Archive for May 7th, 2009

WHAT BANKS OUGHT TO BE FOR, FIRST.

May 7, 2009

 

BANKING CLARITY A MUST TO REPAIR THE ECONOMY.

Abstract: The basic functions of banking (deposits, clearing payments, extending credit) have little to do with the massive plutocratic rescue plan started by the Bush-Geithner administration and extended by Summers-Geithner.
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Stiglitz and Krugman, who have been nearly as critical as the present author about the financial policy of the USA, had dinner with Obama. Krugman said he could not talk about it, because it was “off the record”.

What should be on the record is this: the banks have a primary function, a secondary function, and a tertiary function. Absent these three functions, it’s as if there are no lungs, and no heart: the corpse of capitalism can’t walk.

It is not clear that these three functions that define banking philosophically have been insured as much as they should have during the first four months of the Obama administration, while it was busy pursuing further the (disastrous) financial policies of the Bush administration.

Instead a great deal of attention was given to having the bank holding companies make good the very contracts that put in danger the very ability of the banks to conduct the three basic functions.

The three basic functions that should have been attended to are the following.

The first two are so fundamental that they were probably present in inchoating form in prehistory. They are the sanctity of deposit of capital (which is primary), and the clearing of payments (which I view as secondary, considering that payments clear from account to account, and that cannot happen if the accounts are busted). The financial system does not exist without these two functions. They thrived in prehistory (because long range trade did, archeology has shown, which means trusted intermediaries did).

The ability to extend credit is tertiary. Although the economy can work for a few hours without it, many small companies depend upon credit for going from paycheck to paycheck, month to month, especially small, often growing companies (small companies are around 80% of employment). Some will argue that lending is now the banks defining function, and capital (from deposits) is ancillary (see addenda).
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Obama had to insure the three functions above. I am not sure about the third function, credit, because I have not seen authoritative studies (banks have been saying they lend plenty whereas professionals in other industries have been claiming the opposite). But for the first two it was easy: just do like the French republic. And do not let banks go bankrupt, which the French presidency also declared would not be allowed under its watch. Lehman Brothers, a huge, old and famous bank, a treasury bond market maker, was allowed to go chapter 11, destroying confidence in the banking system WORLDWIDE, a system that not only rests on trust, but, one could argue, is all about trust. At that point many payments could not clear.

In France Sarkozy decided that all deposits would be insured, in any amount, in any bank. (This can be done in two ways: either by boosting the insurance fund, the FDIC in the USA, or by preventing any banking failure by having the government step in as soon as a bank threatens to become insolvent, the later route being followed in France, so far.)

Insuring any deposit would provide any country with a lot of confidence. Since the currency system is a myriad of contracts in trust, this is crucial, as fundamental a measure to take for the economy as possible. Relative to this, the waste of toxic “assets” is completely irrelevant, just as irrelevant as it should always have been to daily banking.

Unfortunately Geithner proposed with his PPIP a plan that threatened to compromise the FDIC to death (a fully engaged PPIP would have bankrupted the FDIC). Geithner’s aim was to save the bank holding companies’ upper management, and various elements of the plutocracy connected to them, which he seems to view as the essence of the economy (too much socializing with the plutocracy will do that to you).

Instead, the Obama administration should have stuck with the INSTILLING TRUST IN DEPOSITS, the basic function of banking, the one prehistoric man understood, but Geithner apparently does not. His PPIP was another effort against it.

Just an example of the sort of difficulty the refusal of insuring all deposits led to: millions of small businesses may only find challenging to maintain balances below $250,000 (there are technicalities, see addenda). This is all the more silly, since the Obama administration made clear it viewed the 19 top banks as too big too fail (thus there was no risk insuring all and any deposits; in a huge contradiction, though, depositors did lose their money in smaller banks going in receivership!)
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Patrice Ayme
http://patriceayme.com/

Technical addenda:
1) REPAIRING BANKS:
Stiglitz called Geithner’s PPIP a “robbery of the American people”. I agree (and already said this about TARP, calling it Transferring Assets to Rich Plutocrats, as soon as it appeared). But a week later, Obama repelled the mark to market rule, and that pretty much made the PPIP unworkable. The ways of Obama are not as mysterious as those of God: one week he makes a blatant gift to the hedge funds, delivered by his human poodle, and the hedge funds are all happy that the plutocrats are solidly in control, and the week after, Obama takes away their food, but they are too stupid to notice.

Stiglitz and Krugman opposed the conversion of preferred to common stock. Indeed the preferred route for cleaning the banking system would have been receivership (the bank fails, and is reorganized by the government, and then sold for a profit). The point being that the USA then takes ownership of the bank for the cost of recapitalization. The drawback is that severe disruptions to the financial system can happen as shareholders lose everything and bond holders can lose a lot.

The Obama administration had first followed the Bush administration policy (reimbursing indiscriminately losses on derivatives with taxpayer money, which I have long argued was unworkable: I valued the losses at 8 trillion, minimum; now the IMF is at three trillions in the USA alone). Thus I was satisfied by the conversion into common stock (which has the right of vote, that preferred do not have). It is as good as nationalization can get, once receivership has been excluded (for the reasons of the massive financial disruption that rightly bothered Obama).
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2) BANKS AS CLEARING PAYMENT INSTITUTIONS:
Some will say that depositing money is the fundamental function, and that clearing payments is not a core function. In this view, prehistoric woman can walk to the bank, extract her currency (fancy shells), and go give it to who she wants to pay. True. But you will not build a bridge that way. Instead of building the bridge, you will have to run around paying everybody continually, because thousands of workers and contractors are involved. And certainly prehistoric women could not be expected to run all around the horizon.  

The “clearing of payments” is the ability to transfer, in the general case “currency” (value, liquidity, whatever one wants to call it) from one deposit to another (or one account to another, to use a different noun). In general the deposits (“accounts”) are in different banks. For that circulation of currency to occur at all, trust by one bank into another bank is necessary. The first bank needs to be sure the second bank it transfers the money to is solvent, lest the money disappears, and it gets sued by the depositor who asked his money to be transferred to start with. I do not know the official lingo too well, and I think the overabundance of lingo is made to be confusing. That is why I tried to stay close to the concept of deposit. It seems to me that if a deposit (=account) disappear, the bank has failed in its most basic function. The clearing of payments is from account (=deposit) to account, so it requires the sanctity of accounts first.

3) BANKS AS CREDIT INSTITUTIONS:
Banks are no longer banks in the sense of Rome, or the Italian Middle Ages. Historically banks lent from what they had in capital. No more capital, no more lending. Applied to central banks, that was the idea of the gold standard. It is obsolete. Indeed sticking to the gold standard prevented the growth of credit, hence investment during the depression of the 1930s.

Now credit creation is a Bank’s primary function, in the sense that most of the money from the bank is created that way. Capital allows to resist to unexpected withdrawals, without borrowing in despair from the central bank. So it is an anchor fixed at 8% of total lending.

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