I read Andy Kessler's excellent piece in the WSJ suggesting a different route for bank bailouts. Kessler's key point is this:
What we need are healthy banks with clean balance sheets and enlightened risk assessment to provide consumer and business loans that will generate returns to shareholders. And to this end, Mr. Geithner wants to create a public-private partnership to buy toxic securities off bank balance sheets. This is a truly worthy goal, but I don't think his plan for doing so will work. Banks are more than able to sell these toxic loans today. They just don't like the price...
Mr. Geithner should instead use his "stress test" and nationalize the dead banks via the FDIC -- but only for a day or so. First, strip out all the toxic assets and put them into a holding tank inside the Treasury. Then inject $300 billion in fresh equity for both Citi and Bank of America. Create 10 billion new shares of each of the companies to replace the old ones. The book value of each share could be $30. Very quickly, a new board of directors should be created and a new management team hired. Here's the tricky part: Who owns the shares? Politics will kill a nationalized bank. So spin them out immediately.
I agree with Andy, but I think the current banking crisis begs a salient question: Why is banking immune from creative destruction or, more pointedly, why do we need banks at all? If it sounds crazy - a world without banks - it is not.
We have become so used to storing money in banks and talking to our banks that we have forgotten what they do. Simply put, banks borrow money from you, and lend it out to borrowers at a higher rate than they pay you in interest. That is it: Banks are lenders. They provide credit. Everything else is window dressing.
A banker or bank is a financial institution whose primary activity is to act as a payment agent for customers and to borrow and lend money. It is an institution for receiving, keeping, and lending money.
You think banks provide safety? Wrong. That is the government and FDIC. Buying stocks, bonds or currencies? Just an added service. So why do you go to a bank? Because your brain has been trained to believe that you can trust them. Their brand means safety to you. You assume that their risk management is better than yours, and therefore will protect your money and enhance its value.
What if that assumption is wrong? What if we cannot trust banks to protect and enhance our assets? We would be left with one function for banks: lending money or providing credit. If we could replace that credit function, or if we believed that our own risk management was better than the bank's, then we could do without banks (someone else will give you that free mousepad). Technology and the internet is going to provide this.
Sound farfetched? It is not. In fact, the financial world has been evolving in this direction for a while. We just chose not to pay attention.
Today, you can open an
E*Trade account and do all your brokerage online for less cost than going through a bank. You can transfer money using
Paypal. You can trade currencies through endless online options from
EasyForex and
SaxoBank for experts to
eToro for novices. Think you need advice on investments or consumption patterns and fees? Forget your banker and try Seeking Alpha or
Mint.com (full disclosure:
Benchmark companies).
Which brings us back to lending. There are numerous efforts around P2P lending from Zopa to
Prosper (Benchmark company). There are other nascent efforts around commercial lending (which anyway the banks are not doing now). Essentially, startups can use the web to provide risk management tools and investment opportunities that disintermediate banks and thereby make credit available to borrowers.
One of the things that got banks in trouble with mortgages was that they were divorced from their borrowers. The FDIC has a
long procedure around Know Your Customer regulations, but banks do not really know them or their customers' creditworthiness. They were buying sliced and diced mortgage paper at a distance (which is why some community banks are in better shape - they really knew their customers).
Think ahead, and you can imagine a world where there are local social community lending tools that enable person to person or company to company lending where you can really know the borrower. Banks use technology for risk management and asset allocation. Why can't we put those tools in consumers' or business' hands? Are banks really experts? Are they bigger experts than crowd-sourced wisdom on creditworthiness or risk management?
Here is the kicker: one of the other roles banks play is they intermediate between the government (Treasury) and consumers and businesses to keep liquidity flowing in a risk-managed way. In the age of the internet, why can't consumers buy currencies directly from governments/central bank or currency trading platforms (answer: they already can) and access that liquidity directly? Businesses could as well. It is just a technology question. As always in creative destruction, it will happen from the bottom. Clunky tools like P2P lending will grow up and become full-fledged lending platforms with appropriate risk management that might disintermediate obsolete banks entirely.
If you go back to Andy Kessler's piece, the banks have simply become a filter that robs consumers of 90% of their money. That is a recipe for creative destruction of Banks. Not A bank but Banks in general. Andy's suggestion:
Each taxpayer would get about $100 worth of stock for each $1,000 of taxes paid. Of course, each taxpayer has the ability to sell these shares on the open market, maybe at $40, maybe $20, maybe $80.
Why give $1000 of hard earned savings to the government, which routes it back to banks so you can get shares at a lower value? Maybe banks should be obsoleted and disintermediated. This is not a prescription for a "bad bank," but rather a suggestion that maybe all banks are or will be bad in this day and age of direct online trading, online risk management tools, P2P lending and government-provided liquidity.
1) The Fed and other central banks use commercial banks to do risk assessment for their massive lending process. You and I buying T-bills from Uncle Sam via Treasury Direct provides nowhere near the liquidity that the Fed - and the commercial system on the other end - needs. Who will provide this service?
2) Commercial and residential lending involves huge sums changing hands, and centralization in a limited number of banks that are considered safe for depositors provides that liquidity in a way that citizen-based lending cannot, currently. Why? Because a) the work involved in proper risk assessment on lending is very demanding and requires expertise, and b) borrowers don't want to work with hundreds or thousands of lenders.
In this vein I have to ask: Do you see a future with no VC firms? Startups receiving funding from angels and thousands of lower net worth individuals only? It's possible, but right now - for companies with high capital requirements - both the entrepreneur and investor need larger firms to pool the capital, do the risk assessment, and provide the liquidity. Show me the tool for crowdsourced assessment of the risk/benefit of investing in that startup that just dropped its powerpoint on your desk. What's true in private equity is even more true in public equity, where the capital requirements are orders of magnitude greater.
3) What are the difficulties that Prosper and other peer-to-peer lending efforts have faced? I understand that Prosper is having a tough time... why?
Several of your contributors delight in railing against big, cancerous, leeching, life sucking government. Dare they raise the same question about the banking aristocracy ?
I apologize in advance for lack of numbers - I had done diligent research on the subject, and can't seem to find the data right now. So much for my file system.
Supervision and regulation are the first failure when the system get into trouble.
The use of mortgage agents (or any type of agent) which is a major weakness in the system. Agents gain from transactions, so they will circumvent rules to get the deals done.
Poor credit control is also evidence in this crisis.
Slice and dice, securitisation, of loans are done by INVESTMENT banks. Securitisation is done for other products such as insurance, with purpose of decreasing risks of default for a share of the interest. Used properly securitisation adds to health of the bank since it is offloading the risks.
CDS is also critical as it insures against counter party risks. Failure to control the miss use of the CDS is major cause of the crisis.
Other services such brokerage, remittance, etc. are also highly regulated.
Low interest rates and cheap money is major cause of this crisis.
Not even close!
The major cause of this crisis is the fact that greedy bank executives were permitted to give themselves millions and millions of dollars in salaries, bonuses, and perks while milking consumers on interest charges, credit card fees, and so on to the point they could no longer pay.
When a bank executive getting $20+ million a year, raises the interest rate on a credit card from 5.9% to 25.9% simply for missing 2 payments, thus making it impossible for the user to pay, please do not try and tell me that it was a fair system...that it was the consumer's fault that the banks are in the trouble they are in.
Sadly enough, this is not much different from what the drug and oil companies are doing. Choosing between paying a credit card however, and paying for a life-saving drug, or putting gas in one's car to get to work, clearly does define priorities. But like the banks, drug and oil companies do rape consumers for all they are worth. The cost of a barrel of oil is now less than 1/3 what it was 6 months ago. But are you paying only 1/3 as mush for gas that you were paying 6 months ago? Not likely!
Please do not try and rationalize drug companies profiting billions of dollars per year, with their executives getting millions of dollars per year in salaries and bonuses, while people die because they cannot afford some overpriced life-saving drug, nor try and rationalize oil companies making billions of dollars while we are all gouged at the pumps for no real reason but corporate greed.
The banks, drug and oil companies, all need to be completely torn down and rebuilt from scratch, this time with strict external controls in place to make sure that these situations will never happen again. It's time to wake up everyone. Together we can do something.
banks bought a lot of the bad paper even if the I-banks created the security. I am trying to challenge conventional wisdom here and to suggest that since banks have not existed since creation, it is certainly possible that we will not need them in the future.
On Feb 12 01:09 PM who wrote:
> Banks are safe - your deposits are protected. Essence of a RETAIL
> bank is take deposit and lend out money, split the interest. Banks
> are regulated more so then any other industry.
>
> Supervision and regulation are the first failure when the system
> get into trouble.
>
> The use of mortgage agents (or any type of agent) which is a major
> weakness in the system. Agents gain from transactions, so they
> will circumvent rules to get the deals done.
>
> Poor credit control is also evidence in this crisis.
>
> Slice and dice, securitisation, of loans are done by INVESTMENT banks.
> Securitisation is done for other products such as insurance, with
> purpose of decreasing risks of default for a share of the interest.
> Used properly securitisation adds to health of the bank since it
> is offloading the risks.
>
> CDS is also critical as it insures against counter party risks.
> Failure to control the miss use of the CDS is major cause of the
> crisis.
>
> Other services such brokerage, remittance, etc. are also highly regulated.
>
>
> Low interest rates and cheap money is major cause of this crisis.
>
>
>
>
>
>
On Feb 12 09:19 PM Marcap wrote:
> "Low interest rates and cheap money is major cause of this crisis."
>
>
> Not even close!
>
> The major cause of this crisis is the fact that greedy bank executives
> were permitted to give themselves millions and millions of dollars
> in salaries, bonuses, and perks while milking consumers on interest
> charges, credit card fees, and so on to the point they could no longer
> pay.
>
> When a bank executive getting $20+ million a year, raises the interest
> rate on a credit card from 5.9% to 25.9% simply for missing 2 payments,
> thus making it impossible for the user to pay, please do not try
> and tell me that it was a fair system...that it was the consumer's
> fault that the banks are in the trouble they are in.
>
> Sadly enough, this is not much different from what the drug and oil
> companies are doing. Choosing between paying a credit card however,
> and paying for a life-saving drug, or putting gas in one's car to
> get to work, clearly does define priorities. But like the banks,
> drug and oil companies do rape consumers for all they are worth.
> The cost of a barrel of oil is now less than 1/3 what it was 6 months
> ago. But are you paying only 1/3 as mush for gas that you were paying
> 6 months ago? Not likely!
>
> Please do not try and rationalize drug companies profiting billions
> of dollars per year, with their executives getting millions of dollars
> per year in salaries and bonuses, while people die because they cannot
> afford some overpriced life-saving drug, nor try and rationalize
> oil companies making billions of dollars while we are all gouged
> at the pumps for no real reason but corporate greed.
>
> The banks, drug and oil companies, all need to be completely torn
> down and rebuilt from scratch, this time with strict external controls
> in place to make sure that these situations will never happen again.
> It's time to wake up everyone. Together we can do something.
On Feb 12 11:49 AM rogersails wrote:
> I couldn't agree more. The banking sector has has grown significantly
> faster than the overall economy (and faster than our dreaded "Big
> Government") over the last 20 years. This, while many of us go months
> without even walking into a bank. 20 years ago weekly bank visits
> were part of the fabric of our life. What are they doing in the
> 4 banks on many street corners ? The argument that the banking sector
> is our helpful friend has evaporated.
> Several of your contributors delight in railing against big, cancerous,
> leeching, life sucking government. Dare they raise the same question
> about the banking aristocracy ?
> I apologize in advance for lack of numbers - I had done diligent
> research on the subject, and can't seem to find the data right now.
> So much for my file system.
I am trying to challenge conventional thinking here. see my below comment. i would not overestimate the expertise needed on risk management. Just look at the sorry state of banks risk maanagement today. The whole expert notion is a little overblown since banks invest in adavanced technology to do risk management and that tech will get cheaper.
The same is true in the opposite direction of P2P lending. It has problems today (transparency, regulation etc) but it is a first stab at a new bankless model and inevitably they get better. Read Clay Christensen on this.
great question on VC firms!!
On Feb 12 09:14 AM M. Weinstein, SA Editor wrote:
> I like the 'wipe the slate clean and rethink the role of/need for
> banks' thought experiment, and I think in principle we could end
> up here one day, but you clearly need to address these issues still:
>
>
> 1) The Fed and other central banks use commercial banks to do risk
> assessment for their massive lending process. You and I buying T-bills
> from Uncle Sam via Treasury Direct provides nowhere near the liquidity
> that the Fed - and the commercial system on the other end - needs.
> Who will provide this service?
>
> 2) Commercial and residential lending involves huge sums changing
> hands, and centralization in a limited number of banks that are considered
> safe for depositors provides that liquidity in a way that citizen-based
> lending cannot, currently. Why? Because a) the work involved in proper
> risk assessment on lending is very demanding and requires expertise,
> and b) borrowers don't want to work with hundreds or thousands of
> lenders.
>
> In this vein I have to ask: Do you see a future with no VC firms?
> Startups receiving funding from angels and thousands of lower net
> worth individuals only? It's possible, but right now - for companies
> with high capital requirements - both the entrepreneur and investor
> need larger firms to pool the capital, do the risk assessment, and
> provide the liquidity. Show me the tool for crowdsourced assessment
> of the risk/benefit of investing in that startup that just dropped
> its powerpoint on your desk. What's true in private equity is even
> more true in public equity, where the capital requirements are orders
> of magnitude greater.
>
> 3) What are the difficulties that Prosper and other peer-to-peer
> lending efforts have faced? I understand that Prosper is having a
> tough time... why?
The world has been led to believe the debt is backed by the "full faith and credit" of the government and therefore buying T-bills, Notes, Bonds, etc. is "safe". I assume the pledge implies the debt is backed by the production wealth of all U.S. business, because fiat money by itself is not worth anything. The cost to the government (tax payers) is the interest paid on the debt to foreign, domestic and central bankers.
But government is unique in that it has a has a printing press.
So why doesn't government print and loan the money to regional/community banks, credit unions, etc. and charge interest? The money is backed by the "full faith and credit" of the government just like the debt. The interest received is deposited into the treasury which pays for the annual budget.
Voi·là, no more national debt and the oppressive interest paid by the income tax!
You seem to agree that the destruction of working capital in the OECD via the insolvency of the Anglo-American banking system (and probably the European system) is also "no problem."
Good luck with that view.
One thing that I find quite sad about this whole financial situation that our great country faces is that we don't have financial experts dealing out the money, they are mostly lawyers taking advice (usually with a grain of salt) from economists. That's pretty scary if you ask me. It's laughable to think that I just baled out a bank with my tax dollars and now they are lending me my money back in which I pay 5.55% interest on!
We can unlock the mysteries of the atomic bomb in a few years but we can't come up with an answer to our financial system. Reason why? I think Beurocracy... your thoughts??