PIMCO's Bill Gross has remarked that our nation became a superpower because "we were getting richer by making things, not paper." Unfortunately, for the last few decades, our nation has primarily grown weaker by making worthless paper in a variety of ways -- junk bonds, subprime mortgages, and countless types of derivatives -- through banks. If we step back and ask ourselves what banks were originally designed to do, it was simply a depository where people with savings can store their wealth, and borrowers could access capital to pursue investment opportunities.
Today those simple functions can be easily replaced by software. After all, from a savings perspective, are there material differences between a checking account at Citicorp versus one at Bank of America? Do we really need thousands of banks and bank branches spread around the country when we have the internet to make distance of banks irrelevant? If these banks are essentially backed by the government because they are too big to fail, why not just buy U.S. Treasury bonds to park your savings? It would be easy enough to use Google as the banking interface and park your money with the U.S. Treasury or the Federal Reserve in lieu of a bank.
From a lending perspective, the banks clearly have failed to allocate their resources to investment opportunities that would power economic growth into the 21st century. Their cash has primarily been used for short-term profit opportunities such as speculating in the capital markets for quick profits, leaving many small and medium sized businesses cash-strapped. Instead, if we engage in this thought experiment, wouldn't it make more sense to leave the lending, and/or investing to the savers themselves? In this hypothetical world, individuals can save by stashing their cash directly with the Treasury or Federal Reserve. But if they want to invest in promising companies and potentially earn a return higher than they can through T-bills, they could do so by investing their cash in other financial institutions or companies not backed by the U.S. government such as mutual funds. By eliminating banks with captive capital, investors do not have to worry about moral hazard and uneven playing fields that develop when banks have too much power. If companies need loans, they can apply through some central marketplace like eBay and attract the funds from savers and investors who have larger risk appetites. In short, all the basic functions that a bank does today can be easily replaced by software that enables individuals and companies to achieve their savings and investment outcomes much more inexpensively, efficiently, and productively.
Defenders of banks would argue that banks also economize -- when properly functioning because of proper regulation -so-called 'monitoring' costs. The argument goes something like this: if you, I, and a bunch of other people all separately lent money to some big borrower, we might all in effect replicate each other's efforts in investigating the credit-worthiness of the borrower. Alternatively, since each of us would be only a small lender, we might simply refrain from monitoring altogether, and accordingly subject ourselves to considerable aggregate risk that could have been minimized had somebody monitored on behalf of us all. That would be 'socially inefficient.'
This argument would make sense if compensation to loan officers were tied to the performance of the loans they made. However, the reality is that most loan officers merely make loans based on guidelines that could be easily automated. Monitoring loans is more likely to be better served by constant communication between many well-informed individuals similar to what happens on Wikipedia because the costs are not socialized by the government. Furthermore, the savers/investors can insist on a full list of lenders from any borrower to be disclosed by signing a non-disclosure agreement. Finally, if there is enough interest in loan monitoring services, more independent research firms could spring up that charge a fee for providing ongoing monitoring reports and would lessen the likelihood of a conflict of interest for hiding bad loans which exists today. The costs of this approach would not cost trillions of dollars which is what the current price tag is for keeping the banks afloat.
While a return to Glass-Steagall has often been offered as a solution, it doesn't go far enough. First, given the commoditization of banking services, a separation of commercial banks would likely lead to large scale bankruptcies of banks anyway. Why have all these large physical banks when Africans and Indians have shown that microloans work even better? If the banks are to survive, they will again make riskier loans to profit as they did during the S&L debacle and cause yet another crisis for taxpayers to mop up. How many times do we have to make the same mistake before we learn our lesson? The way to real growth is through lending to investments in the future and consumption based on savings, not out of control credit growth by banks.
The endless portfolio of "financial innovations" such as equity derivatives, credit derivatives, and other complex financial contracts should be left for those risk-loving entrepreneurs who want to risk their own money instead of other people's money playing in that market. This way, they are free to innovate as much as they want. But without the guarantee of Uncle Sam to bail out their bad bets, these speculators would likely keep their speculative bets within reason or exit those markets altogether as any gambler who has run out of money playing in a casino would do. This would also save government the need to hire armies of regulators who are next to useless in the current environment from stopping the next financial crisis. Smaller firms playing with their own cash are unlikely to entangle the entire world with their risky behavior.
Of course, the biggest immediate hurdle we would face to achieving a more responsive and productive banking system is the large unemployment this will cause in the banking sector given that unemployment rates are already elevated. However, these people could be retrained for more productive professions or they may seek to become entrepreneurs. Like a cancer that has caused the rest of the economy to get sick, the banking tumor that has grown out of control must be removed or it will eventually kill the whole economy. Better to have a sick patient in intensive care for a few years who will have a chance to recover than a dead one.
Follow Ann Lee on Twitter: www.twitter.com/annleesays
Don McNay: Bank of America: The Perfect Example of Why You Should Move Your Money
Ann, "a return to Glass-Steagall" that "doesn't go far enough" implies that your solution would be to re-regulate (and more) back to the good old days. The rest implies that you'd like to cut the old boys off from the government altogether, at least for bailouts. If you want it both ways, strict regulation with no risk assumption, well, if you want New Deal agriculture policies, you're going to end up with ADM getting huge subsides for nothing.
So please, Ann, help me out. Just what is your prescription? If Ann can't be bothered to reply to my comment, I'd appreciate anyone who can give me their opinion about what she thinks should be done.
Now all anyone focuses in on is short term profit. Heck, I was reading where investment houses have algorithms that buy and sell stocks in less than a minute.
This short term view made the US embrace free trade. As a result, many businesses that the banks could have lent to went to China and the small business closed as manufacturing plants left. Now the banks and corporate America is eliminating the hands that feed them, all for short term profit.
I must say that one of the most disappointing aspects of the Obama administration was their wasted opportunity to fix Wallstreet when they were weak and the political protections were at a historic low. Now we have pushed nearly $5T into the banks with absolutely nothing to show for it other than more TBTF and another likely bailout. Sigh.
However, with no bank access, she can't just write a check to her landlord. No, she will have to spend 45 minutes driving to his home or office. Likewise the guy who mows her yard, the electric company, her cell phone provider ad nauseum.
This would be why ivory tower intellectuals have such a bad reputation for common sense. She might want to open an account with PayPal, but I will stick with my local bank, thank you.
deposits, fund availability, payments - all currently available through mechanisms other than credit cards. i can pay for gas, parking meters, and rent with text messages from my cell phone. My cell phone also accepts payment at my weekend garage sale. small examples of how the world is moving beyond traditional banks - you will see soon.
Credit cards are soon to see intense competition from more convenient payment options: i can pay for gas, parking meters, groceries, and rent with my cell phone - either direct funds or credit. i can accept payment at my garage sale with my cell phone - either a credit card or fellow cell phone payment. pay the gardner - a simple text message. sure, there still exists a network to skim some of the transaction, but nowhere near what banks charge for visa or m/c. We will soon be rid of the overhead...
Of course the cell phone mechanism is tied to bank deposits currently, but why not tie it directly to CD's or Fed treasury as Ms. Lee discusses? Again, removing the 2-6% skimming by the big banks.
Just how do you propose I pay the guy who mows the yards at my rental units? How about the guy who does my handyman work? The rescue organization from which I got my Golden Retriever puppy?
My bank isn't skimming me by one cent. It is local and both my checking account and debit card are free, and, per my call to them this week, will be for the forseeable future.
Not to mention, if I need to buy a car, a new heat pump or get a good deal on a rental unit, I have a long term relationship with my bank.
Or this use to be the case before the government passed both the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (IBBEA) swept away all state barriers to interstate banking. And the Gramm-Leach-Bliley Act (GLBA), also referred to as the Financial Services Modernization Act of 1999, repealed part of Glass-Steagall, tearing down the walls between banking, insurance and investments. Funny it took only 9 years after removing the protection of Glass-Steagall to have our 2nd Great Depression.
Come to think of it Banking in it's present form is a cancer! No - banking done right should be a symbiotic relationship. Unfortunately in our case it is more of a parasitism (one organism benefits and the other one is harmed).
However one looks at the whole picture, it would be quite a big mistake to claim the operation has been a success. Tantamount to saying 'the operation was a success however the patient died.'
Even worse to consider, is the status of the great American experiment, where democracy seems to be on its last legs.
What is the purpose of the financial sector, what is it designed to do? Simply said, its purpose is to provide services &/or products.
When you ask about design, some people tend to think design or planning sounds like Socialism. They seem to prefer ideas related to mythology, shattered myths like the 'Invisible Hand' & 'Free Market' abound.
In Capitalism, the simple underlying principle is to sell the least amount of products &/or services for the greatest amount of profit.
That said, we have the FIRE sector (financial, insurance, real estate) whose 'mission' is to create profits for themselves rather than to provide products &/or services to the economy. Even when the financial products created to increase profits have proven to be toxic to the global economy.
Stating the obvious, this is not a self-sustaining model. Although it certainly is self-perpetuating. Outsourcing of jobs, if that will increase profits, also fits this model. Apparently, the only jobs created are lobbying ones to perpetuate the status quo.
"The number of registered lobbyists in Washington has more than doubled since 2000 to more than 34,750 while the amount that lobbyists charge their new clients has increased by as much as 100 percent. Only a few other businesses have enjoyed greater prosperity in an otherwise fitful economy."
http://www.washingtonpost.com/wp-dyn/content/article/2005/06/21/AR2005062101632.html
This would only be a good idea if the net interest received after tax and after accounting for inflation was positive - otherwise you are losing not saving.
Also, most of the world's largest banks are already not American. Check out:
http://www.economist.com/node/18898228
http://www.bankersalmanac.com/addcon/infobank/bank-rankings.aspx
Only 4 of the world's top banks by Tier-1 capital are American. Only 1 of the top ten by total assets is American. There is already a major problem with Americans preferring to deal with non-US banks, imagine the movement of assets if there were no US banks.