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What Banks Are For.

by Patrice Ayme Wed May 6th, 2009 at 12:44:33 AM EST

BANKING CLARITY A MUST TO REPAIR THE ECONOMY.

Stiglitz and Krugman had dinner with Obama. Krugman said he could not talk about it, because it was "off the record".


What should be on the record is this: the banks have a primary function, and a secondary function. Absent these two functions, it's as if there are no lungs, and no heart: the corpse of capitalism can't walk.

It is not clear that these two functions that define banking philosophically have been insured as much as they should have during the first four months of the Obama administration, while it was busy pursuing further the financial policies of the Bush administration.

Instead a great deal of attention was given to having the bank holding companies make good the very contracts that put in danger the very ability of the banks to conduct these two basic functions.

The two functions were the deposit of capital (which is primary), and the ability to extend credit (which is secondary). Obama had to insure both. I am not sure about the second, because I have not seen authoritative studies. But for the first it was easy: just do like the French republic. In France Sarkozy decided that all deposits would be insured, in any amount, in any bank. It provided the country with a lot of confidence. Since the currency system is a myriad of contracts in trust, this was crucial, as fundamental a measure to take for the economy as possible. Relative to this, the waste of toxic "assets" was completely irrelevant, just as irrelevant as it should always have been to banking.

Just an example of the sort of difficulty the refusal of insuring all deposits led to: millions of small businesses may only find difficult to maintain balances below $250,000. This is all the more silly, since the Obama administration made clear it viewed the 19 top banks as too big too fail (thus there was no risk insuring all and any deposits; in a huge contradiction, though, depositors did lose their money in smaller banks going in receivership!)
*

Patrice Ayme

Addendum: REPAIRING BANKS: Stiglitz called Geithner's PPIP a "robbery of the American people". I agree. But a week later, Obama repelled the mark to market rule, and that pretty much made the PPIP unworkable. The ways of Obama are not as mysterious as those of God: one week he makes a blatant gift to the hedge funds, delivered by his human poodle, and the hedge funds are all happy that the plutocrats are solidly in control, and the week after, Obama takes away their food, but they are too stupid to notice.

Stiglitz and Krugman opposed the conversion of preferred to common stock. Indeed the preferred route for cleaning the banking system would have been receivership (the bank fails, and is reorganized by the government, and then sold for a profit). The point being that the USA then takes ownership of the bank for the cost of recapitalization. The drawback is that severe disruptions to the financial system can happen as shareholders lose everything and bond holders can lose a lot.

The Obama administration had first followed the Bush administration policy (reimbursing losses with taxpayer money, which I have long argued was unworkable: I valued the losses at 8 trillion, minimum; now the IMF is at three trillions in the USA alone). Thus I was satisfied by the conversion into common stock (which has the right of vote, that preferred do not have). It is as good as nationalization can get, once receivership has been excluded (for the reasons of the disruption that bothered Obama).

Obama argued that this was how to make the TARP money go a long way, just as I had argued last September (OK, there was no TARP yet, but it was clear that "If you want leverage, nationalize!").

http://patriceayme.wordpress.com/

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The two functions were the deposit of capital (which is primary), and the ability to extend credit (which is secondary).

No.

The deposit of capital financial assets is irrelevant, except as a regulatory measure. If push comes to shove, SertaBank can work perfectly fine for that.

The central, absolutely vital, cannot-be-missed function of the banking system in an industrial production economy is the clearing of payments.

Certainly, not being able to trust ordinary on-demand accounts is a problem. Partly it is a political problem of ordinary people's money going poof. But that part is easily solved by printing physical tokens to replace the virtual tokens (this would cause a bank run, but that's another story...). A far bigger problem is that on-demand accounts are used to clear retail transactions. If they break down overnight, ordinary people cease to be liquid. That Is Not Good.

Taking deposits, extending credit and all that jazz is only interesting on the medium term - you can survive without credit for a month or two. You cannot survive without liquidity for a month or two.

So the payment clearing system must be protected at almost any cost. The credit creation system, OTOH, can in principle be allowed to burn to the ground (although that is probably not desirable in most cases...).

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed May 6th, 2009 at 07:13:36 AM EST
And there is no reason that payment clearing couldn't be done by an international trust or some other not-for-profit organisation.

Effectively some of it is already - banks provide a public interface to CHAPS, SWIFT and other clearing systems.

But in the UK there's still paper cheque clearing, which is still done - get this - by letter post.

The 3-5 day clearing schedule is a massive drain on the economy. Payments are made late and debt defaults happen because of it.

So it would be to (almost) everyone's benefit to automate the system to the maximum possible extent, and to speed up transactions so that credits and transfers would be available instantly.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Wed May 6th, 2009 at 10:34:18 AM EST
[ Parent ]
Personal cheques haven't been used in Finland for 20 years.

You can't be me, I'm taken
by Sven Triloqvist on Wed May 6th, 2009 at 10:38:58 AM EST
[ Parent ]
Or in Spain, but in the US and UK they are still used.

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith
by Migeru (migeru at eurotrib dot com) on Thu May 7th, 2009 at 01:57:03 AM EST
[ Parent ]
but mis-expressed myself. Let me try to think this through. The "clearing of payments" is the ability to transfer, in the general case "currency" (value, liquidity, whatever one wants to call it) from one deposit to another (or one account to another, to use a different noun). In general the deposits ("accounts") are in different banks.

For that trust from bank to bank is necessary. The first bank needs to be sure the second bank it transfers the money to is solvent, lest the money disappear (?), and it gets sued by the depositor...

As you can see, I do not know the official linguo too well, and I think its overabundance is actually confusing. That is why I tried to stay close to the concept of deposit.

it seems to me that if a deposit (=account) disappear, the bank has failed in its most basic function. The clearing of payments is from account (=deposit) to account, so it requires the sanctity of accounts first. That is what I tried to say (certainly awkawdly).

PA

Patrice Ayme Patriceayme.com Patriceayme.wordpress.com http://tyranosopher.blogspot.com/

by Patrice Ayme on Wed May 6th, 2009 at 10:43:15 AM EST
[ Parent ]
Banks are no longer technically banks, but "credit institutions" with the privilege of creating credit on the base of an amount of regulatory capital.

Deposit taking institutions such as credit unions also exist, but these create no credit in the way that banks do, and have no role in the clearing system other than as clients.

So credit creation is a Bank's primary function, and deposit taking is ancillary to that purpose.  The clearing of credit obligations is the same thing as the clearing of payments, and it is essential to the operation of a modern economy both in terms of the circulation of goods and services, and the creation of productive assets.

The matter of long term funding of productive assets is where secured loans and counter-balancing deposits come in. It is this part of the system which is imploding and draining credit out of the system, which adversely affects the flow of working capital as well.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Wed May 6th, 2009 at 06:50:15 PM EST
[ Parent ]
& that's why I made credit one of the fundamental functions.

Nevertheless, that function could not exist without the capital (8%). Ancillary comes from anchor, no? The capital allows to resist to unexpected withdrawals, without borrowing in despair from the central bank.

Historically banks lent from what they had in capital. No more capital, no more lending. Applied to central banks, that was the idea of the gold standard.

It is obsolete, but as you point out, "long term funding of productive assets" is imploding because credit was given in a self feeding loop to the financial system, a bit like when an amp feeds a microphone, that makes the loudspeaker scream even louder, etc...

What has been missing is the notion of PRODUCTIVITY, indeed. Instead short term profits to "credit institutions"(whatever that means, $12 billion of TARP gift through AIG in the case of Goldman) have been confused with long term profits to society.

So society stopped being profitable, basically... Ethics is the way out.
PA  

Patrice Ayme Patriceayme.com Patriceayme.wordpress.com http://tyranosopher.blogspot.com/

by Patrice Ayme on Wed May 6th, 2009 at 07:13:38 PM EST
[ Parent ]
Ancillary comes from anchor, no?

No, it comes from ancilla which is Latin for handmaiden.

ancillary
1667, "subservient, subordinate," from L. ancillaris "relating to maidservants," dim. of ancilla "handmaid," fem. dim. of anculus "servant," lit. "he who bustles about," from root of ambi- "about" + PIE *kwol-o-, from base *kwel- "move round, turn about, be much about" (see cycle).
You know, some 19th century philosophers also made a career out of squeezing deep meening out of etymologies and (especially German ones) word composition.

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith
by Migeru (migeru at eurotrib dot com) on Thu May 7th, 2009 at 01:56:36 AM EST
[ Parent ]
not this time. Thanks.

Anyway, the initial point was whether deposits were still important or not. As a gentleman above pointed out, banks are in charge of CREATING credit nowadays, that means creating money outright. Most of the money coming out of banks is made that way, so some will view credit as the most important function of banks.

But that function cannot happen without banks having SOME capital. (The capital standards were developed by the international organization called the Bank for International Settlements, based in Basel, and famous, long ago for being kind to Nazis). Indeed if some loans fail, capital is needed.

PA


Patrice Ayme Patriceayme.com Patriceayme.wordpress.com http://tyranosopher.blogspot.com/

by Patrice Ayme on Thu May 7th, 2009 at 12:04:50 PM EST
[ Parent ]
The requirement that banks have some level of "hard money" is a regulatory one. It is not a "law" of economics. There is a number of other possible ways to regulate money creation (e.g. by having the central bank clear all interbank transactions and limiting the amount of credit it will clear in any given time frame).

Further, there is a distinction to be made between short-term credit secured by intrinsically valuable stuff (which essentially means the payment clearing system), short term credit that is either unsecured or secured with stuff that has no obvious intrinsic value (e.g. brokers' loans secured by stocks) and long-term credit (whether secured or unsecured).

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Thu May 7th, 2009 at 03:23:41 PM EST
[ Parent ]
while engaging themselves, and not a central bank each time (or they would become a subsidiary of the central bank). Hence the capital requirements.

The distinction between law and regulation is interesting in political philosophy. Regulation is mid way between law and interpretation.

Patrice Ayme Patriceayme.com Patriceayme.wordpress.com http://tyranosopher.blogspot.com/

by Patrice Ayme on Thu May 7th, 2009 at 07:08:06 PM EST
[ Parent ]


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