A Radical Solution for America's Insolvent Financial System 27 comments
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A plan for the resolution of the insolvency of the U.S. banking system:
The core problem of the U.S. banking system (and maybe the world's banking system) is not liquidity but insolvency. The liabilities of the U.S. banking system exceed the value of its assets. The issue is not only the toxic assets (toxic mortgage backed securities, toxic commercial real estate loans, sub-prime mortgages, alt-A loans, adjustable loans likely to go bust, increase in prime mortgage default rates, etc) but also off-balance sheet liabilities (such as expected, huge-unaccounted-for future derivatives losses).
This means that bailouts are just beginning and will require bigger and bigger sums of taxpayer money as time goes on. The government will resort to borrowing more and more and eventually to printing money when treasury debt auctions start failing. The end result of this path is a currency collapse and probably total chaos as expected by gold bugs.
One other way to deal with this issue is to stop the bailouts and let the dominoes fall. Defaults and cross-defaults will cause many, many depository institutions (even very large ones) to collapse, leading to an extreme decrease in money supply as bank deposits are destroyed. Deposits of failed banks cannot be used to pay bills, make purchases and/or service debts.
Which will probably lead to even more defaults as unemployment increases and debtor's are unable to service their debts. This process will probably cause extreme deflation as businesses lower prices in a bid to survive. This will also lead to wage cuts, increased unemployment and a deflation spiral and much chaos. But probably less chaos than a currency collapse.
Is there a better way?
Here is my idea:
1) We essentially need an orderly bankruptcy and liquidation of the U.S. financial system.
2) I suggest we create a government owned bank and transfer all deposits of the private commercial banking system to the new government owned bank. This "transfer" is really just new money creation. This new money will be digital cash (electronic version of physical paper cash). Very much like reserves at the Fed.
3) Note that the plan will not create net new money since we will be destroying all deposits of the commercial banking system in the process.
4) All assets of the commercial banking system will be transferred to the government and auctioned off in an orderly manner over the next 10 years. The proceeds from the sale would go the United States treasury and not the commercial banks. The assumption here is that commercial banks deserve nothing since the entire industry would have been most likely destroyed any way. Even good banks would have been destroyed due to bank runs and defaults if the government had allowed the dominoes to fall. Of course bank shareholders, bank bond holders and counter parties of bank derivatives would not receive anything.
5) After the transfer FDIC protection will be removed for any private bank which wishes to remain in business or any new private depository institution or bank. From that point on the government should make it absolutely clear that there will be no more bailouts and no more conversions. This will discourage (but not completely eliminate) fractional reserve deposit banking and private money creation that results from pyramiding of government created money. This will also limit debasement of the currency that results from fractional reserve deposit banking. In fact, we can have "free banking" from that point on and not even have reserve requirements or capital requirements. All depositors who use private banks will be fully at-risk. The industry will have to set the interest rate high enough to attract depositors.
6) The new government bank will act as an electronic "piggy bank" only. All deposits will be 100% reserve and it will make no loans. Loan making will be left to the private banking system (with no deposit insurance or a possibility of a future bailout). The new government-owned bank exists only as a "safe" money storage and a payment clearing system so the public does not have to carry around physical paper cash to make purchases and pay bills.
6) Of course this plan is not without pain or cost. Cost of funds for banks and borrowers will probably rise as bank deposits are a source of very low cost money for the banks. Nothing is free. We are just exchanging higher cost of funds for removal of systemic failure risk. Economically we are recognizing that when money is loaned there is always credit risk.
7) We are just separating the payment and clearing transaction system which is absolutely necessary for day-to-day commerce (no credit risk) from the loan banking and investment system (has credit risk).
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I have come to the conclusion that only violence will solve the entenched problems we face. We got rid of the British for less than what our own government is doing to us.
This is the best idea I have heard to date. If a few of the banksters got their brains splattered I would bet it would be a pretty good example and the rest will think twice before they try any more of their tricks.
On Sep 07 12:29 PM dcb wrote:
> Alas,
> I have come to the conclusion that only violence will solve the entenched
> problems we face. We got rid of the British for less than what our
> own government is doing to us.
Kirby
1) No bailout and let all US banks fend for themselves.
2) Remove all restrictions for foreign banks to enter the US market and conduct business in all manner.
3) Any foreign banks willing to enter will be large, well-capitalized, and have a sterling reputation.
Such foreign banks will fix the US banking system automatically without costing tax payers a dime.
Yes, the nationalists and big biz elite will cry murder. But it is time for them to get murdered for a change.
First, a blanket confiscation of commercial banks would run into constitutional problems -- punishing people without due process, etc. (either the banks or any depositor with uninsured deposits could make this argument). So instead, we have to cancel all existing bailouts, and wait for an actual, documentable insolvency event to bring a bank into FDIC receivership. At that point, there is an established legal process for taking over the bank's assets and discarding its liabilities.
Second, for fairness' sake, we should ensure that any deposits uninsured by the FDIC are first credited against any debts that person owes to any other FDIC insured institution (e.g., a person with $500K in an account and a $500K home mortgage, both with FDIC institutions, would be left with $250K cash and a $250K mortgage; to leave him with $250K cash and the $500K mortgage would be grossly unfair, and also prompt time-consuming litigation).
The period during which banks were failing would be unstable, but brief so long as the government stopped backstopping some and abandoning others. Let them all face the music they were playing.
Going forward, expansive new regulations are not necessary -- indeed, as an attorney, I can tell you that the current regulatory environment is part of the problem, since it can just as easily be captured by banks as used to restrain them. There is only a few regulations that are necessary:
1) limit leverage at every stage to no more than 75% LTV. If every time someone borrows, they have to put up 25% of the price, they will pay attention to price, and the lender will have some cushion. These leverage limits would apply to ALL lenders and ALL transactions -- from buying a TV at Best Buy, to buying Rockefeller Plaza.
2) Allow securitization only of whole, recourse loans. As we are seeing now, slicing and dicing into tranches leads to the mispricing of risk. And securitizing non-recourse loans is particularly problematic, since the borrower's ability to walk away if the asset falls in value below the loan is an option whose price should be deducted from the value of the loan, but because that option can be hard to price, it was often ignored entirely, leading securities to be priced way too high at the outset (for 100% LTV non-recourse loans, in some cases the borrower's option to walk was worth 25% of the loan value).
3) Going forward, eliminate or phase down FDIC insurance.
4) Going forward, eliminate the Federal Reserve, and go to a currency board that would keep the dollar within a tight range based on the price of a commodity basket anchored by gold.
5) Reform the tax system to be neutral between equity and debt. One thing that could be done right away is to switch from depreciation over a complicated schedule, to deducting principal and interest when paid -- giving a nice tax benefit for large downpayments. Eliminate the home mortgage deduction and the capital gains tax on owner-occupied residences altogether. Eliminate all double-taxation of business profits by eliminating the corporate income tax an instead requiring that most (80% minimum) business profits be distributed to individual owners, who will pay tax on it at their individual rate (this also prevents retained profits, which in principle belong to shareholders, from being used for CEOs' empire-building).
6) the above, in order to work, will absolutely require serious cuts in government spending. The debt used to resolve failed banks and pay depositors should be fully amortized over 10-20 years. The payment (probably around $300B/year) should be made out of cutting spending by an equal amount from the level of the fiscal 2008 budget.
On Sep 22 04:47 PM Dave Herr wrote:
> I like the general parameters of this idea, but there are some problems
> in the details.
>
> First, a blanket confiscation of commercial banks would run into
> constitutional problems -- punishing people without due process,
> etc. (either the banks or any depositor with uninsured deposits could
> make this argument). So instead, we have to cancel all existing
> bailouts, and wait for an actual, documentable insolvency event to
> bring a bank into FDIC receivership. At that point, there is an
> established legal process for taking over the bank's assets and discarding
> its liabilities.
>
> Second, for fairness' sake, we should ensure that any deposits uninsured
> by the FDIC are first credited against any debts that person owes
> to any other FDIC insured institution (e.g., a person with $500K
> in an account and a $500K home mortgage, both with FDIC institutions,
> would be left with $250K cash and a $250K mortgage; to leave him
> with $250K cash and the $500K mortgage would be grossly unfair, and
> also prompt time-consuming litigation).
>
> The period during which banks were failing would be unstable, but
> brief so long as the government stopped backstopping some and abandoning
> others. Let them all face the music they were playing.
>
> Going forward, expansive new regulations are not necessary -- indeed,
> as an attorney, I can tell you that the current regulatory environment
> is part of the problem, since it can just as easily be captured by
> banks as used to restrain them. There is only a few regulations
> that are necessary:
>
> 1) limit leverage at every stage to no more than 75% LTV. If every
> time someone borrows, they have to put up 25% of the price, they
> will pay attention to price, and the lender will have some cushion.
> These leverage limits would apply to ALL lenders and ALL transactions
> -- from buying a TV at Best Buy, to buying Rockefeller Plaza.
>
> 2) Allow securitization only of whole, recourse loans. As we are
> seeing now, slicing and dicing into tranches leads to the mispricing
> of risk. And securitizing non-recourse loans is particularly problematic,
> since the borrower's ability to walk away if the asset falls in value
> below the loan is an option whose price should be deducted from the
> value of the loan, but because that option can be hard to price,
> it was often ignored entirely, leading securities to be priced way
> too high at the outset (for 100% LTV non-recourse loans, in some
> cases the borrower's option to walk was worth 25% of the loan value).
>
>
> 3) Going forward, eliminate or phase down FDIC insurance.
>
> 4) Going forward, eliminate the Federal Reserve, and go to a currency
> board that would keep the dollar within a tight range based on the
> price of a commodity basket anchored by gold.
>
> 5) Reform the tax system to be neutral between equity and debt.
> One thing that could be done right away is to switch from depreciation
> over a complicated schedule, to deducting principal and interest
> when paid -- giving a nice tax benefit for large downpayments. Eliminate
> the home mortgage deduction and the capital gains tax on owner-occupied
> residences altogether. Eliminate all double-taxation of business
> profits by eliminating the corporate income tax an instead requiring
> that most (80% minimum) business profits be distributed to individual
> owners, who will pay tax on it at their individual rate (this also
> prevents retained profits, which in principle belong to shareholders,
> from being used for CEOs' empire-building).
>
> 6) the above, in order to work, will absolutely require serious cuts
> in government spending. The debt used to resolve failed banks and
> pay depositors should be fully amortized over 10-20 years. The payment
> (probably around $300B/year) should be made out of cutting spending
> by an equal amount from the level of the fiscal 2008 budget.
Aside: If we hadn't abandoned the gold standard in 1971, would we have been in IRAQ or Afganistan at all? Wars cost real money, but the leveraging of fiat currencies has put the US in several theatres that it simply couldn't of afforded otherwise. Again, banks making inroads on US foreign policy. Not a fan, and I don't say it lightly being US Army (ret).
On Sep 24 11:10 AM Boot wrote:
> I agree that there needs to be an orderly bankrupsy. However, giving
> the government the power to be the digital bank doesn't give me warm
> fuzzies. I simply don't trust our current (albiet privately owed
> FED) and the inroads these oligarchs have made in the US govt at
> all levels. Who would run the GOVT bank, but the current banksters.
> We need to disband the FED and create seperation of Banks and State.
> We fought for religious freedom, now we need to do so in the market
> place.
> Aside: If we hadn't abandoned the gold standard in 1971, would we
> have been in IRAQ or Afganistan at all? Wars cost real money, but
> the leveraging of fiat currencies has put the US in several theatres
> that it simply couldn't of afforded otherwise. Again, banks making
> inroads on US foreign policy. Not a fan, and I don't say it lightly
> being US Army (ret).
And digital money? Please -- that is more of the same fiat-induced problem that makes it seem easy to expand via credit. We need to move to a system backed by hard assets, so that real value does not get lost. Credit bubbles exist only because the expansion of paper money is so far out of whack compared to actual hard goods. Some call this leverage. It's also the ratio of fake-to-real. When money is based on something real, it can't happen.
The (usually) transparent process of inter-bank lending works so well that most of the time we don't even think about it. This process has largely weaned the public away from physical paper money. Note that most money (about 90%) now exists only as entries on bank ledgers, backed by loans (debt). Also, note that possessing physical paper dollars is like having equity in the economic output of the United States of America, and has no credit risk associated to it. Physical paper money is not anyone's liability.
Bank deposit money, on the other hand, does have credit risk associated to it. That risk consists of the liability of the bank in which the deposit resides. Strangely enough, most of the time the credit risk of bank deposit money is lower than the theft and physical-loss risk of physical paper money.
That is why we use bank deposit money more than physical money. Through this (normally) transparent process of inter-bank lending, the banking system acts like a huge clearinghouse (essentially a giant ledger) which clears payments between its customers without the physical transfer of cash, and keeps track of who has how much money. Most money in the world economy is not physical (paper cash or gold) but logical (ledger entries).
To summarize: physical paper money is equity. Bank deposit money is backed by debt (actually that's not 100% true--reserves at the federal reserve system are also equity, essentially an electronic version of physical paper cash).
That difference -- that physical paper money = equity in the nation's economy, and that a bank deposit = debt (a bank obligation) causes great confusion.
We have become very comfortable with bank deposit money, without thinking much about the credit risk we are taking. Bank failures, when they happen, create confusion and chaos because the vast majority of businesses and individuals use checking accounts for convenience (they can write checks rather than handling physical paper cash) and they don't really think much about the credit risk that is normally associated with keeping their money (their most liquid capital) in a bank in a checking account. In fact, in most cases users of checking accounts do not want to take a credit risk. But in the current banking system there are no alternatives.
Is There a Better Way?
Consider the banking industry's contribution to society. The banking industry provides three major services to the public:
It provides a "safe" place to hold the public's most liquid assets (cash).
It acts like a giant clearinghouse (settling checks without physical paper cash transfer).
It is a source of loan money (banks evaluate the credit worthiness of borrowers). Think of "credit worthiness evaluation" as a service to society. If bankers do a poor job at evaluating credit worthiness they will end up mis-allocating economic resources.
What I am asserting is that it is possible to have a banking system where a customer would get benefits 1 and 2 described above without taking a credit risk, if banks gave people a choice between a regular account and a special "100% reserve account."
These special accounts, which are not available to the public today, would have no credit risk. The money in such accounts would not be lendable. There would still be fraud risk, of course. A bank desperate for cash might be tempted to "dip" into the reserves allocated to their 100% reserve accounts. Of course we would make such "dipping" illegal. The 100% accounts would be the electronic equivalent of storing physical paper bills in a safe deposit box at the bank.
Such accounts would have no credit risk (like physical paper cash) but would have the benefit of being used in electronic transactions and be accessible by personal checks. Of course, a 100% reserve account would not earn interest but would most likely have monthly maintenance fees associated to it (similar to a safe deposit box; it would also be very much like the reserve accounts that banks have with the Fed).
Such accounts, if widely used, would lessen the impact of bank failures on the economy in terms of a contraction of the money supply, chaos and confusion--but would not completely eliminate them.
Lending involves business risks (credit risks). If a customer were to choose a non-100% reserve account then he would be subject to losing his money. This would force the public to do some homework before handing money over to a bank (in essence, customers would need to consider banks' credit ratings, quality of management, etc.).
Of course, in this type of setup, a non-100% reserve account would probably have to pay a higher interest rate than the fractional reserve accounts do today. In fact if the public had a choice of 100% reserve accounts, there would be no need to impose legal reserve requirements on non-100% reserve accounts. There would be a clear separation between accounts that have a credit risk and accounts that don't. The accounts with credit risk would need to set their interest rates high enough to attract depositors.
If our banking system were set up this way, we would avoid huge systemic risks in the future, since a major part of the money supply would likely be sitting in non-lendable accounts. Many enterprises probably should not take any credit risk with their liquid capital (utility companies, municipalities, states, hospitals, etc.). In any insolvency or bankruptcy the 100% reserve accounts would receive priority, and unless the bank was fraudulently “using” these reserves the deposit owners of such accounts would never lose their money. If an electronic deposit account with no credit risk were available, then any individual or business choosing not to use such an account would be subject to losing their at-risk deposit. If such an alternative were available, then the depositor who chose the lendable money account would be warned that he or she could lose money if the bank became insolvent.
Once this choice is given to the public, the banks can then be allowed to fail without severely impacting the payment system which is needed to conduct day-to-day commerce. The only job of the FDIC would then be to insure smooth transfer of 100% reserve accounts to another bank.
I will go a step further and state that the availability of such accounts (non-lendable, 100% reserve accounts) should be mandated by Congress through force of law. Each business and individual should be able to choose whether they want to take a credit risk or not.
On Sep 24 04:08 PM Socialism cannot compete! wrote:
> No. A government-owned bank? NO!!! The solution is not more government
> takeover! Too much government is what got us here!! Let failure
> happen, but let private capital pick up the pieces at bargain prices
> -- those who have been prudent and preserved capital will have incentive
> to continue to do so, and to thrive for it. Those who were not prudent
> will have to face the risk of continuing down the wrong path.
>
> And digital money? Please -- that is more of the same fiat-induced
> problem that makes it seem easy to expand via credit. We need to
> move to a system backed by hard assets, so that real value does not
> get lost. Credit bubbles exist only because the expansion of paper
> money is so far out of whack compared to actual hard goods. Some
> call this leverage. It's also the ratio of fake-to-real. When money
> is based on something real, it can't happen.
On Sep 25 08:37 AM Marli wrote:
> Mansoor's solution is carefully thought out, and well articulated.
> However, it completely fails to factor in the human element. The
> unintended result of this program would be crippling cprruption and
> widespread fraud.
>
On Sep 24 11:10 AM Boot wrote:
> I agree that there needs to be an orderly bankrupsy. However, giving
> the government the power to be the digital bank doesn't give me warm
> fuzzies. I simply don't trust our current (albiet privately owed
> FED) and the inroads these oligarchs have made in the US govt at
> all levels. Who would run the GOVT bank, but the current banksters.
> We need to disband the FED and create seperation of Banks and State.
> We fought for religious freedom, now we need to do so in the market
> place.
> Aside: If we hadn't abandoned the gold standard in 1971, would we
> have been in IRAQ or Afganistan at all? Wars cost real money, but
> the leveraging of fiat currencies has put the US in several theatres
> that it simply couldn't of afforded otherwise. Again, banks making
> inroads on US foreign policy. Not a fan, and I don't say it lightly
> being US Army (ret).
U.S. Rally Is Doomed Gold Will Hit $5000 oz Peter Schiff
for more on Peter Schiff and other dollar bearish economists check out these interesting blogs on a daily basis :
:
www.PeterSchiffNews.com
www.Jimrogers.tk
www.Marcfaber.tk
www.Geraldcelente.tk
On Sep 26 06:01 PM Gold_Investor wrote:
> great article :
> U.S. Rally Is Doomed Gold Will Hit $5000 oz Peter Schiff
> for more on Peter Schiff and other dollar bearish economists check
> out these interesting blogs on a daily basis :
> :
> www.PeterSchiffNews.com
>
> www.Jimrogers.tk
>
> www.Marcfaber.tk
>
> www.Geraldcelente.tk
My only unanswered question is how do you create the additional dollars (inflation) that is a required component of any banking system which charges interest? Adnthe reorganized and new banks will be charging interest.
Right now, the Fed's role is to continually create surplus money (inflation) so that wages can be increased to help borrowers (wage earners) keep up with the treadmill of compound interest.
Since the creation of what CNBC empty suits call the "inflation fighting" Fed, the value of the 1913 dollar has dropped 95 pecent. When the Fed gets so stretched it can't inflate any more, as at the end of the realty bubble, its battle plan collapses into chaos.
Your plan is so radical there is no way the banking establishment will let it see the light of day. And there is no way the banking establilshment will ever let the government just print money for its projects and needs, for then it would not be in hock to and under the control of the same banknig establishment, as is clearly the case today.
1) Where will the money come from to pay for compound interest? In my plan the money supply will be grown by the government by 3% to 4% annual rate. This is just a very simple formula. I am using the average annual historical rate of growth of gold money supply as my guide. Note that I am NOT proposing a gold backed currency. I am just using history as a guide to determine the rate of growth of the money supply when gold was used as a medium of exchange. The new money will simply be spent by the government for general expenses (military, courts, jails, food stamps, etc).
2) The new banks will be charging interest and making loans or equity investments as they wish with no one looking over their shoulder. The depositor's money will be fully at risk in the private bank (of course zero risk in the government bank). The interest rate will be set by supply and demand (no open market operations to play with short or long term interest rates to distort price signals as is done by the current FED). Over time the public will learn that the rate of inflation is low (1% to 3% if productivity increases average 1% to 2%). The public will not bid up asset prices as much in anticipation of inflation (eventually). A bank that is too loose in lending will go bankrupt and cannot be bailed out (this means fewer bubbles and less often). The banks will not have deposit insurance and that means a public that will be more discerning when handing cash over to a private bank. This in itself discourages risky behavior but does not eliminate it. Adam Smith's invisible hand will punish incompetent banks and greedy depositors.
3) I expect the interest rates to be low in my plan (eventually) because inflation expectations will be low (eventually). Also, it will be much more difficult for banks to create money (i.e., mismatched maturity lending which enables fractional reserve banking). The higher the mismatch in maturity between deposits and loans the more the probability that a bank will not be able to meet a redemption request (withdrawal request). This means that either the bank must keep very high level of reserves or not mismatch maturities between deposits and loans too much. This limits private money creation (but does not completely eliminate it).
4) As far as the probability of this plan being adopted I would say that review of world history shows stranger (good) things have happened in the past. The fact that I am typing this on this blog over the internet discussing this stuff proves my point. I suspect that bankers know the value of these ideas (since publishing my blog I have learned that these ideas have reached as far as being on proposed bills in Congress. See wealthmoney.wordpress..../). Banking industry is strongly resisting change in this direction. But remember Bankers are people too with minds and hearts and kids and grand kids. When enough of them are convinced that a radical re-design of the whole system is needed for a better world it will happen. In the meantime we can educate each other and the bankers and pray for change.
On Oct 03 11:31 AM swaps wrote:
> Interesting plan for an orderly liguidation and reorganization of
> the financial system.
>
> My only unanswered question is how do you create the additional dollars
> (inflation) that is a required component of any banking system which
> charges interest? Adnthe reorganized and new banks will be charging
> interest.
>
> Right now, the Fed's role is to continually create surplus money
> (inflation) so that wages can be increased to help borrowers (wage
> earners) keep up with the treadmill of compound interest.
>
> Since the creation of what CNBC empty suits call the "inflation fighting"
> Fed, the value of the 1913 dollar has dropped 95 pecent. When the
> Fed gets so stretched it can't inflate any more, as at the end of
> the realty bubble, its battle plan collapses into chaos.
>
> Your plan is so radical there is no way the banking establishment
> will let it see the light of day. And there is no way the banking
> establilshment will ever let the government just print money for
> its projects and needs, for then it would not be in hock to and under
> the control of the same banknig establishment, as is clearly the
> case today.