THE BLOG
06/30/2010 05:12 am ET Updated May 25, 2011

It's the Snake Oil, Stupid

The financial industry, aided and abetted by rating companies on the take, politicians on the make, and regulators on a break, systematically manufactured trillions of dollars of securities that we now call toxic. And we call them toxic, not because they were risky, but because they were phony.

The fraud arose because large parts of the finance business decided to make money the old fashioned way: by stealing it. When you issue liar mortgages, rate CCC assets as AAA, insure the uninsurable, pay yourself massive and fully undeserved bonuses, shop for compliant regulators, and bribe politicians to change rules -- that's theft, plain and simple.

Proprietary information, not proprietary trading, was the key to the crime: ``We'll make you a mint. But no questions. If we disclose, others will learn, and we'll no longer beat the market.''

If only everyone could beat the market. And if only Wall Street's wizards, as a group, actually had proprietary information of social value. But the main information they were keeping private was their sale of snake oil.

When the fraud surfaced, so did the questions. Was every asset toxic? Was every loan overvalued? Were any financial statements to be trusted? These questions were asked about every bank, no matter its pedigree, the tenure of its ``top'' management, or its regulator.

And this new information, that there was no information, laid waste to one financial company after another. Today, two-plus years into the crisis, full non-disclosure prevails. No one can drill down on the Internet to the individual holdings and liabilities of any major financial institution, least of all our central bank -- the Federal Reserve, which has printed more than $1.2 trillion to buy up who knows precisely what.

And, as far as I understand, there is nothing in the pending financial "reform" legislation that will change this sorry state of affairs. Thus, the "reform" will leave our financial system vulnerable to ongoing financial runs.

The reason is simple. No one will swap something real for bank paper, which they suddenly suspect is worthless and aren't permitted to inspect. Hence, financial plague, whether spread by truth or rumor, can strike any part of our financial system at any time. And if the plague hits our central bank, its paper, the almighty buck, will find few takers. The Fed has already laid the basis for such hyperinflation, having printed more money in two years than in the entire history of the republic.

If consumer prices were to skyrocket, we would see a run on the banks, with people desperate to buy something real before their money becomes worthless. Federal Deposit Insurance Corp. guarantees that our dollars, as opposed to our purchasing power, are safe, would be of no help. And such a run would force the U.S. government to douse the fire with a gas tanker. It would be forced to cover explicit and implicit FDIC, money-market, commercial-paper, insurance-industry and other financial guarantees. This means printing at least $10 trillion more.

There's a simple cure for an ever-virulent financial plague. It's called limited-purpose banking. This implements what Bank of England Governor Mervyn King strongly advocates, namely transforming financial companies into utilities that stick to their legitimate purpose: intermediation, rather than gambling with the taxpayers' money. Mervyn King, former U.S. Treasury Secretary and Secretary of State George Shultz, former Senator Bill Bradley, Jeff Sachs, Simon Johnson, Ken Rogoff, George Akerlof, Jagdish Bhagwati, Michael Boskin, Niall Ferguson, Robert Lucas, Robert Fogel, Murray Weidenbaum, Kevin Hassett, Bill Niskanen, former Secretary of Labor Robert Reich, Edward Leamer, as well as many other top policy makers and economists from the left, right, and center have endorsed serious consideration of Limited Purpose Banking.

Please go to www.kotlikoff.net. Read the columns about this simple solution and forward this url to everyone you know and ask them to do the same. And call your members of Congress and get them to this site. We have very little time left to really save Main Street from Wall Street.

Laurence Kotlikoff is a professor of economics at Boston University, President of Economic Security Planning, Inc. (see www.esplanner.com), and the author of Jimmy Stewart is Dead: Ending the World's Ongoing Financial Plague with Limited Purpose Banking.