Why Do We Need Banks at All?

by: Michael Eisenberg

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.