Geithner's Financial Reform Is Doomed to Fail 39 comments
an article to
-
Font Size:
-
Print
- TweetThis
Treasury Secretary Timothy Geithner has unveiled his concept for preventing the repeat of the financial system failure which has occurred. It travels the same road of increased and more effective financial system surveillance which has occurred after each failure in the past. This surveillance approach has not worked in the past – and it will not work in the future to prevent the next financial system failure.
When you design a system, you try to make it idiot proof. It always fails at the worst time at the weakest link. The problem, Mr. Geithner, is the system. The system must be designed not to fail in the first place.
You cannot make a rule that says – “You cannot fail”. Nor can you expect audits to uncover deficiencies or wrongdoing. The brightest minds do not become auditors.
The government and Fed officials are fighting fires to keep our banking system intact. Why are we trying to save something that goes into failure mode at times of major economic stress?
One problem with banking is that it does not meet the test of capitalism. Either your money is at risk or it is not at risk. Banks are stuck halfway in between. We are trying to pretend banks are capitalist institutions.
There is a big difference between depositing money (parking money) which you expect back and loaning money. Loaning money is risky and capitalistic. Being given money carries no risk. In most countries in the world, the government is involved in the banking system. In America, the government’s role is to regulate the system and provide guarantees. In other countries, they are a player in the system competing against traditional banks.
The current system which was legislated in 1913 is not working well. Major interventions by government using taxpayers' money occurred during the Great Depression, the Savings & Loan Crisis of the ‘80’s and ‘90’s, and now the Great Recession. Our crisis today added a “too big to fail” ingredient into the pot.
In a capitalistic society – too big to fail is unacceptable. Nothing in Mr. Geithner’s plan addresses this issue because he does not know how to solve it.
A proposed new banking model divides the current banking system into three elements:
- Banking (guaranteed deposits, home and student loans)
- Credit Banking (Consumer Loans and business loans)
- Market Makers (Enterprise Financing and debt purchasing by entities such as BlackRock or PIMCO)
The system revolves around the Credit Banks (pretty much the existing brick and mortar banking system) who make loans and package them for resale to pools of investors (Market Makers). Credit Banks then become only storefronts that turn deposits over to the government (interest rates paid per current treasury rates) and sell loans the Credit Bank has issued to investors (Market Makers).
The deposits to the Government Bank can be commingled with the government’s General Fund (like social security) and used to offset Treasury funding operations (reduce need for Treasury auctions). As there is no need for guarantees anymore – we can eliminate FDIC making the system more efficient. Deposits for the Government Bank can be made at any Credit Bank or Post Office (government would pay a handling fee on money deposited or withdrawn).
Credit Banks would have a relatively small asset base as their function becomes retailers of financial products. Home loans and student loans would be issued against government guidelines, and sold to the government. Other loans would be packaged in a way they would be of value to the Market Makers – and sold off to them.
The Market Makers would market financial packages of loans for investors via mutual funds, ETFs, bonds, or any other investment vehicle. In addition, the Market Makers can put together private pools of money for larger endeavors such as corporate financing. They would specifically be tasked with investing in innovative new companies or technologies which offer employment.
The government (through the Fed) can increase or decrease liquidity in the system by becoming an investor with the Market Makers. To soak up liquidity, they can sell home loans to the Market Makers.
Regulatory Features:
- The Market Makers must use some of their own funds in each product. There can be no leverage (hedging) as this is part of the banking system. Leveraged products are subject to failure during economic events and do not belong in a banking system designed to withstand economic maelstroms.
- There is a limit on the fees the Market Makers charge for managing these investments (my opinion is not more than 1%).
- There will be no Federal Auditing program per se. Monthly, an audited balance sheet will be submitted to the SEC. In the event an irregularity is uncovered, both the auditor and all individuals involved will be subject to criminal prosecution. It will be assumed that the entire chain of the command is guilty of wrongdoing unless reasonable management oversight could not have discovered the wrongdoing. (Management in large companies purposely insulates themselves from day to day knowledge to avoid implicating themselves in wrongdoing.)
- There can be no common ownership between the Market Makers and the Credit Banks. Transactions between the Credit Banks require government approval. Transactions between Market Makers require government approval.
- No Credit Bank or Market Maker can grow larger than 1% of the market size.
- The Credit Banks must repurchase all loans sold where due diligence was not exercised in qualifying buyers or assets being purchased.
- The Government Bank will provide criteria for lending standards for all loans it purchases. The Market Maker can also provide criteria for lending standards – or can rely on stated standards the Credit Bank used (as the Credit Bank is essentially warranting the standards for the loans as they will be required to repurchase if they do not meet those standards). All bank records (including correspondence) will be on-line, be to an established government standard, and available for government review 24/7.
- Quarterly, government regulatory authorities will produce a Banking System Risk Report quantifying the risks and trends of the banking system.
- No lobbying or contact between the Credit Banks or Market Makers and Congress unless it is in an open Congressional hearing. If a congressman receives campaign contributions from any bank, corporate member of any bank, or board member of any bank – the congressman is considered to have a conflict of interest and shall excuse himself from voting.
This model completely changes the relative importance of the banking sector, and removes the systemic risk of a banking failure during economic contraction. In the event of a failure of a Credit Bank, only the employees and owners would feel the pain. The Market Makers are creating “backed” securities (not derivatives) – and in a case of a Market Maker bankruptcy, the role of the market maker would simply be transferred to another company. Investors in Market Maker products would only take a bath if what they purchased turned into crap – this is the risk of all investments. Mark-to-Market debate disappears.
We can have a discussion on the virtues of the phantom money created by the current fractional reserve system. In this new system, the government would have to create real money. But this argument is academic at this point as the massive printing operation by the Fed has proven printing massive amounts of money has little effect on the dollar.
We are spending a lot of money to save a defective banking concept. Is it worth it?
Disclosures: None
Related Articles
|
-
The Seeking Alpha 100
See allThe top 100 stock
market authors
selected for publication in the last week
Seeking Alpha 100 » -
Fastest Climbers
Those with the largestSee all
increase in followers
in the last week
Fastest Climbers » -
Top Commenters
Top commenters,
as ranked by their peers-
1
User 353732
-
2
Moon Kil Woong
-
3
doubleguns
-
4
optionsgirl
-
5
Mayascribe
Top Commenters » -
1
-
Top Instabloggers
The 100 most activeSee all
Instabloggers.
Top Instabloggers » -
Top StockTalkers
TopSee all
StockTalkers.
Top StockTalkers »
A cheaper solution is not to allow any one organization to become too big to fail
If you want to give the bank a loan so that it can make additional loans then do at your own risk.
Your article provides food for thought, and contains worthy ideas. I also like the two ideas many have raised to begin correcting a deeply flawed system:
1) Bring back Glass-Steagall to separate insurance, banking, and brokerage; and,
2) Enforce the anti-trust laws to keep uber companies (so big that they incur systemic risk) from forming.
The first would clarify who is in charge of regulation and what regulations apply. The second would prevent the systemic failures and eliminate the greed opportunities (or at least minimize them) in the future.
Geithner's approach seems overly complicated and is fraught with what I call experimental exuberance. Too much is untried and subject to failure at a colossal scale. His actions to date are characteristically doomed to bankruptcy of the department he runs. We simply cannot afford his mistakes any longer.
It is a principle of distributism that ownership (as opposed to income per se) needs to be widely dispersed for healthy capitalism. 'Back in the day' they were speaking of land ownership and had programs to literally move the poor out of cities and onto small farms, but I keep musing that it could apply to anything, and waiting for someone to apply it to more intangible capital.
On Mar 27 07:06 AM Chezfrederick wrote:
>
> A cheaper solution is not to allow any one organization to become
> too big to fail
Steven's scheme here is such a powerful analysis of the problem. He keeps trying to get down to the structure of the problem.
It seems premature to be nonchalant about the consequences of QE for the dollar. Already there are serious discussions going on about a new global reserve currency and who knows what kind of inflationary genie has been let out of the bottle - we have some time to wait before that becomes clear.
But isn't Geithner giving the US tax payer( and eventually the OZ citizens) 90% of the risk?.
it all appears to be a a non recourse loan that ,if it goes bad will be bourne by the US tax payer .
Here in OZ we are going to be loaded with a 78 billion dollar loan from the Chinese .A loan Australia really shouldn't need to borrow,and this with the approval of Geithner and Obama ,or so our press tells us. perhaps the loan isn't the only Chinese thing we are getting.
As long as governments have this power, global economies will move from crisis to crisis.
On Mar 27 09:18 AM morph366 wrote:
> I would take issue with one of your concluding remarks..."the massive
> printing operation by the Fed has proven printing massive amounts
> of money has little effect on the dollar."
> It seems premature to be nonchalant about the consequences of QE
> for the dollar. Already there are serious discussions going on about
> a new global reserve currency and who knows what kind of inflationary
> genie has been let out of the bottle - we have some time to wait
> before that becomes clear.
He'll also promise NOT to Do Or say anything that they might take offense at !
Is this the Change He promised , when he said he was going after the bad actors on WS ?? No this just another slick politcian , once again lying to The People to get elected then doing what evers going to make him Richer when He leaves office ! So there it is all the other stuff is just the usual smoke and mirrows , this guy is out for Himself period . He could care less about the American People ,, Kinda like when Clinton said "I feel Your Pain" while he was really feeling someting else ;) So Its Washington and WS ,, Vs You who do You think will be better off 4 years from now ???
Take a lesson from the Canadian banking institutions.To further understand the monetary system-refer to zeitgeistmovie.com.
You can down load addendum free.
The way it works is that We The People are bent over a table with our pants pulled down. The guy behind us is crying about how badly we are being raped and promising to find the culpret, surprized OJ isnt in charge of the investigation.
I think that guy is congress
This is a well thought out article. Now what is the plan to get it communicated to those who could start a meaningful discussion and perhaps get it implemented?
Jack
Thanks for putting these "outside-the-box" ideas out here for discussion. We need more original thinking on the question of financial system structure.
Since the banks were too big to fail so the solution has been lest make them bigger by all these shotgun mergers. Most of these institutions are insolvent and simply too big to succeed (and save). Banks etc have lost touch with reality – their customers. All their business models are centered on quick buck – derivatives etc, and not on giving credit to business for economic growth. GE, with GE capital, is the classic example – 50-60% of its profits come from financing. Now finally Immelt realizes that is the wrong model and they have o revert back to ‘producing things’. Obama is saying the same thing.
G-20 next week all these issues will be front and center, China, Brazil, Russia are making clear they want drastic change, a system led by west and America is unacceptable. Lula (Brazilian president) yesterday said: “Blue eyed white bankers have caused all these problems, they claimed to know everything; facts now show they know nothing”. The only thing western bankers have done last two decades is – create one bubble after another and collect hefty bonuses, with the help of one and the only Greenspan, and now his disciple Bernanke.