A Convenient Fiction”

Suppose we stopped pretending the corpse is breathing.

Suppose we laughed at our leaders for suggesting the U.S. banking system is alive and recovering?

Suppose we recognized that putting makeup on a corpse doesn’t bring it back to life?

Suppose we admitted our banking system has been nationalized?

Suppose we dealt with our rage at being on call for trillions in losses to come— all to maintain the decaying corpse that is suffocating our jobs, incomes, and home values?

Our leaders have been telling us a convenient fiction. It is that our banking system didn’t die when its reckless executives wiped out the entire shareholder equity— and got rewarded with mega-million-dollar bonuses while doing it. The convenient fiction is that quick action has provided trillions in helpful federal support. In fact, it has done nothing to breathe actual lending back into our banking system. The convenient fiction is that Washington came to the rescue. In fact, no reform has occurred. The same rotten incentives for risk still exist.

Get one thing straight. The real bill is being paid by you and me. If the trillions in new federal debt have no meaning to you, just think about your personal bank deposits. If you have money on deposit at a bank, you are subsidizing the corpse. According to the latest FDIC report, the profits of the entire banking system in 2009 were a piddling $12.5 billion. Allowances for loan losses of $71.5 billion got in the way of greater profitability.

But the same banking system also had about $7 trillion in checkable deposits, savings deposits and time deposits upon which it is paying virtually nothing in interest.

That’s our money.

The decay of the corpse is being covered by paying zilch for deposits. That $71.5 billion in loan loss reserves is covered simply by shorting us 1 percentage point of interest NOT paid on our deposits. So you tell me— do you think your bank shorted you by only 1 percentage point last year?

The buck doesn’t stop in Washington; it just disappears before it gets to you and me.

Can we get out from under this dead weight?

Yes. It’s called Limited Purpose Banking. You can read about it in a new book, “Jimmy Stewart Is Dead: Ending the World’s Ongoing Financial Plague With Limited Purpose Banking,” by Laurence J. Kotlikoff (Wiley & Sons, $28). Professor Kotlikoff is an economist at Boston University. In a fast-paced 205 pages that anyone can read, the book reminds us of the institutionalized stupidity and arrogance we have endured. It tells us how to change the banking system so that neither we nor Uncle Sam can get taken down again. Filled with zingers and comparisons that help us understand numbers in the trillions, this book tells it like it is. Then it shows the way to a better future.

Discussed in a column co-written with Kotlikoff a year ago, Limited Purpose Banking would convert existing banks and insurance companies into mutual fund complexes that sold funds for different purposes and with different levels of risk— including virtually no risk. As a consequence, we could take risks as individuals. Banks, however, would no longer be able to take risks whose losses would have to be covered by Uncle Sam, the FDIC, or you and me. The cure is more in creating a new institutional structure than in more hapless regulation.

The idea isn’t far-fetched. Kotlikoff points out that mutual fund firms accounted for 14 percent of total financial assets 30 years ago. Today they account for 34 percent. As he puts it, “We’ve been moving toward limited purpose banking over time, but clearly not fast enough.” With interest building in Europe, Limited Purpose Banking may be the model for future banking.

One reason is that it would go a step beyond the restoration of Glass-Steagall suggested by former Fed chairman Paul Volcker. (Glass-Steagall, repealed in 1999, separated commercial, deposit-taking banks from investment banks.) “If we re-enact Glass-Steagall, the nonbank/ shadow bank/ investment bank industry will have a competitive advantage because they would implicitly be getting lender-of-last-resort protection from Uncle Sam without having to pay for it. This would lead the regular banking system to yell foul and push and pay for deregulation, leading us right back to where we are today,” professor Kotlikoff notes.

Meanwhile, there is a simple way to express our anger. We can move our money. Indeed, it’s already happening: Witness moveyourmoney.info.

On the web:

The Move Your Money Website

Arianna Huffington on “Move Your Money”

Federal Deposit Insurance Corporation Quarterly Banking Profile

Federal Deposit Insurance Corporation statistics on banking industry

Economic Indicators: Components of Money Stock

Economic Indicators: Bank Credit 12/09

February 5, 2010: Right Incentives, Wrong Incentives

Earlier Burns and Kotlikoff columns on the financial crisis:

“A Modest Proposal— Limited Purpose Banking” (3/13/2009)

“Getting an Economic Grip” (10/17/08)

“Promises, Promises, Promises” (09/26/08)

“Insider Rating and the Credit Crisis” (3/28/08)

Earlier Scott Burns Columns on the Foreclosure/Financial Crisis