Wednesday, April 13, 2011

Banks Should be treated as Public Utilities - Thomas Hoenig, KC Fed President

The analysis that banks are public utilities is a very basic and honest one.   Of course they should be regulated as one, as suggested by Kansas City Fed President Thomas Hoenig (  
The situation with banks is actually worse than with utilities.  Utilities at least provide something of value for the economy.   Banks provide none, they are totally 100% parasitic.  Profit to a bank is a direct loss to someone else. The more profits a bank makes, the more in debt the rest of productive society is.   Growing profits in the banking sector should be looked with alarm, like a growing colony of parasites on a healthy body.  If it is not controlled, the body could die, as we are seeing in our current debt deflationary episode.   Because the economic interests of banks are diametrically opposed to the economic interests of the productive economy, the whole banking sector should be regulated very carefully, with strict caps on usury and profits. 
The Outdated Theory of Banking Utility
The economic utility of banks supposedly resides in their ability to bring together the supply of unproductive capital with the demand of creative business ventures.   Indeed, that logic had value back when money consisted of gold, and the economy suffered from the pressure of constant money shortages.   
However, such a situation no longer applies.  Banks don't make profit because they are agreeing to take on the risks of making loans.   Today, banks make profit from CREATING MONEY through loans.   It is money they never had in the first place, so they certainly aren't risking anything by giving it away.   The money is literally created in the process of issuing the loan.   
Thus, the banks are in a NO RISK position.  If the loan goes bad, they lose nothing, since they ventured nothing in the first place.  If fact, they may gain something, if the loan was secured by some real collateral (such as real estate) and they get to seize and resell the collateral if the loan fails.    The only so-called "risk" they face is if their books get so far upside down that they can no longer meet their deposits, and in that case, the bank is simply nationalized.
The Fractional Reserve Scam
This is the fundamental lie and scam at the heart of fractional reserve lending.  Under the "10% reserve requirement", supposing you have $100, you can lend out $500 to your mom, $300 to your dad, and $200 to your sister, while getting to hold on to the original $100!    This is a far cry from the old days, when banks faced actual risk with a limited and real supply of money. 
Under the old system of real money, if a bank lent out that $100, if the loans went bad, they could be wiped out, along with their depositors.   Note that the gold piece money still existed somewhere.  In other words, society still had as much money, but the particular bank would be wiped out.   This created an iron discipline in the banking system, creating competition in an environment of real risk.   This risk was very real and personal to the bank owners, because it was their personal capital that was at risk if the bank was wiped out.
Perversion of Capitalism
Today, the risk profile has been inverted.  Under the Fractional Reserve System, banks can never actually be wiped out.  At the last resort, the Federal Reserve jumps into the picture, takes ownership of the bank, and creates the money to honor the deposits.   The owners of the bank do not face bankruptcy in this scenario, either, since their personal wealth is shielded away from the performance of the corporation.  
Society as whole might be wiped out by inflation or deflation, but banking deposit accounts will always be made whole, and bank owners face no personal risk.  In other words, in good times, banks make all the profit while taking no real risk.  While in bad times, they are bailed out by the government.  Profit is privatized, loss is socialized.  This is not your grand-daddy's "capitalism". 
That is why banks are essentially agents of the government.  They are not truly private enterprises, facing free and open competition, under the threat of being put out of business and personally impoverished by bad decisions.    Their ability to make a profit is based on a government-protected monopoly in money creation.  If they mess up, the government has to bear all their losses.   Heads they win, tails you lose.   Nice time to be a banker, no? 

1 comment:

jessilydia said...

There is an even more radical solution to the same problem, one that would fit a lot better with the reality too.

If you take the problem as being "how to get there" rather than "where to go", you discover another part of the problem with money, that the solution is FAR better seen as a need for people with profits to spend them.

Just getting people with profits to spend them ends the hyper-concentration of wealth. With that the overbearing influence of money on our lives is over. I think you're not being radical enough if you’re not stubborn enough to think through how ending the compounding of wealth would automatically and gradually distribute wealth and break the hold of the extremely rich. But… are people radical enough to want to really solve the problem we face? It often seems not.

I've written lots about it. Oddly so did the "secret" JM Keynes. Everybody seems unaware that the problem could really be just pushing a good thing too far. It’s more popular to search for malevolence, where it's only mistakes caused by deep ignorance being made.

We need to face that too. The biggest problem is perfectly nice people with wonderful intentions, making unwitting enormous mistakes, of pushing their good intentions too far. The right way to tame the beast is for the whole money market to make the choice to spend its profits.