Attention Lloyd Blankfein: The Public Purpose of Banking
Tuesday, 11/10/2009 - 1:55 pm by Marshall Auerback | 11 Comments
Marshall Auerback argues that the purpose of banking is not to make a small number of people fabulously wealthy — but (wow!) to serve the public good.
It seems odd that days after we were told by Goldman Sachs’s CEO, Lloyd Blankfein, that bankers are doing “God’s work”, we are still having active debates about how to regulate these selfless apostles of capitalism.
The latest foray into financial reform comes from the Senate. Senator Christopher Dodd will propose creating a single U.S. regulator that would strip the Federal Reserve and Federal Deposit Insurance Corp. of bank- supervision authority, according to a report from Bloomberg. Dodd, according to the Bloomberg report, has faulted the U.S. bank regulation system, saying “it encourages charter shopping and a ‘race to the bottom’ by agencies to win oversight roles.” Bloomberg notes that “his proposal goes further than proposals by President Barack Obama and House Financial Services Committee Chairman Barney Frank to merge the OTS and OCC.”
Certainly, almost anything is an improvement over the abomination that came out of Barney Frank’s committee. But we feel that the ‘race to the regulatory bottom’ could easily be solved via a simple mechanism: If you don’t fall in line with our regulatory requirements, you’re simply denied a banking license to operate in this country. Problem solved. The United States is the biggest banking market in the world. Do you think any major bank would willingly vacate this market?
And even if the “too big to fail” behemoths decided to transplant a bunch of their operations elsewhere, the country would still be left with thousands of community banks which could fill the void and better fulfill the public purpose described by Mr Blankfein: namely, to “help companies to grow by helping them to raise capital”, rather than extracting their pound of flesh via grotesquely high financial intermediary fees, as is the case today.
We have argued before on New Deal 2.0 that the FDIC is best suited to carry on the role of chief systemic regulator, given its role as deposit insurer. That regulator has the best institutional incentives to be concerned with systemic risk and to be a vigorous regulator. It should be the least subject to regulatory capture (a pervasive problem at the Fed, which is full of quant economists who have virtually no interaction with other Fed examiners).
But WHO controls the banks is ultimately less important than HOW we control the banks’ activities. Oversight is all very nice, but at times it pays to get back to first principles. What on earth is the public purpose of these things?
Banks are set up and supported by government for the further benefit of the macro economy via providing a payments system and lending in a way that is specifically defined by regulators. Newsflash: the public purpose of banking is NOT to provide profits per se to shareholders. Rather, the provision of the ability to earn profits is only a tool used to support the attendant public purpose. Banks should only be allowed to lend directly to borrowers, and then service and keep those loans on their own balance sheets. There is no further public purpose served by selling loans or other financial assets to third parties, but there are substantial real costs to government in regulating and supervising those activities. There are severe consequences for failure to adequately regulate and supervise those secondary market activities as well.
Banks should be prohibited from engaging in any secondary market activity because it serves no public purpose and may result in severe social costs in the case of regulatory and supervisory lapses. Some argue that these areas might be profitable for the banks, but this is not a reason to extend government sponsored enterprises into those areas. Therefore, banks should not be allowed to buy (or sell) credit default insurance. The public purpose of banking as a public/private partnership is to allow the private sector to price risk, rather than have the public sector pricing risk through publicly owned banks.
If a bank instead relies on credit default insurance, then it is transferring that pricing of risk to a third party, which is counter to the public purpose of the current public/private banking system. Banks should not be allowed to engage in proprietary trading or any profit-making ventures beyond basic lending. If the public sector wants to venture out of banking for some presumed public purpose it can be done through other outlets.
If the activities of the banks are not facilitating the production and movement of real goods and services what public purpose do they serve? It is clear they have made a small number of people fabulously wealthy. It is also clear that they have damaged the prospects for disadvantaged workers in many parts of the world.
It’s more obvious to all of us now that when the system comes unstuck through the complexity of these transactions and the impossibility of correctly pricing risk, the real economies across the globe suffer. The consequences have been devastating in terms of lost employment and income and lost wealth.
All governments should sign an agreement which would make all financial transactions that cannot be shown to facilitate funding for real goods and services illegal. Simple as that. When we keep these principles at the front of the argument, we can see that what Senator Dodd and Congressman Frank are arguing about is akin to how to rearrange the deck chairs on the Titanic.
Man, I could not agree more with this. I came to the same conclusion
(”Banks should only be allowed to lend directly to borrowers, and then service and keep those loans on their own balance sheets…Banks should be prohibited from engaging in any secondary market activity because it serves no public purpose”)
myself a couple months ago after I started reading this blog and the New Economic Perspectives blog a few months ago, except I suggested that we simply nationalize all banks, with the individual states running the smaller banks inside their states. I don’t know the legal problems involved in this, but it might be an easier alternative than trying to force these more or less all-powerful financial corporations to actually abide by laws that would severely limit their ability to profit instead of lobbying to weaken or eliminate them and capturing the regulatory structure.
Posted by Zach P | November 10th, 2009 at 8:20 pm
Another great article. But the real question is: how do we possibly build a consensus around this thinking? How do we hold congress accountable, how do we develop the consciousness needed in the body political to hold congress accountable? This is not meant as a pissant reaction, this is a genuine question. How can it be done, given the dissemination of information in this country?
So disheartened with Frank right now, incidentally.
Posted by James Call | November 11th, 2009 at 11:25 am
Richard C. Cook, a former Treasury official and the whistleblower on the Challenger disaster is the best-known (to me) proponent of credit as a public utility. Videos here:
http://www.opednews.com/articles/-Credit-as-a-Public-Utilit-by-Richard-C-Cook-090329-936.html
More articles at Global Research:
http://www.globalresearch.ca/index.php?context=listByAuthor&authorFirst=Richard%20C&authorName=Cook
The book Social Credit, available online at http://www.mondopolitico.com/library/socialcredit/socialcredit.htm
is the founding document of the “social credit” economic movement of the 1930s. Robert Heinlein used much of For Us, the Living to espouse this theory, and it appeared as a major element in the later Beyond This Horizon as well.
There is no reason to wait for the government to spend interest-free money into circulation. A person can do it themselves by obtaining new dollar coins from their bank/credit union. The US Mint will pay shipping on up to $500 of each Presidential dollar or $5000 Native American dollars when available.
Posted by Phillip | November 11th, 2009 at 2:39 pm
Could we build consensus around this issue? Arguably we have consensus amongst 95% of the population. Unfortunately it’s the 5% which control government which will oppose this. If we have an economic relapse next year (which I suspect will occur), then that will go a long way toward discredting the prevailing neo-liberal ideology and the elites who peddle this nonsense, as well as exposing the TBTF banks for the insolvent wrecks that they are. If unemployment is still in double digits by the middle of next year, do you think Obama and the Dems can survive politically if they keep telling us that what they are doing is “working” and that unemployment is merely a “lagging indicator”?
Posted by Marshall Auerback | November 11th, 2009 at 2:44 pm
Mr. Auerback,
Two points-
The FDIC is doing an exceedingly incompetent job at obeying the law, specifically U.S. Code Title 12, 1831o the Prompt Corrective Act. If they had taken down Colonial Bancgroup of Birmingham, Alabama immediately instead of delaying that action, the amount they spent would have been reduced and the acquiring bank would not have had to take a 37% “haircut” on the value of assets (loans) they acquired.
Banks only started looking profitable (after the first quarter)after the politicians put the screws to the Financial Accounting Standards Board and “convinced” them that banks should not be required to report their assets (loans) at market value. In other words, banks were given permission to carry loans (even those in foreclosure and those making no payments) at any value they want. Your statement that the TBTF banks would be exposed as insolvent wrecks indicates you are not paying attention to the banks the FDIC has been taking down all year. Many hundreds of banks are insolvent if the measuring stick is their tier one capital ratio (which is being manipulated to look better) when the banks can report the asset side of the equation at a higher than market value.
Consensus building starts with acknowledging reality. Until the left and right cut their respective bullfeathers about their priorities being so wonderful and enlightened to the point of justifying the feckless piling on of trillions of dollars in debt on future generations there is no hope for this country.
Posted by Chris C | November 11th, 2009 at 3:37 pm
Would be trivially easy for these banks to convince Washington that their products facilitate funding for real goods and services.
This MBS? “Oh, it helps increase the supply of credit for homeowners and lowers interest rates. Surely you support homeownership, right senator?”
This CMO? “Oh, the tranches help resolve the problem with unreliable prepayment on my MBS, and so it helps increase the supply of credit for homeowners and lowers interest rates. Surely you support homeownership, right senator?”
This synthetic CDO? “Oh, it helps create a tradeable liquid market for the other CDOs so more people will buy them, and so it helps increase the supply of credit for homeowners and lowers interest rates. Surely you support homeownership, right senator?”
The agreement you propose would be completely ineffective, and thus is not a realistic solution to a very real, real problem. Sorry.
Posted by Jay | November 11th, 2009 at 6:25 pm
I think we should let China decide what the purpose of US banks should be. Their purpose over the last few years has been to devise ways to multiply private and public debt so we ca borrow more from China. Only fair to let China decide.
Posted by John McGrath | November 11th, 2009 at 7:17 pm
While we’re at it can we please return to bloodletting as a key medical therapy, and whale-oil lamps for lighting? It would all be so much simpler if we just went back to the good old days…
Posted by rational | November 12th, 2009 at 3:54 am
This article is a bit simplistic in its tone and in its public policy prescriptions. The author assumes that banking provides a “public” service and should therefore be subject to strict regulatory controls by the public. But there are already copious numbers of regulators who either failed to perceive the crisis or failed to act to contain. To imagine that our so-called representatives in Washington would ever do anything to limit their friends in the banking industry is plainly naive. To imagine that such a system would maintain the goals and philosophy of banking outlined here for any length of time is mere daydreaming. Regulators are not accountable to the people, and recent history has shown us that they are not really accountable to the law either.
How about we consider the problem a little more deeply. Why did banks have the money to lend in all of these speculative ventures? It seems to me that they wanted to get loans off of their books because they were bad loans. Where did they get the capital to throw around so freely? If you ask that question, you’ll end up scrutinizing the loose monetary policy pursued by the Federal Reserve in conjunction with Congress and the Treasury. You’ll have to address how the existence of the FDIC has allowed banks to essentially lend out money from your checking via nightly “sweeps”. You’ll realize that there are virtually no reserves in the entire banking system, and that all of the credit in our system is backed by less that $100 billion in actual cash notes inside the US, and that even this cash is built upon nothing but the “faith and credit” of the US. Our whole monetary system is a shell game. What we need is not a system of government control to prevent bank failures; we need a system where money is sound and banks are free to fail. Anything else will just lead us right back to this same place in due time.
Posted by Alan L | November 12th, 2009 at 3:50 pm
This thinking couldn’t be to the point. The purpose of any bank should be to know its customers, account for and hold its loans, and grow the economy it serves, be that local, state, or national. If they blow that charge then they and their stockholders should bear the consequences.
Posted by John H | November 14th, 2009 at 6:42 pm
Bravo!
Posted by hrvoje | November 28th, 2009 at 10:39 pm