to multiply 64 times.
Even Steve Keen has talked about a modern day debt jubilee.

Debts are fine, but I think debt at interest is unsustainable(servicing exponentially rising debt must be). There should be some mechanism to write them off or write them down to the ability to pay.

Perhaps Osborne's first instinct to allow failing banks to fail were right. Debts would have to be written down. As long as the government maintained the insurance deposit scheme I am not entirely sure what the negative fallout would be.


They make some points using legalese that banks do not give up commensurable consideration when they exchange money for a promissory obligations (loan agreement).And therefore have no right to charge interest. But on the other hand, If my understanding is correct, banks cannot use the principal as profit when it's on their books. And they make opportunity costs and risk their balance sheets if they make loans that could potentially go bad.(admittedly this risk is limited if government continues to bail them out)

Neil Wilson said...

jake,

Don't forget that interest is spent. Interest is merely the wages of bankers just as profits are the wages of capitalists.

Bankers are human too (just) and consume. Whether interest is sustainable actually depends how much bankers spend!

jake said...

So If you take the Private sector by its self. It would be fair to say that the recession(07-08) was caused by a failure of bank's profits to circulate back to the households and companies to pay off on going debt? This affected asset prices which in turn affected bank solvency, which obviously undermines any prior bank over saving. And somewhere in this the 18 year land market/credit cycle fits in?

Neil Wilson said...

I'd say it's more complex and multi-layered than that and there are lots of PhDs in it.

There has been excess net saving from the NFC sector for a very long time.

At the gross level the financial sector was just expanding its balance sheets continuously for a very long time spinning around greater and greater quantities of debt. Eventually the music stopped and some of the debts went bad.

That caused a cascade in the opposite direction.

Random said...

Could the government implement land value taxation to prevent collateral-debt spirals, at least in the property market? Then people will also invest in buildings/improvements.
My idea was to implement LVT and bank regulation but offset this with large tax cuts.

Neil Wilson said...

Land Value Tax (or a hut tax as Randy has suggested) is a great basic tax system to maintain demand for state money in a country.

Politically very difficult to get through though.

Anonymous said...

The way I would narrow banks is to offer them an incentive - an unlimited cost free overdraft at the Bank of England. 0% funding costs. In return they must drop all the side businesses and just do capital development lending on an uncollateralised basis - probably in the form of simple overdrafts. In other words they become an agency businesses delivering state money to those that require it.


How many banks will be doing this and where is the competition ?

How will they make their money by lending - interest rates ?

Will all of them not just have a race to the bottom ?

Cheers

Neil Wilson said...

Of course it is a chase to the bottom. That's what a functioning competitive market does - drive down costs and improve service.

Those that can't hack it go bust.

A currency area is a simple public monopoly. Which means that all regulated banks using the currency would have to conform to the restrictions to get the benefit of lower costs.

Banks make money by charging for lending. A flat arrangement fee might be better, but probably it would be an interest rate since loans get paid back and amortising the fee helps cash flow. It all amounts to the same thing in the end.

Tom Hickey said...

@ Anonymous

That was included in Warren Mosler's proposals for banking and financial reform. See proposals in the nav bar at moslereconomics.com, To the best of my knowledge all other MMT economists agree about unlimited provision of liquidity to solvent banks, setting the overnight rate to zero, and limiting Treasury debt issuance to 3 mo. bills, as well as breaking up the TBTF and TBTJ banks, creating a firewall between banking and other activities, and regulating bank credit extension from the asset side.

This decentralizes credit extension, turns the central bank largely into a settlement system, and also gets rid of the monetary policy function in the hands of a group of unelected technocrats.

Anonymous said...

Yes of course.

However, would then not mean that all of them would then offer the lowest rate possible ?

I could see most banks operating from exactly the same model after a while and they would all look and act the same. Even down to their customer service.

Good for the customer of course but why would anybody want to do it ?

Neil Wilson said...

Because in business once you're in it's quite difficult to get out.

Capitalism in a competitive market is a faustian bargain. That's why firms spend so much time trying to extract rents and railing against competition.

Look at the supermarkets in the UK. Competition largely works there, and yet they still continue to operate. We even get new entrants!

Tom Hickey said...

Good for the customer of course but why would anybody want to do it ?

Mosler, a former small bank owner, points out that banks are not ordinary businesses but public-private partnerships that exist that the pleasure of the government in accordance with banking law, regulation and oversight. They don't have any choice when government creates or alters the institutional arrangements other than to comply.

Of course, banks can and do lobby government and use the revolving door to shape law and policy in ways favorable to them. Sen. Dick Durbin about the US Congress: "The banks own the place." But that's a problem with US "democracy."

Mosler further argues that the problem lies fundamentally with government, which doesn't properly understand banking and doesn't know how to create institutional arrangements that serve public purpose. Moreover, government rely heavily on bankers to "understand" banking. Obviously, that understanding is interested.

With proper knowledge of banking operations, a system could pretty easily be implemented that eliminates the major issues in the existing system.

It's really just a matter of tweaking the existing system to remove the bugs, rather than designing a whole new system. Neil is much better qualified to explain this that I am. I am just summarizing Mosler's view for those who may not know about it.

The problem is therefore not so much with banking as such as such as the warped political system. This is a reason that MMTers object to creation of another independent government committee to address fiscal policy non-democratically on top of a politically independent committee that addresses monetary policy, or to give the monetary policy committee fiscal power.

Random said...

Neil, what is your view on 'free banking'?https://en.m.wikipedia.org/wiki/Free_banking

Neil Wilson said...

It already exists (Bitcoin and the other electronic assets) and unsurprisingly has been competed out of the market for the most part by the more effective state provision.

Advocates miss that because they can never believe the state can make things cheaper and more effective. And they don't understand why the central bank is there. The central bank is there to ensure that liabilities clear between competing commercial banks at par and that you can make payments in the pegged currency across the whole area. It's a fixed exchange rate area in other words.

Self-regulation has shown to be a foolish concept throughout the current crisis. Harking back to the 19th century for 'evidence' is desperation to fit to a belief.

This idea that depositors and shareholders will regulate the activity of a bank better than a central regulator defies logic. Fragmented shareholders are unable to overcome the agency problem in large firms, never mind banks. We've seen that over the years with the ongoing failure and consolidation of building societies.

Making banking more expensive doesn't fix the problem. You have to regulate what banks can create and lend money for.

Random said...

"You have to regulate what banks can create and lend money for."
What if a bank disobeys the rules? I would guess the best option would be to enforce it as a gift from the bank rather than a loan?

Neil Wilson said...

For a loan to be enforceable in the courts it has to be within the rules. If the loan can't be enforced then it is has to be written out as a bad debt.

Too many of those and the bank goes bust.

Jake said...

Hi Neil,

I am currenctly reading the recent BoE of the failure of HBOS,

I am having difficulty squaring That bank lending is only constrained by a lack of lending opportunities,and that a credit crunch is a dearth of lending opportunities.
With the other explanation that banks mispriced assets and experienced a seizure in the interbank markets of liquidity,became unable to meet existing liabilities and secure funding to make new loans.

"I'd say it's more complex and multi-layered than that and there are lots of PhDs in it."
If possible could you recommend all that you know off,I haven´t been able to come across any, least of all not MMT consistent.I really want to roll up my sleeves read a few a get to grips with all the detail.

"NFC sector"-is that the financial sector

ta

Anonymous said...

I sent C. Dillow a link to this article on his post "Should we nationalise banks?"

http://stumblingandmumbling.typepad.com/stumbling_and_mumbling/2016/02/should-we-nationalize-banks.html

"to the extent that banks have a positive net present value at all, their transfer to the public sector represents not a loss of wealth but a mere transfer: what bank shareholders lose, the tax-payer gains. The only wealth loss would come if banks are worse-managed in the public sector than they would be in the private – and that’s a low bar. Net, there might well be a positive wealth effect."

Also:

"the quickest way to do that is via a debt jubilee, where everybody gets a set amount of money from the state to set against a loan. That way loan amounts, property values and the level of lending all go down at the same time, and those currently without loans get the cash as compensation for loss of asset value."

Could you have tax cuts or basic income or increases in spending as alternatives?

Neil Wilson said...

So Chris is another one of those 'marxists' who likes to mail cheques to millionaires and wealthy people.

Ask him what supply side reforms he's going to put in place to cope with all that 'equity release' blasted onto the market. And all those people who are renting but don't have any loans because they are too poor to get loans.

When people get money they spend it. When they get a lump sum they spend a lot. People are not going to save the money because they generally have no idea what the value of their house is from one minute to the next (unless they take the Daily Mail).

A Debt Jubilee is another one of those neat, plausible and wrong ideas - like basic income. You can tell the people who push these ideas have never implemented anything that actually has to work.

Random said...

"A Debt Jubilee is another one of those neat, plausible and wrong ideas - like basic income. You can tell the people who push these ideas have never implemented anything that actually has to work."

Neil, you have suggested a Debt Jubilee. That's why I suggested it! On this very post :)

Here it is in context:

"Any lending businesses that doesn't want to take the oath, then has to fully fund their lending on a maturity matched basis Zopa style. No deposit insurance, no access to the Bank of England, and losses absorbed by those doing the lending. This then becomes the fate of the shadow banking system - the building societies and money funds.

So that sets state funded lending against fully match-funded lending in competitive tension. State funding will likely be conservative but actually injects extra net financial assets into the non-government sector economy. Fully funded lending is just patient man helping impatient man for a fee in return for the risk.

Now narrowing banking in any way will put the cost of lending up markedly - particularly if you de-collateralise to get away from asset bubble spirals. With the current level of loans that is likely to cause fun and games. So you have to get the total amount of lending down at the same time as the narrowing is put in place.

Probably the quickest way to do that is via a debt jubilee, where everybody gets a set amount of money from the state to set against a loan. That way loan amounts, property values and the level of lending all go down at the same time, and those currently without loans get the cash as compensation for loss of asset value.

So with complete disintermediation by the central bank you can have several models - from a fully nationalised state bank with employed underwriters, through the 'Provi Model' where you have self-employed lenders and collectors, to the normal bank with employed bank managers."

Now I can see that you want to expand general govt spending but I have no idea if the resources freed up are the same ones. I was hoping you would have an idea. Because narrowing banks means a recession unless govt does something or there is a deus ex machina.

Random said...

"Ask him what supply side reforms he's going to put in place to cope with all that 'equity release' blasted onto the market. And all those people who are renting but don't have any loans because they are too poor to get loans. "

This has been UK govt startegy for the past 30+ years according to commentator "blissex":

"But *for the people involved* owning a house makes them feel like landlords and owning shares makes them feel like capitalists, more often than not.

I have often repeated in my comments here that the foundation of right-wing politics since 1980 in most Anglo-American countries has been a study thqt showed that people who owned a house, shares, car voted to the right regardless of income and social class.

Sierra Man surely did:

«Dad always voted Labour. He used to vote Labour, he said, but he bought his own home, he had set up his own business, he was doing quite nicely, so he said I’ve become a Tory.»

And as to The ridiculous idea that;

«Owning a house (unless BTL) does not make you a landowner as there is no ground rent,»

One of the crucial tools of right-wing social engineering has been ensuring high levels of tax-free effort-free large capital gains for decades cashable via low interest remortgages by any so-called Middle England tory. My usual figures:

http://www.bbc.co.uk/news/business-19288208
«In 2001, the average price of a house was £121,769 and the average salary was £16,557, according to the National Housing Federation. A decade on, the typical price of a property is 94% higher at £236,518, while average wages are up 29% to £21,330»

In the South East that means a two-up-two-down terrace house, that has given £12,000 a year tax free to a working class owner who bought it in 2001, and that might be nearly doubling their after tax income.

Again, do people who write comments like above read the Telegraph or Mail, if not commonly published statistics?"

That's quite a bit of Free Money, cashed in via remortgages. If Labour wants to win they have to pander to those voters and give them Free Money. Elections are decided in the South, not the North, where voters gleefully asset strip themselves. That's why I think Corbyn's mob won't win without a house price crash and recession.

Neil Wilson said...

A debt jubilee is unworkable in practice. What you find is that you have to drip it out slowly to stop the supply side getting swamped.

And there is another name for that - wage rises.

Neil Wilson said...

"That's quite a bit of Free Money, cashed in via remortgages"

Remortgages can only release money if there is the income to service the mortgage, or you're doing retirement equity release. I wonder how much of that is going off at the moment with wages stuck in the doldrums.

Otherwise the value is entirely notional and most people don't think about it. They just pay the mortgage.

Random said...

Right. Property price capital gains, the preferred vehicle for big yearly handouts to buy tory/nulab voters in the South, are necessarily purely redistributive.

Via trickle-down some of that may end up employing someone who was unemployed, but not necessarily in the UK.

But a policy of large scale upward-redistribution that funds a small flow of trickle down is the toriest of the "private keynesian" policy spectrum. Thus the preferred one by "making speculation pay for hard waiting families" George Osborne and David Cameron.

Random said...

Basically government spending according to blissex. Although as we know the current system based on ever rising private debt is flawed.

"The biggest part of the Tory story is exactly the opposite: they tell voters that they will become rich only by maxing out the credit card to borrow a lot of debt for highly leveraged property speculation, and that a Tory government will lend (or even handout cash) to them whatever it takes to satisfy that "aspiration" for lots of debt and the resulting tax-free capital gains.

Note that this story applies *only* to voters in the South East.

The minor story is that the same voters in the South East are tired of their precious capital gains being wasted in rather small part on the unemployed and disabled people in the North, and they want that part of the deficit and the national "maxed-out credit card" to be cut.

Look at all the policy announcements the Tories have made: the big ones have always been about bigger cheaper government sponsored loans/handouts to South East property speculators.

Usual quote from George Osborne that carries both stories:

«A credible fiscal plan allows you to have a looser monetary policy than would otherwise be the case. My approach is to be fiscally conservative but monetarily active.»

Here «fiscally conservative» means "cut spending on the Northern scroungers" and «looser monetary policy» means "bigger cheaper loans to aspirational South East property speculators".


www.opendemocracy.net/ourkingdom/oliver-huitson/thatcher-black-gold-or-red-bricks
«Another of Thatcher’s magic potions was ‘home equity withdrawal’ or remortgaging – drawing down the equity in the borrowers home for (mainly) consumption purposes – new cars, holidays, and so forth. Under the two Prime Ministers that preceded her, James Callaghan and Ted Heath, home equity withdrawal as a percentage of GDP growth was around 36% for both.
Under Thatcher, this exploded to over £250bn across her premiership – a staggering 104% of GDP growth. [ ... ]
[ ... ] But Blair did his homework and let loose – as did Thatcher – a wave of cheap credit, financial deregulation, house price inflation and an equity withdrawal-led consumption boom.
Withdrawals under Blair’s leadership totalled around £365bn, that’s a full 103% of GDP growth over the same period,»"

Random said...

Here is some Daily Mail links that explain a lot:

http://www.dailymail.co.uk/femail/article-2308344/Petronella-Wyatt-Its-hell-posh-poor.html
http://www.dailymail.co.uk/femail/article-2841450/Just-live-1m-house-doesn-t-mean-m-not-breadline-Ursula-knows-ll-little-sympathy-says-trying-match-parents-comfortable-lifestyle-left-penury.html
http://www.dailymail.co.uk/money/mortgageshome/article-2105240/Stuck-rent-trap-How-middle-class-family-kept-remortgaging-home-pay-bills-longer-afford-repayments.html

"Otherwise the value is entirely notional and most people don't think about it"

All people if Tories don't count as people :)

Random said...

All this is to avoid having to recognize that many millions of South East families are effectively bankrupt like many millions of Northern families have been for decades. It's ridiculous. Tory voters are effectively saying "No. I am not bankrupt! Look at how much my house is worth!"

Osborne is making "Northern scroungers" and "overpaid public workers" pay the price of continuing to avert the consequences of the collapse of the debt-collateral spiral on Southern rentiers, helped by the City as "he is one of ours" and to allow him to boast of being the "no crisis chancellor".

That £12,000 a year for median income voters not only is huge, and goes mostly to toryish swing voters in the South, and it comes out of the pockets of the poorer half of residents, but it is highly visible, all newspapers celebrate loudly bigger better property prices, and indeed can be cashed in easily with a visit to the local remortgage shop at low low rates thanks to demand and wages being pushed down by fiscal and labour policy.

Has Uncle Jeremy got something bigger and more visible to buy voters in the South than Slimy George does or Slick Tony did?

Random said...

Widespread remortgaging and rising private debt has been a core target of economic policy for decades, because it means that when the small number of properties that get traded every year results in higher valuations, these can be applied to the vast majority, justifying booming debt levels.

Crucially, *without putting those properties on the market for sale*, and thus boosting valuations even higher than otherwise, by creating a thinner market.

If a street in some South East suburb has 20 houses and just one of them is sold for £230,000 10 years after being bought for £110,000 this generates (notional!) £120,000 capital gains for each of the other 19 too.

This means potentially not just new *net* debt of £120,000 for the mortgage of the property that has been sold, but an extra £2,280,000 of remortgages on the other 19 properties, crucially again without them actually having to be put on the market.

Totally safe lending of course :), as it is at that point an easily verifiable fact that the valuation of properties in that street as collateral is indeed £230,000 as it is a matter of record.

So not only remortgages can balloon in volume, but this is also entirely safe!
And government-guaranteed! :)

Let's just pretend that there was not a small dip in prices in 2008 and not change anything about our perfect system.

Such are the wonders of the debt-collateral spiral.

Neil Wilson said...

There isn't as much equity extraction as you seem to think.

Random said...

"And there is another name for that - wage rises. "

Too funny Neil. It's like Thatcher never happened.

I have noticed that there are many in the delusional left who think that the socialist policies of the Foot, Benn and Kinnock governments of the 80s and 90s have dulled the class consciousness of the working class who having gained and maintained their good jobs and pensions and enjoying the low prices of property and low cost of dentists they now think that class consciousness is something from the past and everybody is comfortably working class now :D

But they ought to *wake up* and read the Telegraph and the Mail, or at least the Giles Radice pamphlets in the "Southern Discomfort" series.

Swing voters now want two things - tax free capital gains and *lower* wages as cheap hired help is hard to find.

Voters were/are far more likely to vote to the right if:

* They owned and used a car rather than using public transport.

* They owned shares rather than having a pension.

* They owned a house instead of renting.

* That is even middle-upper class voters were more likely to vote left instead of right if they used public transport, had a pension, and rented, and most importantly even working class voters would vote for the right if they owned a car, some shares, and a house, no matter how thin such ownership was.

The policy of tory governments, whether Conservative or New Labour, has been consistently to subsidize property speculation, undermine public transport, and discourage pensions. Every election since 1987 has been decided by swing voters who love tax free capital gains.

Thatcher was a genius. Blair was a genius for doing the same things but less viciously and introducing pro-corporate policies like tax credits. That's how he won, and lack of house price growth meant Major and Ken Clarke were screwed.

Pushing up house prices and pushing down wages may be break even for a voter - but what it does is mean they have a far greater % of income coming from property. People notice when being landlords nearly doubles their income.

This was the goal of the *social engineering* policy, because it was a *social engineering* policy, not a political engineering one.

The goal was not (completely) to make working class people change their *vote* to that for the party of another class, it was to make them change their *class identification* to that of the other class.

This arguably has succeeded *materially*

A large chunk of South East property owning middle aged and older baby boomers who grew very "liberated" during the 60-70s and a lot of them got rid of their husbands one or more times. They are both Thatcherite and “socially/sexually liberal”

Relevantly Piggylover owes a large part of his being leader of the Conservatives to his targeting that constituency.

Random said...

R. Musgrave's comments piss me off:

http://stumblingandmumbling.typepad.com/stumbling_and_mumbling/2016/02/should-we-nationalize-banks.html?cid=6a00d83451cbef69e201bb08b95d17970d#comment-6a00d83451cbef69e201bb08b95d17970d

"I agree that banks are into the “hostage” business, as you put it. But I don’t think you’ve got it quite right. I suggest it’s money creation and storage which is the hostage.

That is, private banks create and store the vast bulk of the nation’s money supply. That means that if they screw up on the LENDING front, they can say to government, “Rescue us else a big chunk of the nation’s money supply vanishes, i.e. ordinary depositors lose their money, and there’ll be riots.” Indeed, in the 1930s before the days of deposit insurance, ordinary depositors lost $6bn as a result of bank collapses in the US.

The solution is to separate lending from money creation and storage. I.e. have government be responsible for all money creation and storage (as suggested by Milton Friedman and three other economics Nobel laureates), while LENDING is funded by equity or equity like liabilities (like bog standard corporate bonds). That way, if there’s a screw up on the lending front, lending entities do not go insolvent: all that happens is that the value of lending entity shares decline in value."

What about - asset side regulation! "That way if there is a screw up on the lending front" we don't want there to be do we Ralph.

Neil Wilson said...

Not only do you need asset side regulation, but you also need the commercial banks to be 'in the bank'. That way the central bank is essentially the only depositor other than current account holders. Everybody else is off at national savings earning interest.

This idea that 'shareholders' will discipline banks is total nonsense. They are fragmented and have no control at all over large operations. They just collect the dividend or coupon.

Shareholders and bond holders didn't do a great job of managing the banks up to 2008, and they won't do afterwards. It requires hard regulation - which also has the added advantage of eliminating the cost of liquidity to the banks which makes loans cheaper.

Trying to do the 'market forces' trick just puts the price of borrowing sky high. Which is bad for the capital development of the economy.

Separating the payment system out onto a separate balance sheet is about the only half decent idea from the sovereign money people. That way commercial banks act as agent rather than principal. But it doesn't really matter because the central bank can inject the necessary assets into a bank shell whenever it needs to. So why have the centralisation complication when you can do the same thing via insurance and regulation?