Podcast Summary
Questioning the Role of Private Retail Banking: Implicit deposit guarantees raise questions about the need for private banks, but they serve important functions beyond safekeeping and have implications for the future of banking and individual account holders.
The recent government intervention in saving depositors of Silicon Valley Bank and Signature Bank raises questions about the role and function of private retail banking. With the implicit guarantee of deposits becoming more explicit, some are questioning why not have everyone have a checking account at the Fed, eliminating the need for private banks. However, banks serve important public functions beyond just being a safe place for money, including providing loans and playing a crucial role in the financial system. Despite the moral intuition that everyone deserves protection for their savings, it's important to consider the implications of these actions on the future of private banking and the potential consequences for individual account holders and the financial system as a whole.
The SVB disaster revealed deeper structural issues within the banking system: The SVB crisis underscored the importance of ensuring deposit safety, revealed complex systemic risks, and highlighted the role of political economy in bank regulation.
That the SVB disaster highlighted deeper structural issues within the banking system that go beyond just the riskiness of assets. Professor Saleh Omarova, a Cornell law professor and former nominee for the Office of the Comptroller of the Currency, emphasized that past policy choices shape future constraints and that there is significant political economy involved in bank regulation. Most importantly, the crisis revealed the public nature of the banking business and the importance of ensuring the safety of deposits, which are treated as equivalent to sovereign money but are actually liabilities of private banks. Omarova's scholarship has long focused on this idea, and the SVB failure underscores its relevance. The complex and dynamic nature of systemic risk, the role of political economy, and the public nature of banking are crucial areas for rethinking the banking system.
Money as a Public Good Provided by Private Banks: Banks create money through lending and ensure its value through deposit insurance, but the debate exists on whether to remove deposit insurance caps for larger depositors
Money functions as a public good, ensuring the ability to participate in economic transactions without worrying about the value of money. However, this public good is provided by private banks through their lending functions and creation of money. This system, while complex, allows for the allocation of credit and expansion or contraction of money in the economy. The FDIC insures deposits up to $250,000, but there's a debate about whether larger depositors should manage their funds in riskier banks. Some argue that removing the cap would eliminate incentives for bank runs and acknowledge that deposit money is publicly backed. This is a significant structural consideration for the banking system.
Community banks' role in assessing creditworthiness and financial needs of their communities: Community banks' local knowledge and understanding are essential for a balanced and effective banking system, promoting their existence is crucial.
The role of community banks in the economy is crucial despite their opposition to certain regulatory figures. Community banks, being locally-focused, are uniquely positioned to assess creditworthiness and financial needs of their communities. While larger institutions may have more assets and a more diversified depositor base, they cannot match the local knowledge and understanding that community banks bring. Therefore, it is essential to promote and support their existence to maintain a balanced and effective banking system. Additionally, there are two options for managing banks' liabilities if we consider them as public: either make banks act as public utilities or separate investment and deposit functions between public and private entities. This debate highlights the importance of striking a balance between public and private sectors in the banking industry.
The structural issue of banks becoming too large and complex leads to a perception of 'too big to fail'.: Perception of 'too big to fail' causes depositors to prefer large banks, leading to complex financial systems and potential risks to public money.
The structural issue of banks becoming too large and diversified, moving away from traditional long-term lending towards riskier investment banking and trading activities, has led to a situation where these institutions are perceived as "too big to fail." This perception, in turn, causes depositors to prefer placing their funds in large banks like JPMorgan or Bank of America over smaller community or regional banks. To address the mismatch between money as a public good and private risk-taking, historically, regulations like the Glass-Steagall Act have attempted to limit the activities and investments of banks. However, repealing such acts in the name of competition and innovation has led to the current complex financial system where banks engage in various risky activities. To ensure the safety of public money, banks could be made purely payments providers, limiting their activities and affiliations to only providing a public utility of safe money. However, the political reality of implementing such changes is challenging due to the fickleness of politics and the balance of power between various lobbying groups.
Acknowledging the role of government in private banking: The Fed could offer a political solution by allowing individuals to open checking accounts directly with the Federal Reserve, maintaining the public-private partnership while ensuring safety and accessibility for all depositors.
The current era demands acknowledgement of government support for private banking, but addressing the balance between public and private sectors goes beyond technical solutions. The Fed could offer a political solution by allowing individuals to open checking accounts directly with the Federal Reserve, while smaller community banks manage these accounts on the Fed's behalf. This change would maintain the public-private partnership while ensuring safety and accessibility for all depositors. The vision goes beyond a technocratic fix and aims to alter the power dynamics and conduct of banking.
Fed accounts for individuals: A new approach to banking and monetary policy: Direct Fed accounts for individuals could stabilize community banks, eliminate deposit insurance, and offer tailored deposit rates as a monetary policy tool, potentially improving financial stability and efficiency
The proposal of having the federal government offer central bank services directly to individuals through Fed accounts could bring stability to community banks and eliminate the need for federal deposit insurance. This system would make transactional accounts the liability of the federal government, and the rates on various deposits could be tailored to public policy needs, acting as a tool for monetary policy. The potential for differentiation in rates between individuals and companies exists, allowing for targeted liquidity in specific sectors or to certain groups, such as low-income families. This system could lead to improved transmission of monetary policy and potentially make the financial system more stable and efficient.
Fed could provide subsidized funding for private banks: The Fed could redesign discount window arrangements to subsidize loans to creditworthy borrowers, giving them control over which loans are discounted and ensuring productive lending
The Fed could provide subsidized funding for private banks to support lending to the real economy, rather than relying on cheap deposits. This could be achieved through a redesigned discount window arrangement, where banks could extend loans to creditworthy individuals and businesses and then discount those loans with the Fed at a preferable rate. This would give the Fed the capacity to fine-tune their credit policy and ensure that banks are lending to productive enterprises rather than speculative activities. The Fed has used similar facilities during crises, and it could be a permanent solution to funding needs for lending institutions. This approach subsidizes on the asset side rather than the liability side, and it would allow the Fed to control which loans are discounted. This discussion highlights the importance of the Fed's role in supporting the economy and the potential for innovative solutions to address funding challenges for private banks.
The role of the Federal Reserve in providing liquidity facilities to banks: Public subsidy or private risk-taking?: The debate over the Federal Reserve's role in providing liquidity facilities to banks raises questions about the balance between public subsidy and private risk-taking, with recent events and discussions around CBDCs adding fuel to the conversation.
The ongoing debate surrounding the role of the Federal Reserve in providing permanent liquidity facilities to banks raises questions about the boundaries between public subsidy and private risk-taking. This conversation has gained more mainstream attention due to recent events, such as the SVB crisis, and the discussion around Central Bank Digital Currencies (CBDCs) that has been ongoing for some time. The tension between private profit in banking and the public's expectation of a utility function is becoming more apparent, with some arguing that the cord between private deposit-taking and public responsibility should be cut. However, the opposition to this measure from vested interests, including the banking industry, may make it a difficult change to implement. The coming months will likely see continued regulatory discussions and debates on this issue.
The focus on banking regulation is on past crises, but current economic conditions require a more proactive approach.: Regulation's focus on past crises may not address current economic challenges, emphasizing the need for a proactive approach to banking regulation.
The fear of financial instability comes primarily from large banks due to the risks they take on, and the public's perception of banking has shifted towards wanting a more utility-like system. However, the focus on regulation has been on addressing past crises, leading to potential issues with current economic conditions. The community banks played a significant role in shaping the conversation, and the idea of serious structural reform of banking faces significant political constraints. The 2008 crisis saw a panic on the depositor side, with the safest assets taking a hit, which is a reversal of the typical perception of where financial crises originate. It's important to note that the nature of regulation tends to be backward-looking, and the current inflation challenges call for a more proactive approach.
Exploring Alternative Solutions to Financial System Issues: Address underlying problems and consider alternative solutions when faced with issues in the financial system.
Key takeaway from this episode of the Odd Thoughts podcast is the importance of addressing underlying issues when faced with problems. The discussion revolved around potential issues with the financial system, and if even that is a problem, it may be necessary to explore alternative solutions. The hosts also announced a new podcast, Money Stuff, where Matt Levine and Katie Greifeld will dive deeper into Wall Street finance and related topics every Friday. The podcast is available on various platforms including Apple Podcasts and Spotify. The Odd Lots podcast, hosted by Tracy Alloway and Joe Weisenthal, also has a blog and a weekly newsletter. Listeners are encouraged to follow the hosts and the podcast on social media and sign up for the newsletter for more content. Additionally, American Express Business Gold Card offers flexible spending options and annual statement credits for eligible business merchants.
