– I’m Maria Minniti, I’m a professor in the Department of Entrepreneurship
and Emerging Enterprise and the Louis Bantle Chair in Entrepreneurship and Public Policy at the Whitman School of Management. In 1990 thanks to a generous
gift the Louis Bantle Chairs were established at Syracuse University. The purpose of this endowed
chairs is to provide for teaching and thought leadership in entrepreneurship, business,
and government policy. One chair resides at Whitman and as I mentioned I have the
privilege of occupying it. The other chair reside
at the Maxwell School and is currently occupied by
my colleague David Van Slyke who’s professor of Public Administration and Louis Bantle Chairs in business and government policy in the Department of
Public Administration here at Maxwell, this symposium
is a joint initiative of Whitman and the Maxwell School. The goal is to foster synergies
across the two colleges and to facilitate the
discussion of important issues that are relevant to
business and government. Today we welcome professor Larry White from George Mason University
and we are honored to have him as our our speaker at
the first Bantle symposium. Larry White is Professor of Economics at George Mason University, he specializes in the theory and history
of banking and money, and is best known for
his work on free banking. Indeed Larry White is one of the original architect of the modern theory of the banking which has grown significantly in importance since he started working on
this in his dissertation. Larry received his bachelor’s degree from Harvard University and his MA and PhD from UCLA where he studied with. He previously taught
at New York University, the University of Georgia, University of Missouri, St. Louis. Professor White has published
several books among them The Clash of Economics Idea published by Cambridge University Press in 2012, The Theory of Monetary
Institution published by Blackwell, Free Banking in
Britain published, there are two editions published by the Institute of Economic Affairs
and Cambridge University Press and Competition and Currency
from New York University Press. Is the editor of Frederick Hayek, The Pure Theory of Capital,
The History of Gold and Silver. Free Banking which is a three-volume set, and Decrease the Crisis
in American Banking in several other volumes. Professor White has
published also several dozen articles in top journals
for examples his articles on monetary theory in banking history have appeared in The American Economic Review, The Journal of Economic Literature, The Journal of Money Creating and Banking, and Economic Inquiry,
he has also published a ton of other stuff the
list was several pages long, way too much stuff for me to cover it. In 2008 Professor White received a Distinguished Scholar
Award of the Association for Private Enterprise
Education, he has been a visiting professor at Queen’s
University in Belfast, visiting fellow at the
Australian National University, visiting research fellow and lecturer at the American Institute
for Economic Research, visiting lecturer at
the Swiss National Bank, and a visiting scholar at
the Federal Reserve Bank in Atlanta, Professor White has also very prominent editorial profile, he co-edits a book series for Rutlede called Foundations of the Market Economy, is a co-editor of the Econ Journal Watch announced bimonthly podcast for EJW Audio, he’s a member of the
Board of Associate Editors of the review of Austrian Economics. A member of the Editorial Board of the Cato Journal and is also a contributing editor to the Foundation for
Economic Education’s Magazine and lecturer at the
Foundation’s annual seminar in advanced Austrian economics. Finally, Professor White is a member of the
Academic Advisory Council of the Institute of Economic Affairs. To conclude I would like to spend just a few words to describe his last book entitled the
Clash of Economic Ideas, again published by Cambridge
University Press in 2012. In this book Dr. White interweaves the economic history of the last 100 years with the history of economic
doctrines to understand how contrasting economic
ideas have originated and developed over time. The book offers a fresh perspective on laissez-faire, socialism and fascism, on the roaring ’20s business cycle theory, and the Great Depression
on the Keynesian Revolution the war and central planning,
after 1945 the book also explores the post-war revival
of invisible hand ideas, economic development and
growth, the gold standard, the post-war Bretton Woods system, free trade versus protectionism, and finally fiscal policy and public debt. So it’s very, very comprehensive analysis. The book is already
considered a classic and by the way it’s got 4.5 stars
out of 5 on Amazon reviews. I know because I checked. By contrast Thomas Piketty is Capital in the 21st
Centuries got only four, and just to give a measure
even the Harry Potter series lags behind with only 4.4
stars, so I think you made it. The title of today’s talk is Can the Banking System Regulate Itself, is government Regulation an
Improvement Over Laissez-Faire? Please join me in welcoming
Professor Larry White. (applause) – Thank you Maria. You know of course that
those Amazon ratings are based on very small samples. (laughter) It’s a pleasure to be here I
was a little puzzled when I was invited to speak between
10:00 a.m. and noon, I said why so early? And then watching TV last
night on CBS I learned the tip-off is at 12:10
today for the first game in the round of 64, 32,
I don’t know whatever. So the big question I want to address is can the banking system regulate itself, and why not? I mean let’s let’s look at
the pros and cons of that proposition I think it can. I think it can certainly more
than it’s allowed to now. Meaning, we certainly need to move in the direction of
greater market discipline. I’m not saying that market
regulation is perfect in the sense that no bank
will ever make any mistakes, that’s too much to hope, for the question of course though is whether it’s better than the alternative, that’s the way economist always think about things, what’s the alternative? So I’m going to try to
state fairly and identify the problems in the self-regulation view and in the contrary view
that government regulation is an improvement over
laissez-faire and banking. Now my position on the laissez-faire side is a minority view among people
who study banking regulation so I don’t expect to persuade everyone entirely this morning but maybe I can nudge you in the direction
of greater market discipline. I understand Paul Volcker was
here yesterday it would have been great if he had stopped in this morning we could have had
some interesting discussion. I actually think of the Volcker Rule as an attempt to undo some of the perversities caused not by
laissez-faire in banking but by our current regulatory regime. So I’m gonna try to help at least alert you to some of the problems of our current regime that you might
not have been fully aware of, and some of the self regulatory mechanisms you might not have known about. And so if I’m gonna talk crazy, I hope at least it’s interesting crazy. I like to think of the case for free banking as very much parallel to the case for free international trade. I like to do that because that’s pretty uncontroversial I mean most economists certainly think that international trade ought to be free from legal restrictions it’s pretty much a consensus
view I’m going to take it for granted that that’s correct, that protectionism and
mercantilism are mistaken views that banking ought to
be free is not so much a common view even though at the beginnings of economics as a discipline and I’m sort of drawing on the book that Maria had just mentioned, Adam Smith thought that banking should be pretty much free from legal restrictions he endorsed two minor restrictions on the issue of banknotes but he didn’t propose any restrictions
on deposit banking, and enunciated a theory according
to which it could regulate itself not a perfect theory
we’ve improved on it since then but he had a lot of respectable supporters in the 19th century on this view, and they developed a theory
of how banking system regulates itself, how their
built-in checks and balances against any bank started
going wild and there were big debates when proposals
were made to establish government oversight to
establish central banks there were big debates
over that there were arguments on both sides. We don’t hear those debates anymore, central banking is taken for granted and likewise deposit insurance, so I’m not actually going to talk much about central banking but
about deposit insurance, which I think is the
most important regulation in the banking system today,
but it’s seldom debated except around the margins, whereas once-upon-a-time
laissez-faire and deposit banking was almost universally accepted
and the idea was depositors could look out for
themselves caveat emptor. So where does the case for government regulation or
intervention come from? On the face of it banking
services are private goods so it’s not clear where the
public goods problem is. If you want to rebut the argument that the invisible hand operates here to make a case for government doing more than enforcing laws against theft and fraud you have to show that it’s prone to market failure right that’s the standard way we conduct these arguments. So I want to go into
those arguments but before we talk about the historical evidence, but before we do that or to use my favorite NPR phrase
before we drill down into the historical cases, I want to make this sort of methodological point that to understand regulation to understand the difference it makes for good or for ill we need to understand what the banking system would look like without it we need to have
a model of free banking as a baseline just as to
understand the difference that tariffs make or
quantitative restrictions on trade, we need a baseline model of what free trade looks like. Now of course it’s true that we’ve had a long history of banking
regulation in the United States from the very beginning that isn’t because laissez-faire was
tried and found wanting it was hardly tried but I’m gonna argue that in the cases where we came closest to trying it we’re banking
was least regulated, the results were actually
the most successful among different types and experiments of with banking systems in U.S. history. So the fact that it’s long
been regulated shouldn’t be taken as evidence that we
needed regulation any more than the fact that we have
tariffs and trade barriers is evidence that those
are good things, right? We understand that tariffs
and trade barriers are harmful to the public interest
and that they’re motivated either by revenue concerns
or by special interests who are protected by tariffs kind of rent-seeking motive we can understand many bank
regulations the same way. So that’s kind of the landscape, but if we talk about at a
purely theoretical level we’re not going to really
resolve the issues because we’ve got theories according to which
markets regulate themselves and we’ve got theories of
market failure, and so just pure armchair theorizing isn’t going to resolve that we need to look at historical cases and when we
do is my sort of broad brush, I’ll give you some more details shortly but the broad brush record
is that less restricted banking systems around the
world across history systems closer to laissez-faire, I can’t claim I can identify one that is laissez-faire, exhibit greater efficiency
and greater stability, that’s the part that often
people, it’s not clear that there are market failures evident that regulation needs to remedy. So we need to look at
the actual track record of banking systems as close to
laissez-faire as we can find and correspondingly when we look at the impact that bank
regulation makes we need to look at the actual track record not just how the imagined efficiency gain looks on the blackboard. Okay, so that’s enough
preamble, let me talk about what you should know about
free banking history, and here I’m drawing on a chapter I recently published in a book entitled Renewing the Search
for a Monetary Constitution, it’s available free as a PDF download on the Cato Institute site. Well if it’s not
currently it will be soon, probably shouldn’t say that. No, I’ve already been paid my royalties. Okay, so when I say banking
systems that are less restricted I also mean banking systems that are less privileged because a lot of legal intervention and
banking systems has not been to hamper banking, but
rather to enrich bankers. So systems close to laissez-faire
have lower entry barriers, activity restrictions, geographic
restrictions, restrictions on branching across county
lines and state lines have been a big part of
U.S. banking history, and fewer pricing restrictions,
no monopoly privileges. No tax payer rescues,
or backing, or bailouts. So as Maria mentioned
my dissertation research was on the debate over
free banking in Britain and in particular one
chapter is on the history of the free banking system in Scotland and that’s interesting because
it was an especially long and lightly regulated system, but it’s not the only
piece of evidence we have, there are literally dozens of other cases. A student of mine wrote a paper modestly titled The World
History of Free Banking. (laughter) In which he identified about
a little more than 60 cases of places that had systems of multiple
issuers of banknotes, no central bank, minimal restrictions, no lender of last resort. Now, they differed from
current day systems not only in having privately issued
currency but also in having gold or silver standards
be the basic money. I mean that’s how you can
have a monetary system without a central bank, the
quantity of money is regulated by the price specie flow
mechanism, by the supply and demand for gold and the gold mining
industry and arbitrage. That’s all part of Adam Smith’s critique of the mercantilist idea that
you needed to hoard money. The quantity of gold in your
country will regulate itself and by extension the
quantity of money issued by banks regulates itself
but I want to talk more about the bank regulatory side
rather than the monetary side. The relatively well studied episodes besides Scotland include New England, so that’s the closest one to home, Canada it’s not that far which way
is north, Sweden, Switzerland, Chile, Australia, lots of big economies. There are still three places
in the world that have sort of the remnants of this in the
form of private note issue and that’s Scotland, Northern
Ireland, and Hong Kong. I was once giving a talk to
a group of Chinese officials and I said there are three
countries that still have private note issue and
they immediately, Hong Kong is not a country, it’s a
special autonomous region. (laughter) Okay, three places, so what we find in these these systems that I’m calling free banking systems compared with more restricted systems where either banks were given monopoly privileges or there were branching restrictions or other kinds of restrictions, again this is painting
with a broad brush, we find a greater record of innovation,
improvement, success, at serving the users of banking services. So the Scottish system was
known in the 19th century as the most innovative
banking system, they developed all kinds of improvements that I’ll mention later, and they sent bankers around the world to teach other people how to conduct banking systems, so a lot of the early banks in Canada are founded by Scottish bankers ’cause they were at the forefront of the industry. And probably most importantly there were fewer banking crises in these places compared with places
that restricted banks, and it’s actually not that
surprising when you see how the restrictions
worked in England banks were restricted in the number of partners they could have which meant they couldn’t have enough
capital to be well capitalized, they couldn’t have enough capital to be widely branched, and therefore geographically diversified, whereas in Scotland banks could have as
much capital as they wanted. So let me drill down into three cases, Scotland, New England, and Canada. So in Scotland you had a system
where there were three banks that had charters which
gave them limited liability, and for many decades those
were the largest banks in the system but entry
was free, anybody could start a bank on the basis
of unlimited liability, so legally basically a partnership but with tradable shares and after about 1800, 1810 lots
of large joint stock banks began to form and so in the
heyday of the system say around 1825 you find a system where there are many large banks but none of them disproportionately large so there are economies of scale but there’s no natural monopoly, all the large banks are extensively branched
throughout the country, and although they’re all issuing their own currency notes all
these notes are trading at one to one against each
other, so no different than today, a check from one bank is accepted at a 100 cents on
the dollar by another bank. So there’s no confusion created by multiple units of account,
everybody’s on the pound standard and the the
liabilities are trading at par and they’re trading at par because it’s in the bank’s interest, you attract more customers that way if you can get your
liabilities to trade at par, it’s a very competitive system,
if you measure the spread between the interest rate charged on loans and the interest rate paid on deposits, it’s very small, it’s like 1, 1.5%, most of the time, as I mentioned, it’s a very innovative system. Scotland is where branch banking develops for the first time. They invent the overdraft,
they invent well, they don’t invent, but
they popularize interest on checking accounts, they
pioneer mutual par acceptance and the first important bank
clearing house in the world is in Edinburgh. They have a lower failure rate than the banks in the English
countryside because as I said those are undercapitalized. Now in England by contrast
you have the Bank of England which has privileges which make it the only large bank in
London, the only bank allowed to issue notes in London,
and that’s a major source of bank funding in those days. So you got this one big solid
bank but it doesn’t behave very competitively, it
doesn’t pay interest on its checking accounts. And then in the countryside
you have lots of little competing banks but they’re not very solid whereas in Scotland you have
banks that are large and solid and competitive, there’s
one important crisis in the Scottish system,
it happens in 1772. It’s described by Adam Smith in the Wealth of Nations, it’s a
failure of a appropriately named Bank, it’s called The Ayr Bank, it’s A-Y-R, but still, it was run by people who
had enthusiastic ideas about how to run a bank,
but they didn’t really know what they were doing, they managed to grow to be a large share of the system something like 25% so when that crashed that was a major event
but it didn’t pull down the other banks it pulled
down a few tiny banks but not any of the other large banks. The system recovered very
quickly, and the other bankers actually financed a study to what went wrong in the Ayr Bank, and that became a kind of manual
for what not to do. So in a way the failure of
the Ayr Bank actually improved the banking system, other banks learned to avoid those kind of mistakes. There’s a recent
dissertation out of Harvard by economist named Tyler Beck Goodspeed, this will be his second book, he’s a fast study, but it’s about the Scottish banking system
and in particular about how the system showed
resilience in the face of the Ayr Bank failure,
so it was a robust system, part of the robustness, part of the credit for the robustness goes to the unlimited liability
that I mentioned, except for the three chartered banks,
unlimited liability meant that the shareholders in the
Ayr Bank and in any other bank failure had to pay
back all the depositors. They didn’t just walk away and
say well my shares have gone to zero, they got letters
saying here are the unpaid debts of the bank on a pro-rata basis. Here it is per share, you have this many shares, here’s what
you have to chip in. And this was such a large failure that estimates are something like two-thirds of the land and
air share had to change hands before the major shareholders
were done paying but they paid, so the depositors
then had no reason to panic when they heard a bank was in trouble because they knew they
would get paid as long as the shareholders had any net worth left. So that’s the kind of remarkable way and it constrains of course the incentives of the shareholders,
sorry, of the shareholders in directing the managers of the bank unlike a system where the bank fails that’s the end of your
obligation in a system like that when the bank’s net worth
gets close to zero you have less and less to lose by
encouraging the bank to start taking crazy risks, and
we saw that in the U.S. during the savings and loan
crisis, but here you still have something to lose, the the
deeper in the red the bank gets the deeper in the red each
shareholder gets, so you actually had a remarkable
phenomenon in these systems with the unlimited liability
or even extended liability double or triple liability is enough. People would close banks without
defaulting, you never see that anymore, people keep the bank open as long as they can until
the authorities close them, but in this case if the
bank’s unprofitable you give everybody their money back and say take it somewhere else we’ve
discovered we can’t make a profit and nobody fails to get paid,
so that speaks to a different incentive system. – [Man] Excuse me sir can I
just ask you one question? Help me understand, what
was the situation as regards to the bank notes and the
deposits, in regards as gold, were they backed in terms of
liability in terms of specie? – Yeah, so that the
basic money in the system is gold or silver you could
redeem the notes at the office of the bank people very seldom wanted gold coins or silver coins
it was much more convenient to deal in bank notes and bank deposits, the Scottish banks had arrangements with London that they could have gold shipped up if they needed it. Okay, that’s one way
to reassure depositors. I’ll talk about some other ways to do that in the absence of deposit insurance. In New England, well, if you look at the
U.S. as a whole it’s a mess. There are 50 different
state banking systems because banking is regulated
by state governments before the Civil War. New England was the best of the systems, and I say New England because the system was unified by a bank in Boston called the Suffolk Bank which developed a clearinghouse for notes and checks that made them all
throughout New England at least all the banks that participated, trade at par, at face value at 1 to 1, so the Suffolk Bank did this as a business it turns out that’s kind of not a sustainable model other banks figured out that they were paying a lot for the clearing services that the Suffolk was providing and so they organized their own bank to do it called the Bank for Mutual Redemption which was a sort of member owned cooperative and that’s been the model for Bank
clearing houses ever since. There are economies of
scale and clearing but it’s not going to exploit the banks that use it ’cause they’re going to
own the clearing house. Anyway, the banks in New
England were much more solid than in other parts of the
country when the War of 1812 came banks suspended payments
everywhere else in the U.S. not in New England, part
of the reason is that people in New England
didn’t like the War of 1812. That was the big success story
and it was a success story I think because entry was
most free in New England. It was a chartering system but the legislators would give out charters pretty freely now there was a movement in other states to allow
more freedom of entry and it became known as the free banking
movement and states enacted what were called free
banking laws, but if you can see my text here it’s in
sneer quotes, “free banking” ’cause it wasn’t the same
as Scottish free banking meaning it wasn’t close to laissez-faire, it was a system in which unlike having to go to the legislature to get a charter anybody could get a charter. This was the forerunner by the way of general incorporation
laws it used to be you had to go to the legislature to become incorporated after reforms in the 1840s anybody could just fill out the paperwork and become incorporated this is the forerunner of that. So anybody can get a bank charter
but there are strict rules on what you have to do to
qualify for the charter in particular, there are still restrictions on branching, your charter is just good
for one office typically, and there are collateral
restrictions on note issue, meaning states looked
at this and said well let’s see, we’re running deficits who can we get to by our debt? We can sell a certain amount in London but we’d like to borrow
even more than that, let’s get the banks to lend
us money, they’ve got money, you all know Willy Sutton robbed banks because that’s where the money is. So, the the deal was if a bank wanted to issue banknotes it had to
buy state government debt in equal amount or in a 100%,
110% of the amount of notes they wanted to issue
and then they would give those assets to the State
Comptroller of the currency and it would be held as a
potential redemption fund so that’s why I say
collateral, if the bank failed the note holders would be
paid back by selling off the state bonds. But that was a restriction because it meant the bank couldn’t flexibly change the amount of notes it had
in circulation unless it went and got more collateral and it couldn’t shrink it unless it reclaimed the collateral which was cumbersome but there was a fiscal motive in it, at least for the states that said you had to
buy our debt some states were more liberal and
said you could buy debt of other states, the person
who’s done the most important research on this is a economic historian named Hugh Rockoff who’s at Rutgers and Rockoff has emphasized that these restrictions were fairly heavy so you shouldn’t make the mistake of thinking free banking in the United States means laissez-faire banking. Rockoff studied why it was
more successful in some states than in others so some states had problems with clusters of bank failures and what he discovered
was that it was a problem in the collateral law in some states they over collapse or
they under collateralized the usual bank notes, that
is they gave the bank credit for the par value of the
state debt even when the bank could buy it for less so this was like a money making machine you can buy collateral for $80.00 use it as the basis first with a $100 in bank notes. Well now you can buy
another $100 of state debt, use that as the basis for
$120 in bank notes and so on. And if the bank notes are
easy to get into circulation because everybody knows that the state is backing them up then you buy as many assets as you can and abscond. So that was the problem in states that had poorly formulated collateral
laws in states that didn’t do that they were it was
pretty successful, and New York was one of the more
successful, this is where it began, in New York State,
one of the more successful examples and it spread to other states. I mean it wouldn’t have spread
if it hadn’t been successful. By the Civil War, so in
New York State it’s 1837, by the Civil War more than
half the states have adopted this kind of system. Now in some places it worked very badly because of the way the regulations were written so in Wisconsin about three-quarters of the
bank’s failed in 1860. Why is that? Because the regulations in Wisconsin said you get collateral credit for
the par value the face value of the bonds you deposit
and you can buy bonds from any state as collateral. So the bank said well where can I buy the cheapest state bonds? Missouri bonds were selling at
about 50 cents on the dollar well there’s a reason, right? ‘Cause the Civil War was coming and Missouri was going to break up, so the bond market was already
predicting that they were putting about a 50/50 chance
on these bonds being paid back. So you get them at 50 cents
on the dollar, you get credit for issuing a $100 worth of banknotes. Now you can sort of freely
finance another $50 worth of assets, so the banks in Wisconsin were completely stocked up
with state of Missouri bonds. Their portfolio was
completely undiversified, that’s what they were doing,
and when the Civil War came and the state of Missouri
broke in two, the bonds fell nearly to zero in
value three-quarters of the bank’s failed because their assets had fallen in value, so
that was not a failure of laissez-faire banking,
that was a failure of a poorly designed regulatory system. The other thing you hear
about American free banking experience are stories
about wildcat banking, and they’re very popular and
money in banking textbooks because they’re colorful right? So, wildcat banking is the idea that wild cats live out in the woods, you start a bank and issue bank notes and get them into circulation and now you’ve got the means to buy assets which you can abscond with and when people come looking for your bank to redeem the notes, they can’t find it because you’re out in the woods somewhere. There were one or two cases
of that but it was not as common as some of the histories would lead you to believe. Alright, during the Civil
War the federal government, or as I learned to call
it while I was teaching at the University of Georgia,
the Union government, first enters banking regulation, and they do it for the
same reason the states do, to raise revenue. So the national banking
acts say the following, we need to sell somebody our bonds, the states do it by selling them to banks, we can do that. So for the first time the
federal government says we will charter banks and if you
want a federal charter, the condition is you’ve got by
federal debt, you got to buy a certain amount before
you get the charter, and then you have to buy
and you have to have hold federal debt in proportion
to the number of notes we’re going to let you issue. So you submit the bonds
to the Federal Comptroller of the currency and they send
you the blank bank notes, just add your name of
your bank to the note and sign it and it’s off in circulation. I said I wasn’t going to talk
about monetary policy, but if we could reinstitute the
rule that every currency note had to be signed that would be
a way of limiting inflation, that’s a joke. So it’s called national
banking but the bank charter, the federal charter doesn’t
allow you to bank nationwide. You’re still limited to
the state in which you are chartered and the
bond collateral system as a restriction on note issue now becomes very important, oh by the way, it’s the National Bank Regulatory Office, it’s still called the
Office of the Comptroller of the Currency, even though National Bank stopped issuing
currency in the 1930s. So what is it now? 80 years later, someday
they’ll get around to changing the name of the office, probably around the time the Fed redraws the map that they drew in 1914 a
Federal Reserve districts. Anyway, it’s clearly a fiscal measure although it was sold as a way of creating a uniform national currency
that was pretty much window dressing. The branching restrictions remain and the problem with the
collateral restrictions is that it makes the supply of currency inelastic, and this is a problem we
don’t really have today, so you have to sort of put
yourself in the 19th century to understand it, but there’s a big seasonal swing in the demand for currency as
opposed to deposit balances. And the reason is that
farmhands are paid in currency, they don’t have checking
accounts, most people don’t have checking accounts. Most workers are paid with an envelope stuffed with banknotes. The farmhands are
typically paid in the fall, so that’s a lot of money, the farmer goes to the bank and says I need currency to pay my farmhands and the bank says I’m not allowed to issue any more currency, I’m up to my limit. And the farmer says okay you can’t issue new banknotes but I’ll take whatever you’ve got in your vault that looks like currency, I’ll take gold certificates, silver certificates, greenbacks left over from the Civil War, those
are still in circulation, I’ll take gold coins if
that’s the last thing you got. And now what could have been just a switch from deposit liabilities
to currency liabilities, this is the right-hand side of the balance sheet
where the liabilities are, as it was in Canada, no problem
now becomes a reserve drain. Here the reserves over on the asset side, so the reserves are running
out and now the country bank has a reserve drain, that’s a problem. They’re gonna run out
of the ability to meet their obligations, if
they run out of reserves. So what do they do? Well, some of their reserves
they hold as deposits in other banks, in banks
in the city because city banks have more investment
opportunities than they do, and they get interest on these deposits and yet they’re counted as legal reserves. So they call on their reserves in the city banks and now the city banks have a reserve drain, what do they do? They start pulling
reserves out of New York. Now New York has a problem and that’s basically the story of the panics under the national banking
era 1873, 1893, 1907, actually 1907 went the reverse
order, there was a panic in New York first and then
it spread to the countryside as the country banks
learned that they couldn’t get their reserves anymore. So that’s why we had the
panics and they all happen in the fall which is the crop moving season when farmers are demanding
currency, so a currency famine becomes a reserve drain, becomes a problem for the entire system, everybody trying to borrow reserves, interest rates spike, and in the worst cases there are suspensions of payments banks to stop paying,
but those kind of panics which are the inspiration
for the Federal Reserve Act, those are not inherent to
banking, that’s the point I want to make, and it’s
pretty obvious if you just look north, which way is north? If you just look north to
Canada, they didn’t have any of these panics, they had
a very similar economy, mainly wheat growing, that was the main, most Americans were farmers
in 1870, so were most Canadians, the difference is they had a nationwide banking system
where if there’s a problem in the farm area, well there isn’t a problem to begin with because there’s no collateral
restriction so the farmer goes to the Canadian bank, I
need some bank notes a, and the banker says that’s fine, I’ll
just issue some new ones. I have no restriction on
that, I’m reducing my other liabilities by drawing
down your deposit balance, so I don’t lose any reserves,
I got the same assets, everything’s fine, if a bank
does have a liquidity problem for whatever reason, if say
customers in some town in Canada want gold, they can get it from
the head office in Montreal, whereas, so there’s sort of
management of the reserve needs of the banks whereas in the U.S. the banks are trying to grab
reserves from each other because they’re not allowed to have their own offices in New York. So panics are not inherent
to banking even though if you just looked at U.S. history you would think so, and I
have the suspicion that people who think bank panics are inherent to banking have only
looked at U.S. experience. So Canada is kind of
like the Scottish system in the New England system and that is slightly regulated,
doesn’t suffer the panics, banks are better diversified
geographically, note issue is not restricted by
collateral obligations. Here’s the most remarkable thing about the Canadian system, there are no bank failures even in the Great Depression. Some banks were unprofitable,
some branches were closed, but none of the banks failed,
so there’s no depositor panic whereas in the U.S.
there are five separate contagion episodes, there are
five separate bank payments between 1930 and 1933. The U.S. got the Federal
Reserve System Act in 1913 because of the panic of 1907. Canada didn’t have a panic of 1907, nobody wanted a central bank in Canada, they finally got one in 1935. But, the bankers were against it, the Federal Reserve Act became
possible when the bankers in New York said okay, we
need help, we want help. Bankers in Canada even in
1935 were against creating the Bank of Canada but they were outvoted. It was created the Bank
of Canada was created from some combination of nationalism and wishful thinking about how having a central bank could help you out of the Great Depression although if you looked at countries
with central banks, no reason to think that. There’s a paper specifically on this question, why did Canada
adopt the Bank of Canada Act? And one of the reasons the
author’s point to and I take this seriously, that I mean
I think this is serious, during the early years of the depression there were lots of
international meetings among central bankers about what to
do, and Canada couldn’t send anybody so they felt left out, that’s what they say. So I at least have argued
and asserted that nearly unregulated banking worked in practice, but doesn’t it have problems in theory? So let’s talk about the
theoretical critique, and it’s a standard approach in economics is to look for market failures. So look for public
goods and externalities, the box labeled market
failure in banking is emptier than you might think, as
I said the services that banks provide are private
services, it’s not like if I borrow money from a bank it somehow makes more
money available to you, or that the checking account I have somehow provides services to
you, so at least at first blush it’s not obvious where
the spillover effects are. At least at the margin, everybody benefits from having a banking
system, but if everybody’s participating in the banking
system then it’s not clear that it’s being under provided. And if you look more dynamically, as I said, the great innovation in payment techniques
have come where banks were freest to be entrepreneurial, innovations like the
introduction of banknotes, transferable deposits that pay
interest, transfer by check. In the Middle Ages you
had to meet in person in the bankers office, in the 19th century the big innovation in payments
was payment by telegraph. Remote, instantaneous, okay it wasn’t wireless, it had a wire, but the telegraph, sorry banking
instantaneous wire transfer was actually the killer
application for the telegraph, that’s why telegraph
spread the way they it did. There’s a kind of popular book on this called the Victorian Internet which I recommend to you. And now what do we have? Payment by telephone,
debit card, the latest one I read about was there are
banks now that allow you to make deposit transfers by
Twitter, so they’re all just ways of signaling to the banker I want to move money from my account to somebody else’s account. And now we’re getting
cell phone payment systems although some of those are being introduced by cell phone
companies not by banks. I don’t know if you ever saw the Pepsi commercial in which
this old guy is fumbling in his pocket for change to use the Pepsi machine and so a sleekly dressed young woman walks up with her cell phone and
aims it at the machine and a Pepsi pops out,
we’re not quite there yet, but we’re getting to
the point where you can wave your cellphone near the
machine and Pepsi pops out. So there are a lot of arguments about possible market failures, failures to internalize costs in banking. The list of bank regulations
we actually have of course is very long, and there’s
somebody’s come up with a rationale for each one of
them, but I don’t have time to go through all of them so let me focus on the most important one the most important one is the problem
of bank runs and panics. So this I think is the most
important argument as to why you might not want to
leave banking unregulated. You’re going to have too
many runs and panics. So you can break this into
three parts, or three claims. Claim one is an unregulated banking system is inherently prone to runs and panics. I’ll define those terms in a second, runs and panics are
harmful and in particular, they have spillover effects, they’re not just harmful to
the people who are already connected to the bank. And third, there’s a kind of regulation that can reduce runs and panics
with a benefit that exceeds its cost right? That has to be part of the
argument, so I’ll examine each of those, but the
one about runs and panics being harmful that’s
the least controversial. The ones I’m going to question are that an unregulated banking system
is inherently run prone and that the appropriate regulation mostly that’s a case for
deposit insurance has benefits greater than its costs. So bank run as I guess you know, is everybody, not everybody,
enough customers are trying to withdraw at the same
time to cause a problem for the bank, out of concern
that the bank will default if they don’t get their money now. And a panic is when
their runs on many banks at the same time, and many
is a kind of fuzzy term, and so there are historical
disagreements about whether this particular event was a
panic in some case, because only some banks were affected
and not a lot of banks. So this is the main argument
for deposit insurance, but it’s also been used to support having a lender of last resort. So the Federal Reserve was
supposed to stop panics. During the Great Depression, it was used to rationalize,
requiring banks to hold more capital, restricting entry, because if we restrict entry
banks will be more profitable, if they’re more profitable
they’re less likely to fail, therefore fewer runs and panics. So this is kind of cutting
off the consumers nose to preserve their face, it’s clearly anti-consumer to limit
entry and competition in order to create
monopoly profits and banks, but the argument was this is
better than having banks fail. Restrictions on deposit interest rates, in the Great Depression we got no interest on checking
accounts regulation queue on savings accounts, the Fed
determined how much interest your bank could pay on the theory that this would make the bank safer, if they didn’t have to
compete so hard for customers they wouldn’t take so many risks. This is like the theory that if you regulate airline fares and keep them high fewer planes
will fall out of the sky. It’s actually not true,
the planes are falling out of the sky at the same
rate now as they were before fair regulation, because
airlines have the same incentives to skimp on maintenance
now that they had then, so that’s reassuring. And of course deposit
insurance but in recent years, too big to fail policies, now it’s hard to find people
who come out and endorse or defend too big to fail
policies in any blanket way, but they defend them when it matters which is when large banks
are pushed to the brink, so the most famous statement or notorious statement, that Larry Summers made during the financial crisis was, now is not the time to worry about moral hazard, now is the time to rescue everybody who needs to be
rescued, is what he was saying. So panics are even worse of course because now you got many banks subject to runs, plus you have systemic effects. If people are running bank A and putting their money in bank B,
C, and D, that’s bad for bank A, but the
system isn’t suffering. If people are running
on bank A, B, C, and D, and putting the money under the mattress, now the whole system is contracting. So I accept that these are harmful events, but there’s a qualification,
these are harmful events if the bank was solvent
and was run upon anyway, because if the bank was insolvent, if the bank had squandered the deposits, depositors funds making loans
that weren’t being paid back, or buying assets that
had gone sour, that bank ought to be closed, it’s wasting money, and it’s better to close it sooner rather than later because
it’ll waste less money. So bank runs at least had this virtue, they closed insolvent banks, a run on an insolvent bank is
good, it stops the bleeding and it has a good incentive effect. The threat of a run keeps
banks on their toes. They have to invest in a way that doesn’t make the depositors nervous, and before deposit
insurance the main complaint about bankers was not
that they were risk lovers the way it is today, but that
they were too conservative. They didn’t want to make
investments that would tie up their money in such a way
that if they were subject to a sudden demand for
redemption they couldn’t meet it. So you could not get a 30
year loan at a commercial bank you had to go to a savings
bank, that’s why we had thrift institutions, but thrift
institutions didn’t issue checking accounts, they only
issued the kind of deposits that couldn’t be run upon. You all remember the famous bank run scene and it’s a Wonderful Life and what does George Bailey tell people? He says come back in 60 days, that’s what your deposit account says, you’re not allowed to withdraw it today. Who closes banks under deposit insurance? Well the FDIC if they get around to it, when they get around to it, so
we have to rely on regulators to close banks promptly, but
they’ve repeatedly failed to do so, and they failed to
do so because their incentives are in the other direction,
the incentive is to forbear, to hope that the bank
recovers while it continues to squander creditors wealth
which means eventually they’re squandering taxpayers
wealth because that’s who gets to pay off the depositors. Now deposit insurance wasn’t
so bad when there were a lot of uninsured depositors, and
as recently as 2008, 28% of our deposits in the U.S. banks were uninsured. They were over the insured
deposit limit, above $100,000. Corporate accounts, churches accounts, people with that kind of money
in the bank did pay attention to the risks the bank
was taking and they would shop around, they would
either put their money in a safe bank, or they would
put their money in a bank that was considered too
big to fail, that meaning everybody would get rescued,
even the uninsured deposits, and you can see it in the
data that banks that were perceived as risky like banks
in Texas, had to pay higher interest rates to get deposits
above the insured limit. But since the spread of too big to fail and among the institutions that are considered too big to fail,
or strategically important as the new phrase, or
to connected to fail, you don’t have that kind of
monitoring by depositors. And so if there’s no depositor monitoring then the management can
take whatever risks it wants without losing depositors. Now the only constraint is
will the regulator’s allow it? So now it’s up to the
supervisory authorities to contain risk because
the market discipline has been removed, so in
a sense we’re putting all our eggs in one basket,
we’re relying heavily just on the regulator’s because
depositors no longer have an incentive to shun risky banks. Back when the insurance
limit was a 100,000 if you had a million dollars
that you wanted all guaranteed you could go to a broker and the broker would place 10 deposits in the 10 banks that were paying the highest rates. Don’t you care what banks they are? Why would you care? It’s a guarantee. So, the Savings and Loan
fiasco in the 1980s showed us what happens if the
regulator’s are either asleep at the switch, that’s the
benign interpretation, or are deliberately forbearing. So the savings and loans were killed when interest rates
rose and the regulator’s the FSLIC, the Federal Savings and Loan Insurance
Corporation said if we wait interest rates will come
back down and these banks will be okay and we don’t
have to do anything. Well what was a 10 billion dollar hole in the balance sheets
of the savings and loans through forbearance became
a 150 billion dollars. That would be 260 billion
in current dollars. Because the insolvent institutions,
or zombie institutions as they became known,
the Living Dead you know, what kind of havoc they can
wreak, they gamble for recovery, the irrational thing to do if your net worth is zero, or negative, the only way the shareholders are going to have a share of something positive is if the bank recovers and the only way to recover is start to gambling long odds, and hope for big payoffs. And that’s why you get
stories in the 1980s about savings and loan, it’s being run by guys in Texas who serve their clients champagne out of their cowboy boots, why this attracts clients I don’t know, but you can understand why
the Board of Directors would hire somebody who is
a high roller like that. So the the problem with bank
runs arises because depositors have imperfect information
and they might run on a bank that’s solvent and then it’s
a tragedy if the bank closes. So that is a problem. But it’s a bigger problem if nobody forces insolvent banks to close,
which is the problem we’ve had in recent years. So now I want to turn to
the claim that the system is inherently run prone. I think I understand that
question we need to ask what triggers a run, or what
typically triggers a bank run? And there are two leading
theories and in one form or another you’ve probably heard them. The first one goes technically by the name of the Sun Spot Theory
or in the literature The Diamond Digvig Theory or you might call it a Bubble
Theory and that’s the idea that I’ve talked about,
well maybe I haven’t. If there’s a bank run how
does the bank respond to that? Well they have to pay the depositors and as their reserves deplete what do they do? They have to sell off their other assets, if their other assets are T-bills, not a problem, if their other
assets are loans, problem. Those are hard to sell. Certainly in the days before loans were securitized that was a problem. So they’re illiquid. If you try to sell illiquid
assets hastily you get what are called fire sale losses, you have to take whatever you can get. You try to sell your loan to another bank and they say you got a
loan to Joe’s Pizza Parlor and you want me to pay a 100
cents on the dollar for it? I don’t know Joe’s creditworthiness. I’m going to take a deep discount before before I’ll buy that. So because of that
opaqueness, non-transparency of idiosyncratic bank loans, which is what banks specialize in,
they’ve got a problem. So if there’s a fire sale that can turn a solvent bank insolvent, so the run then can be
self justifying, even if you think the bank is solvent
today, if you see other people lining up to run, you don’t
say well, that’s foolish. You say I better get
into that line because if I’m last in line and enough people run the bank and empty it out
I don’t get anything back. So that’s sometimes called
the Me First Problem. And under that theory whatever makes you anticipate that other people will run will make you run, ’cause
you want to get there first, and if other people are thinking
the same way then whatever that event is will cause
a run, even if it’s intrinsically irrelevant, even if it has nothing to do with the health of the bank, hence the appearance of spots on the sun, it got the Sunspot name by the way because an economist named
William Stanley Jevons had the theory that sunspots
caused business cycles and other economists
said that’s ridiculous, that’s so ridiculous that we’re going to call any theory where the cause is absurd a Sunspot Theory, but if the absurd cause
makes people think that it’s relevant it will become relevant. You see sunspots and you think that makes other people run,
then you’d better run. It really does cause runs. So this theory boils down to
bank runs occur when people are afraid that other depositors will run. And that could be any time, any place. Banking is inherently
fragile under that theory. This is a logically coherent theory, but it doesn’t engage with our
historical record very well. That’s a polite way of
saying it doesn’t seem to explain any actual events. If you look at the historical
pattern runs don’t happen randomly in the U.S., the panics happen when at the beginning of business cycles they all happen at the
beginning of a recession, so the recession has
already started the run is not the cause of the recession. And secondly, runs are not a problem in all banking systems as I
said Scotland didn’t have any problem with banking panics, occasionally a bank that
was thought to be insolvent and the shareholders
didn’t have enough wealth to pay everybody could be run
upon but it didn’t spread. So bank runs and panics
were a problem in countries that had weak banks due to
regulations that weakened banks not in countries that allowed
banks to fortify themselves like Canada and Scotland. So Sunspot Theory doesn’t
explain that difference. What’s a better theory? Better theory is people run
because they get some signal that tells them that the
bank might be insolvent and it doesn’t have to
be a perfect signal, but it has to have some
information content. So runs occur when depositors
get bad news that the bank might already be insolvent, and then they run because there’s not
enough to go around. That explains why runs and panics occur at the beginning of recessions. Economic historian named Gary Gorton well he used to be an economic historian, later he became a adviser to AIG. Since AIG failed he’s been writing papers about how it wasn’t his fault. There was a general market panic that he couldn’t have anticipated. Anyway, back when he was a respectable economic historian, he looked at the panics in the U.S. and
said well here’s a proxy if you look at the rate
of bankruptcy filings you find that when it
reaches a critical value there’s a panic, and when
it doesn’t reach that value there’s no panic, so what is that saying? People read the newspaper,
they see the local industry is failing, they know the local bank which is not well diversified
geographically is heavily lent to the local industry,
now the local banks in trouble so time to run the bank, and that also explains why you get
Geographic clusters of bank runs if the two banks across
the street are both lent to the same local
industry than if one’s in trouble the others in trouble. So that’s a better theory, but
this debate is still with us, you get people bringing
out the sunspot explanation in the exchange rate crises in
Southeast Asia in 1997-1998. The bad news theory is
those government’s signaled that they weren’t going to
maintain their exchange rate against the dollar so
better get your dollars now while you can before they devalue, the Sunspot Theory is it was just an irrational investor panic if nobody had panicked everything
would have been fine. You hear it again this debate in the Bear Stearns, and Lehman cases, so the Sunspot Theorists
say there was no problem at Bear Stearns, or Lehman except for the funders who didn’t
want to roll over their loans, so the way Bear Stearns, or
Lehman were being funded was not by deposits per se,
but by overnight loans that were renewed every night,
so very short-term deposits. It’s the equivalent of,
and if the funders decide not to lend tonight that’s
the equivalent of withdrawing a deposit, so if everybody
decides not to roll it over that’s like a bank run. So the one theory is it was
just heard behavior by the funders Freddie Mac by the way lost 5 billion dollars when Lehman failed to open on Monday, that’s how much they
had lent them overnight. The Bad News Theory is
that people got a signal that these institutions
were insolvent and decided not to keep rolling over
their money, oh and by the way they were insolvent, there’s this very dramatic
PBS Frontline special about these events and
just as kind of an aside they mentioned that they
closed the bank over and over the weekend they brought
people in to examine the books, see if anybody wanted to buy Bear Stearns, oh by the way, they
discovered it was insolvent, well then the people failing
to continue to lend the money weren’t being irrational, were they? Anyway, Diamond Digvig as I mentioned are associated
with, if they formalize the theory in a very heavily cited paper, but it’s actually an old idea
in a letter to one of his correspondents Thomas
Jefferson wrote in 1813, it is said that our paper currency is as good as silver because we might have silver for it at the bank where it issues, this is not true, one,
two, or three persons might have it, but a general
application would soon exhaust their vaults. Like the banks don’t have
enough money in the vault to pay everybody, nothing
is necessary to affect it that is this general application,
a run, but a general alarm and that may take place whenever
the public shall begin to reflect on and perceive the
impossibility of the bank should repay. So if people just were
aware of the structure of the bank balance sheet
the bank could not survive. Banks are inherently fragile. The Diamond Digvig model has sort of virtues as a
useful tractable model, but it has these features
which are kind of special. Runs are the only cause of
bank failures in the model, they abstract from the problem of banks making bad investments. deposit insurance is
costless in the model, all you need is an agency
that credibly promises that if anybody gets paid less than a full payout because other people have grabbed the money first we will go in and redistribute the payouts so that everybody gets the same thereby taking away the incentive to be first in line. So it’s no longer a dominant strategy to run the bank and because people believe that nobody ever runs, and because nobody ever runs the bank never fails, and therefore the deposit insurance agency never has to make a payout. But the bank is inherently fragile and if you only looked at US
history you might think that was descriptively accurate or
plausible, but if you look at banking history worldwide you wouldn’t believe that, and I mean just
think about it in kind of crude Darwinian terms,
if banks were as fragile as the Diamond Digvig bank
would banking have survived from its origins in Italy in
1200 AD up to the date at which deposit insurance was
enacted, how did they survive if they were really that fragile? Well if you look into the
deposit contract you can see how banks could
fortify themselves, so it’s rational to run your bank if you’re entitled to a certain number of dollars, there’s no condition on
your withdrawing that money. It’s unconditionally redeemable on demand in which case the bank
basically has to pay people first come first serve
Diamond Divid called these the sequential service constraint. And third, the last person in
line isn’t going to get paid or is unlikely to get paid, you put those three things together and it’s rational to run the
bank, but it’s the combination. So to stop runs or to make
the bank less run prone it only has to stop change
any one of those three. Changing the first one changing it from a debt claim means it’s no longer a bank, it’s now a mutual fund, and you can have checkable money market mutual funds that are not run prone because they don’t have a fixed share price, it’s not exactly what we have today because we allow the mutual funds to
fix the share price and carry the assets at their face value instead of at
their current market value would for regulatory reasons but anyway in principle
a mutual fund could provide you with a run
free checking account. What banks did historically was change the second and third conditions they made withdrawals conditional. So an example would be a
notice of withdrawal clause that the savings and loans
in It’s a Wonderful Life had, that was common. So it says normally we
will pay you on demand but if too many people are
asking us we can put you off for 90 days and in 90 days
we’ll have enough time to liquidate enough assets without suffering fire sale losses. Some banks in Scotland
actually put it on their banknotes, we will pay you
on demand, or at our option in six months time. And you might think why wouldn’t they always invoke that clause? And the answer is there’s more to it, it said in that event we’ll
pay you interest so that made it incentive compatible the bank did not want to invoke the delay because then it turned it into an
interest-bearing liability and so they never did
invoke it unless they were subject to a run. Or yeah. Well those clauses were
outlawed in Scotland, that was one of the restrictions that Adam Smith supported, the other one was a minimum banknote size
but they were important for U.S. thrift institutions. The thing that was most
important to secure banks against insolvency, sorry to
secure them against runs given that people ran when they
thought a bank was insolvent was to assure people the
bank wasn’t insolvent, so how do you do that,
how do you assure people that you’re not going to
be unable to pay them? Well, you have adequate capital,
and you advertise the fact that you have adequate capital, so before deposit
insurance banks had about 20% capital on average
and it wasn’t a secret. If I had my PowerPoint
show, I’ve got pictures of bank advertisements and the top item is this is how much capital we
have, bring your money here. Banks used to paint it
in the window of the bank in gold paint, this Bank has
two million dollars capital, when the FDIC comes along they
scrape that out and put in a sticker protected by the FDIC. That’s all you need to know. Now how much capital is adequate depends on how safe the assets are, right? How big the threat to the capital is. So banks as I mentioned
before held much safer asset portfolios, they avoided
interest rate risk by not having long duration assets,
they avoided default risk, they avoided liquidity risk by
having assets that they could sell quickly, so the main
asset that commercial banks had was commercial paper,
short-term business IOU’s that had a secondary market. A third way banks could reassure people against thinking they wouldn’t get paid is of course extended
liability which I mentioned. I’m working on a paper with
a couple of students now about whether it’d be
desirable to reintroduce extended liability in the U.S.? Not to reassure depositors but if we don’t remove deposit insurance it’s a way of giving the shareholders something to lose and the problem with
deposit insurance today is the shareholders don’t have
enough to lose because the depositors aren’t paying attention. Last thing that banks in the U.S. did was they joined clearing house associations initially just to have a convenient way to clear checks and bank notes but the clearing houses learned, you remember the famous Groucho Marx aphorisms? I wouldn’t be one of wouldn’t
want to be a member of a club that would have me as a member,
a bank wouldn’t want to be a member of a clearing
house that would let just anybody join, you only want other banks in the clearing house that are going to pay you at the end of the day ’cause you’re accepting
their checks during the day you want to get paid
at the end of the day. So clearing houses began to have minimum capital
requirements to be a member of the clearing house then they discovered they need to actually enforce
those so banks had to submit their balance sheets and then
that was enough banks actually began to send auditors sorry
the clearing house began to send auditors into the member
banks to make sure they really had the net worth that
they were claiming to have so the first bank auditors
or examiner’s were not federal employees, they were private
clearing house employees. So it’s a remarkable degree of
self-regulation and they were trained by the clearing house. Your job is to tell the
clearing house association whether the bank is solvent, but you’re not supposed
to tell the other banks what their business strategy is. You’re not supposed to
reveal who their clients are, what their deals are like. So banking panics are
a problem in the U.S. they’re not a problem in countries that don’t have the same legal restrictions on banks that the U.S. has
Scotland, Canada, Sweden, Switzerland, et cetera. Okay, so this is all a way of arguing that the run and panic quelling benefit attributed to deposit insurance is really less than estimated if you consider the alternative
not the U.S. system, weak as it is without deposit
insurance but a system that’s not so weak there’s no
movement for deposit insurance in Canada because there’s no
problem of runs and panics. So if we had had a
Canadian-style system we wouldn’t have needed deposit insurance. Now if deposit insurance were costless then it wouldn’t matter that the benefit is small as long as it’s
positive but I also want to argue that the cost is greater than advertised. I mentioned that in the
Diamond Digvig Theory it’s costless because the
only cause of bank failures is runs, but in the real world the main cause of bank failures
is bad loan portfolios. And the cost of deposit insurance is that somebody else foots
the bill when a bank fails because it’s invested badly. Now you might ask don’t
bank spare the expense? Isn’t the FDIC funded
by assessments on banks? And the answer is yes,
normally when there’s no problem in the banking industry but when there’s a big cluster
of bank failures as in the Savings and Loan Crisis, as in the commercial
banking system in 1991, as in the commercial
banking system since 2008, it’s taxpayers who end
up footing the bill? The U.S. The way the savings and
loans depositors were paid was that money was barred from
the U.S. Treasury which means taxpayers who were on the hook for it. The FDIC’s Bank Insurance
Fund is currently in the red, nobody notices. In 1991 when the the FDIC ran out of money and got a 90 billion dollar
credit line from the Treasury. That was big news and it was
such big news that I helped organize a conference and Maria
actually mentioned the title of the book, The Crisis in
American Banking because it looked like it was going the same way that the FSLIC had gone. So the conference was in 1991, the book wasn’t published
until 1993 and by then the crisis was over so the
book never sold very well. I think NYU press still has copies. I was hoping when the book came out that maybe Citibank will fail and then we can sell some copies but it didn’t happen because the reasons I
don’t need to go into. Anyway so, today it’s you and I who were back stopping the FDIC, so let’s talk about the dangers and
cost of deposit insurance today and the authority that
I’m going to draw on the most is Edward J Cain of Boston College who became famous in
the ’80s for predicting the FSLIC crisis, he published
a book in 1985 called The Coming Crisis and
Federal Deposit Insurance. there are some patches in the
Dodd Frank Act but we still have too big to fail
policies, we still have regulatory capture, the regulators
of course won’t tell you that they’ve been captured and the too big to fail
institutions won’t tell you that they’ve captured the
regulators, meaning the Federal Reserve Bank
of New York, the FDIC, instead the regulators
pretend to restrict the banks very sternly and the banks
complain that they’re being, you’re twisting my arm, but
really together the regulators and the too big to fail
institutions are milking the taxpayers, they agreed
to policies that shift risk to taxpayers because that’s who backstops too big to fail policies. So here’s the way Cain puts it, regulatory and banking cultures continue to encourage the country’s largest, meaning too big to fail, banks to take on too high a risk of ruin,
too much tail risk, they encourage a quote,
“Process of subsidy extraction.” Unquote, the central problem
is simple safety nets encourage unhealthy relationships between
banks and their regulators and distort the incentives of both groups. So this is exemplified by
the Federal Reserve Bank of New York, it’s empowered
to bailout money center banks but it has money center banks
on its board of directors. So there are conflict of
interest problems here, governance problems, there’s a study by the General Accounting
Office going into the details of what happened during the
financial crisis but Google the name Stephen Friedman,
he kind of personifies it. He was a Goldman Sachs shareholder, I know Goldman Sachs has
been good to Syracuse so I’m not indicting Goldman Sachs, but he was a Goldman Sachs shareholder who was on the Federal Reserve
Bank of New York board while it was deciding on loans bailouts, how much AIG would pay Goldman Sachs? Things like that. Now it was kind of a fluke
he got on the board because Goldman Sachs was not a commercial bank at the time, it was an investment bank but even after Goldman Sachs was given a commercial bank charter so
it would qualify for TARP, he didn’t resign. More recently we’ve had
this about six months ago we had the story of Carmen
Segura I don’t know if you remember that? She was a New York Fed regulator who was embedded in Goldman Sachs so she had a desk at Goldman Sachs. She was fired for trying to be too strict, for questioning a deal that they were making as sort of not being properly accounted for in the
impact on the bank’s risk. So she was fired but she had taped some of her conversations so this was kind of a scandal but it seems to
have been forgotten largely. Here’s another item we learned
after the financial crisis and after the audits this didn’t come out in the partial audit of
the Fed, we learned that the Federal Reserve Bank of New York had secret lines of
credit ready for Citibank and Bank of America. We only learned this
because Bloomberg News filed a Freedom of Information Act request and they had to divulge
that, so here’s the problem, safety nets can cause financial
fragility because they subsidize risk taking,
and the way Cain puts it, they create strong incentives
for managers to seek out unsupervised risks, to
search them out proudly and exploit them aggressively,
in hard to monitor ways, putting taxpayer funds at risk. And in fact that’s the
profit maximizing strategy to use your option to the hilt, hence going back to the quote,
“Although financial safety nets exist abstinently to lessen the potential for massive losses by the public from widespread
institutional failure, they are used and abused
by savvy banks and other financial managers to extract subsidies in ways that are hard to
see and hard to stop.” Unquote. And you can see why regulators
are reluctant to close Citibank and Bank of America, by the way they they were supposed to intervene well before they approach zero net worth there was a law passed after
the Savings and Loan Crisis, The Federal Institutions Regulatory Reform and Enforcement Act FIRREA of 1989. Sorry, 1991, which said they’re supposed to be early intervention if a bank’s capital becomes below 6% then we suspend dividend payments and if it goes below 4% we fire the board of directors. None of that was done in 2008, completely ignored, so we
have conflicted incentives by the safety fund managers partly because of the revolving door between the regulators and the industry they have incentives to go easy. And so we don’t even have an estimate of what the sort of present
value of the subsidies are from the safety net. And the way Cain sort of formalizes that, crystallizes this, is to say really, taxpayers have become equity holders involuntarily, they’ve
become equity holders, in the too big to fail
institutions because they’re on the hook if
they become insolvent, and yet the taxpayers
are not consulted about the management strategy of
the bank or the risk the bank is taking, so that’s a problem. Now let me say one more thing before I wrap up, which is have you
sort of step back and ask what kind of banking culture we have, what kind of banking environment we have? I guess that’s what I want to
say, regulation has done a lot to homogenize banks and
since the financial crisis. Of course they’ve become a
lot larger there’s been a lot of consolidation through acquisitions, the more rules there are to govern banks the more alike banks become because they all have to follow the same rules and that’s a problem because instead of having a diversified ecosystem we have a monoculture, and
monocultures are subject to a single disease wiping everybody out and in banking we have a safety net but the safety net has loopholes, right? The regulators can’t find
every risk the bank is taking in real time because the bankers
are one step ahead of them so they’re looking for loopholes
and if they all discover a loophole at the same time then you got lots of banks over investing in say mortgage-backed securities and when mortgage-backed securities
go down the tubes then the banks have a big problem, lots of banks have a problem, not just one or two banks, so we
have a systemic problem. So what we would like is a system that’s not subject to catastrophe that way and this way of putting it may
sound familiar to you if you’ve read the works of Nassim Taleb when he talks about
fragility and antifragility. We have a fragile banking system whereas we should want to have a banking
system that gets stronger after shocks, like I
said the Scottish system did after the Ayr Bank failure. A system that relies on bailouts is not an antifragile banking system, it’s a fragile banking system, so in the long run the problem is our too big to fail policies and deposit insurance have fostered moral hazard and contributed to fragility. Am I saying that we should have let Lehman Brothers fail? I’m saying we should have let
large banks fail much sooner. If we had done that if we had
let even Bear Stearns fail, Lehman Brothers would have
been less of a problem. So the challenge that faces
us is developing a way to credibly tie the hands
of the safety net regulators assuming we can continue
to have the safety net not to bail out insolvent
institutions and stepping back to a sort of meta level,
the issue here is having the Rule of Law in our
banking system and not rule by authorities who get to make
up the rules as they go along. If you read sort of classic
sources on the Rule of Law like David Hume, he says yeah there are going to be cases where
it’s inconvenient to stick to the Rule of Law, they’re going to be people who it’s very painful to if you don’t rescue them but in the long run we should venerate our ancestors who came up with this principle because there’s less inconvenience in general
to everyone in the long run if we adhere to the Rule of Law. So I have a paper entitled Rule of Law or Rule of Central Bankers, it sort of goes into this sort of meta issue. So I think that clearly puts
too big to fail, under question lots of people question too big to fail, I think it also puts deposit insurance under question, and Cain and
some co-authors have a study looking across countries
because deposit insurance has spread from the U.S. to
the rest of the world asking has it been an improvement in banking systems around the world? And the answer is in countries that they characterized as having poor
contracting environments, so basically less developed
countries where the Rule of Law is poor and therefore
there’s a lot of cronyism, it’s actually made the
banking systems worse because it’s reduced
depositor scrutiny of banks and therefore encouraged
risk taking, it’s fostered imprudent banking practices,
whereas in countries with good Rule of Law it really
hasn’t made a difference. It’s eliminated the old fashioned
panics, but it’s created the offsetting problem of too
much risk taking by banks. So to end on a positive note, what I’d like to see we should
have an environment that allows and encourages banks,
banking entrepreneurs, I was told to mention the word
entrepreneur, to introduce new services without
having to double check with regulators first, not to spend their time looking for new loopholes. If we block that kind of
discovery as Israel Kerzner the theorists of
entrepreneurship reminds us, we’re losing out on improvements
in consumer satisfaction that we could have but we don’t
even know what we’re losing out on because we block the discovery. So we should rely a lot less on one practice
fits all common restrictions and safety net protections
on banks we should rely more on the markets mixture of
you’re free to innovate but there’s strict discipline
,if your innovation succeeds you keep the profits but if
it fails, if the bank fails you bear the losses, not somebody else. So my mantra is let a 1,000 banking models bloom, but don’t artificially preserve
any of them thank you. I’ll take questions in case I
said anything controversial. (applause) – I think we have time
for a few questions, what time is it? – So over the past few
weeks there have been a number of reforms, to
change how the Federal Reserve is structured, so for
example, John Deering Vice President of Financial
Services Forum suggested, redrawing districts adding
more districts out west. Given that, I think your
proposal would probably be to end the Fed altogether,
correct me if I’m wrong. – [Lawrence] Once we’re ready to yeah. – It seems like that’s probably not on the table in the near future so I’m wondering what suggestions you would make for changing how the Fed is structured or operates now so I guess to make it more in your image while acknowledging the fact that the entity itself is probably here to stay? – Yeah, so the fact that
the Fed map hasn’t been redrawn since 1914 is indicative of sort of how much status quo bias there is in the Fed because somebody’s turf would be reduced if somebody else’s turf were enlarged, but yeah,
the population has moved west to where like a
third of the population is in the San Francisco district
so it would make sense to redraw the map I don’t
have any objection to that. The reform that concerns me or the change that concerns me about
the structure of the Fed is some people have proposed taking the presidents of the
Regional Reserve Banks off of the Federal Open Market Committee which decides monetary policy. And the reason that concerns me is the other voters on the FOMC
are political appointees, the president’s the
Regional Reserve Bank’s represent banker interests and the bankers have the
right interests in this case which is as in the same as
in loan crisis bankers get hammered when inflation
and interest rates go up, so they are inflation hawks. And they have a more credible commitment which we know from the theory of time inconsistency it’s good to
have a credible commitment there’s nothing to be gained
from having the public worried about how much inflation
you’re going to allow, so the Federal Reserve
Regional Bank presidents have a better voting record
from my point of view than the Board of Governors, so I would hate to see them taken off. Now the conflict of interest
problem that you see at the New York Fed mostly
because that’s where the big banks are is having the Regional Reserve Bank presidents on the Board of Governors
is a monetary policy matter the conflict of interest is when we let them in on bank regulatory policy and they’re close to the
banks in their region, that’s a problem. So it’s okay having
autonomous regional banks for the purpose of executing policies that are decided on a national basis and not on a regional basis but to have policies decide on a
regional basis is a problem. I asked my friends at
the Federal Reserve Bank when all these bailouts were
announced AIG, Bear Stearns, who’s calling the shots
here is it the New York Fed or is it the Board of Governors? And I said it’s the New York Fed, Board of Governor’s defers to them on those kind of questions. If you look at the structural reforms, so just to back that up
if you look at the history of the Bundesbank they had
a lot of banker involvement on the board and they had the
best inflation track record, Swiss National Bank same
thing, when it comes to regulatory policy of course, it’s not just the Fed it’s also the FDIC and it’s also the Office of
the Comptroller of the Currency so there were proposals under
the Bush 41 administration to consolidate all the bank
regulation in one agency and it has pluses and
minuses, on the one hand banks could escape from regulations that were inefficient, to a
different regulator who was allowing them to do efficient things, on the other hand they might
be able to escape restrictions on their ability to exploit
the safety net and so I have likewise been sort of ambivalent about the partial repeal of Glass-Steagall because there are safety net spill overs. That there were supposed to be firewalls to prevent that but turned out they were breached rather easily. Yes, so it’s changing
I don’t really see much of a connection between changing the structure of the Fed and changing bank regulation, we did
have a structural change in Dodd-Frank which was
we embedded in the Fed their Consumer Protection Agency, and it was mandated that
its budget doesn’t come from Congress it comes from the
Fed, which is pretty weird. Which means that it’s harder for Congress to review its budget and whether the program is creating benefits in excess of its costs. So I wasn’t keen on that one. – I think they did that because Congress will try to defund. – [Lawrence] So it was
a Democratic Congress anticipating Republican Congress trying to defund it, yeah. – But I was just gonna
ask you about, I believe, I don’t know if I
misunderstood you, but you espouse laissez-faire banking, well so as the system that we have today taxpayers and the government backs the banks, lending, so it would
be I would think impossible to not have the government
and the public have a say when the bank a the banks fail like they do almost every 10 years or whatever due to a crisis in capitalism, not have the taxpayers have a say or basically, have the
government get out of there, and not back the banks,
otherwise, so what would you say about that, against that argument? – Yeah, what I’m suggesting
is not that we should keep the backstopping of banks
by taxpayers and then let the banks do whatever they please. That creates huge moral hazard, that creates a huge contingent
liability for taxpayers, that creates all kinds of bad incentives, and that leads to occasional
calamities like we had in the mortgage crisis that 2007-2008, the panic of 2007, so that’s
what we want to get away from. And today that principally
means taking away the taxpayer backing
of banks so that banks will behave more responsibly, so that taxpayers aren’t
guaranteeing their losses. If we don’t do that, if we continue to have too big to fail, we continue to have deposit insurance, then we get
into a world of second best. So how can we limit the
bank’s ability to exploit this subsidy they’re
being given to take risks? And trying to say okay, we saw banks doing taking risks in this
way investing in mortgages. We’re going to put a
limit on that, we saw them investing too much in less
developed country loans that was a previous credit
problem, we’re going to restrict that if you do it activity by activity it’s like trying to squeeze a balloon to reduce its volume, you just push it somewhere else so my view is if we want to take away excessive risk-taking we have to take away the incentive which is created by having this system where they get to keep the gains but they
socialize the losses. – Just quickly, so the banking system has gone into what it is today we it’s too big to fail due to, it has become unsustainable
we can agree to that, and it has become sustainable
because banking is not doing what banking was meant to do when he was invented which was to lend people so so they could create businesses and that way grow the economy now
just basically gambling if you can put it that way to – [Lawrence] At the margin,
that’s right, so much gambling. – So the gambling that’s going on Wall Street or in London which is created most of the economic growth which is not based on physical realities and since the it was the the
gold standard was taken away in 1970s, now they can just basically grow forever
according to to their thinking without any consequences so what do you think about this when it comes if you weren’t related to equilibrium and you economic theory? – Yeah, so we have had we do have too much bank gambling, it’s not that
that’s all that they do, but too much at the margin,
I think if we sort of look at banking systems around the world that have had smaller problems we might have something to learn if we look at Canada which went through the crisis pretty well if we look at Switzerland even if we look at offshore banking which didn’t have a problem in 2007 and we find there that the banks had better incentives not to gamble not so much that the regulator’s were on top of things restricting the risks that banks were allowed to take but I agree with you, I mean the the function of
the banking system has been distorted by changing the
incentives that banks face and principally by not making the losses come to visit the bankers that suffer them by taking unreasonable
risks so that’s what we need to fix. – Looking into the seek our capital adequacy space
by further restricting or elevating capital levels. Do you feel that those requirements are diminishing
short-term liquidity needs you touched briefly upon this in reference to the Lehman Brothers in the overnight repurchase
agreement environment? – Okay, so people have recognized that banks
have too little to lose, they’re too thinly capitalized
and there’s been a series of agreements on capital
adequacy raising it and trying to graduate it according to the
risk the bank is undertaking and we’ve had this series of
Basel agreements and let me talk about those before I get to your question about liquidity and
so the Basel is this result of sort of bureaucratic compromise
among central bankers we’re going to all have the
same capital requirements so that banks don’t
shop around for a venue where they can operate
with less restriction. So it’s kind of a
non-competition agreement among the regulators and
in the first round they tried to assign risk weights to capital, to different kinds of investments, and banks looked at those
weights and said okay, we can figure out which
ones are over weighted and which ones are under weighted, and we’re going to pile
into the investments where the risk is under weighted,
namely they in particular they put a zero weight on sovereign debt. So banks in France and Germany pile up on Greek government debt and they don’t have to hold any capital to absorb losses on that because they’re not going to be any losses, ha ha, so they went back to the drawing board and came up with Basel two, and banks learned to game that and they went back to
Basel three, but the banks have more resources and more
incentive to find the loopholes they’re never going to
be possible to close all the loopholes. So we had the actually refers back to the last question we have
this weird situation today where bankers in the U.S. are being told by their regulators we don’t want you to do so much lending to businesses ’cause that’s risky and we’re going to raise your capital
requirement if you do that, and in a way they’re
incentivizing banks just to buy government bonds and to sit
on excess reserves and so we haven’t had we’ve had a huge growth in bank reserves and very little
growth in business lending. Now I’m not sure I got
exactly to the nuts and bolts of your question, but and that’s how I understand, that’s the complaint bankers are making that we’re being told, although the Fed is saying we’re trying to spark recovery by encouraging business lending the
regulator’s who visit our bank are saying don’t do too
much business lending, stay safe because they’re
sort of overreacting to the last crisis. – I had a question relating to eliminating FDIC insurance, so if we eliminated FDIC insurance, if we’ve removed money from the system and the reason I say that is, if I were an artist and I have absolutely no financial knowledge whatsoever, no
interest, and I had to make an informed decision about whether I want to put
my money into the bank, why would I put it in in the bank if there’s no protection offered, and I’m scared? I don’t know whether
my money is going to be there without that insurance protection. – Okay, so that’s a good
question, so the question is basically, do we shrink the entire
financial intermediation system if we take away guarantees? Well that would make for an
interesting historical study. I mean we could look before
and after deposit insurance, my impression is it hasn’t
made a big difference, it’s not that the banking sector grew compared to its historical trend but
I haven’t done that study. It helped get the money back out from under the mattresses where it had gone during the banking panics, but I don’t think it attracted any money that had been on the sidelines because people couldn’t find a
bank that they trusted. It’s true that in the
absence of the FDIC sticker the depositor would have to
do a little bit of research. They’d have to go online and
see who are the healthy banks before they decided where to
put their money just as they do when they decide to put
money in a mutual fund, or if you’re serious
about it when you decide to buy insurance you really
ought to go online and see what the credit rating of your
insurance company is to make sure they’re gonna be there
when they have to pay you. So it is possible that that
would discourage some people from keeping money in
banks, but there it’s going to be giving the bank’s
an incentive to convince you that they are safe, so
they have to be more transparent and they have to have some kind of credible certification that they’re solvent and banks tried to do that in the days before deposit insurance. – Comment on that, if I buy a
toaster, I buy a GE toaster, I buy it from Macy’s it’s
got a UL sticker on it, so I got a three fold
insurance if I take it home and plug it in it’s not
gonna blow up on me, so these kinds of, branding,
and seal of approval type mechanisms are totally
out there in the market. Go to Walmart, and get a
Walmart approved bank account. – So you’ve got the banks brand name and you’ve got the clearing
house certifying that the bank is solvent and they should know. What is true is that there’s nobody saying we’re gonna pay you back no matter what the bank does but that has healthy incentive effects
on the bank’s behavior. – Yeah, this kind of
goes along with that but, so the vast majority
of regulation on banks is not made public would you
recommend the findings that regulators are coming up with
are the conclusions to be made public so that the average
consumer is more aware of what’s going on within the institution? – [Lawrence] I’m not quite
sure what you mean by saying it’s not public, I mean
the Fed has a long catalog of rules that you can read online. – Not the rules but the
individual institutions, whatever the OCC or the
FDIC come up with, it’s still not made public
to the general audience. – The bank ratings are not made
public for obvious reasons, they’re worried that
the uninsured depositors are going to flee the low
rated banks, but maybe that’s more discipline, maybe
that’s a good thing, because they’re gonna put money
in the highly rated banks, it’s not going to be lost to the system. Yeah, I’m not sure about
whether the ratings ought to be public when the
private clearing houses did the inspections what they announced was either the bank is solvent, we stand behind it, or the bank wasn’t
solvent, but they’ve agreed to put up more capital and
we’re standing behind it in the interim, or they haven’t agreed to our terms and we’ve kicked them out. So that was enough for the public to know sort of whether they were standing behind the bank sort of more fine-grained what they what the regulator’s found, what the auditors found, you can see why they wouldn’t want to announce that. – My experience where the bank is more based upon my the the service or the experience in in working with them and not on their financial stability, the fact is I don’t even know what the financial stability is of my institution I’ve been with them for a number of years, I would never think of
really doing research. – [Lawrence] Aren’t there
consumer places that rate banks on consumer service? It doesn’t have to be the OCC
or the Fed that does that. – I guess my thought was
that most people wouldn’t have the, wouldn’t really
know where to begin with analyzing a bank’s financials or what’s going on here, they’re really much more of character, much more the experience with the institution. – Well they need to know who’s
ranking of the institution they can trust, so the
underwriters laboratory does that for electric appliances and the clearing houses did that
for commercial banks. – Rating agencies and that proved to be. – Well we had a kind of pseudo market in rating agencies yeah so
that’s a whole nother story, but we created a kind of cartel by giving the ratings
regulatory force, so you had to go to the right the
one of these three agencies to get a rating that would then determine what the regulator’s decided
was your capital requirement. So that gave them a captive business. – [Woman] In the absence
of the protections though, things are still businesses,
their incentives are to make money, and I
mean with no one looking into what they’re doing,
I would think there would be a lot of banks saying, oh yeah we have 20% tier one capitol, tier
one leverage, and people wouldn’t know how to verify that. – What you want to make
sure is that your bank is a member of a clearing
house that’s verifying that, and if it’s not then it’s
going to have a hard time you know providing you
with payment services because it’s going to be more expensive to clear your checks if they
have to hire some other bank to do it for them and the
clearing house is going to make that other bank responsible
for your bank actually meeting its obligations so they’re gonna send auditors into your bank. – [Woman] And would not the
industry shrink considerably because a handful of banks
would get a reputation for being really good and
have a bunch of other ones? – Well, I don’t think the
historical record shows that. – [Woman] Doesn’t Canada
have five big banks? – Canada has a smaller number of banks than the U.S. that’s right and that’s because they always
allowed interstate, or sorry nationwide branch banking whereas the U.S. had an artificially high number of banks because we had these restrictions on branching and we’re
moving in that direction I’m not sure about the the four firm concentration ratio in the U.S. might actually be as high as Canada’s right now, the question the practical question is are the Canadian banks
competing with each other? And the way to measure that is how much are they paying on deposits compared to what they’re charging on loans? And the answer is they are as competitive as the U.S. banking system. – This is a different, thank you very much for a very interesting presentation. Do you consider the use of Bitcoin as an example, or an aspect of free banking? – Well not one that I had
thought about before it happened but in a broader sense yeah I think it’s great to have
people come up with this, I don’t quite understand why it has a positive value, but it does and so it potentially could become a widely used method of payment and I think it should be free to do so so I don’t think there should be laws blocking it. The people trying to promote
it though are facing problems now that the authorities are demanding that Bitcoin payment processors follow all the rules that
banks face with regard to knowing your customer
and that’s a huge burden. So you have to be licensed
as a money transmitter and you have to know your
customer and that’s going to quash these kind of developments
and a lot of that has come since 9/11 because we
discovered that the guys who hijacked the plane
they got their money from the home country
transmitted to them through Western Union. So everybody else who were informal money transmitting services now had to follow the regulations
at Western Union faces in order to fight terrorism. – The first question is that
the first part of the question were there any banking financial
crisis from 1950 to 1980s during that time period? We talked a lot about ’81. – That was a pretty calm period. – And you had FDIC during that period? – [Lawrence] Sure. – So why were there no
crisis at that point, and only after 1980? – [Lawrence] Well, it is kind of a puzzle. – [Man] There was the banking
crisis in the mid 1970s where they had to get
rid of the gold stamp. – Well that was a monetary policy crisis there was regulation queue which was sort of keeping banking profitable there were entry restrictions and so it was not very good for consumers in terms of the returns they were
getting on their bank accounts. It’s kind of like if everybody drives a tank then nobody dies in car accidents so in a
sense the system was sort of two armor-plated. I guess would be my diagnosis of it so it is possible to veer in
the other direction but, monetary policy was very stable, 1980 is too late an endpoint ’cause there is a crisis by 1980 in disintermediation from the banking system when regulation queue began to bind them but inflation rates went up in the ’70s lots of money flowed out of
banks because they weren’t paying competitive returns
so that was a crisis. But if you just look at the 20 years where monetary policy was pretty good then this environment was stable. I guess banks hadn’t
discovered quite how to exploit the safety net as well as they have now. – Is it possible that
increased use of stock options from the ’80s led to more upside
gains but no downside risks it’s not the FDIC downside risk, but another instrument that
caused banking bad behavior? – While we have a safety net there is a case for limiting
the compensation schemes that the top bank management
has so that they don’t game the system, but I would prefer not to intervene into how banks pay people but that means take away the
safety net guarantees. – [Man] Thank you all
for being here today, we really appreciate it,
Larry thank you so much for this interesting presentation. – [Lawrence] Thank you. – [Man] Hope you all have
a great rest of the day. (applause)

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