This clip from the film Terminator 2 shows just what happens if we rely on breaking apart the banks as our path to financial reform. We end up right back where we started.
In the film “Terminator 2” (T2), California Governor Arnold Schwarzenneger has switched from fighting for the machines to fighting against the machines and actually fighting for and with the humans. But in T2 a new and seemingly better terminator model is now in the picture. The T-1000 is made of liquid metal and can easily morph into any form of the same basic volume. Like our too-big-to-fail banks, the T-1000 is seemingly indestructible. But by a stroke of luck the T-1000 gets barrels of liquid nitrogen dumped on top of it and enters a deep frozen state. Our hero, the Governor, then tries to destroy the T-1000 by blasting it apart into thousands of separate, and presumably manageable, frozen shards of now solid metal. It looks like this is the triumphant end of the movie, but then a twist. As the heat from the nearby smelting operation melts the shards of solid metal they quickly thaw and recombine until the T-1000 reemerges every bit as powerful and dangerous as before.
This is exactly what we can expect if we break apart the too-big-to-fail banks. Even if we had a stroke of luck which froze out the bank lobbyists long enough to pass a bill that blasted the banks apart, the law would fail the public in the end anyway. In a short period of time when the economy heats up again, the broken-up banks would recombine and become just as powerful and dangerous as before.
Though we are not dealing with liquid metal here, banks are essentially comprised of liquid assets: the most liquid assets we have. Moreover, these liquid assets want to coalesce together because of what economists call ‘economies of scale’, where it is less and less costly and more profitable on average to operate a bank the larger it grows. Whenever a sector of the economy exhibits these economies of scale, we have a ‘natural monopoly’ where a strong tendency drives that sector toward monopoly operation. It is not that all of banking exhibits these economies of scale, but the financial sector uses their control over the parts of banking which are natural monopolies to carve out other monopoly powers for themselves and ensure they can dominate smaller community banks and maintain themselves in their too-big-to-fail state.
So when we consider combining the liquidity of banking assets together with the natural tendency for these highly liquid assets to coalesce, we must admit that breaking apart too-big-to-fail banks is exactly like blasting apart a T-1000. It gives us an immediate cathartic feeling, but once the economy heats up again the liquid assets coalesce together once again. So we must deploy a solution with long-term success instead. In T2, the eventual solution is to dump the T-1000 into a vat of molten metal. While that would certainly end the powerful and dangerous dominance of banking over our lives, finance plays an important social function and I have a solution I would like to try first. If we can rewire the financial sector’s neural network, we can program it to serve the needs of the public rather than the current situation where the financial sector enslaves the public to the malignant whims of the financial sector itself. So let us try this approach first but keep the kettle of molten metal on the burner just in case.
So what is the plan?
You can read more about my plan across several campaign issue pages (Monetary and Financial Reform, Monetary Reform, National Credit Bureau, National Credit Union, and National Insurance Fund). But here let me summarize the plan and explain the motivation behind the approach.
Since parts of our monetary system, financial system, and insurance system are all comprised of some natural monopoly components, we need to separate those components from the others. When we separate the natural monopoly components from the others, we allow those other components of the economy to operate independently on a small manageable scale through market interaction where none will grow to dominate and control an entire sector of the economy. However, these small manageable businesses still need the natural monopoly services to operate. I propose we socialize these natural monopoly services and subject them to tight democratic oversight and transparent operation with equal access to all. Whereas markets can work to prevent the concentration of power for competitive industries, for natural monopoly industries we cannot vote with our feet to a competitor when we do not like the way the industry operates. So instead we need to find a new way to vote such as literally instead of figuratively voting (there are other problems with voting with dollars since it is usually the ones with the most dollars that always propose changing the system from one person one vote to one dollar one vote, but competitive markets with lots of players, and especially easy entry, do prevent the build up of unwieldy dominance).
So regarding these natural monopoly components, banks needed a way to facilitate electronic transactions so they founded several banking cartels such as Visa, Mastercard, and the Federal Reserve’s FedWire and Automated Clearing House systems which facilitate electronic transaction clearing among the different banks. While this electronic clearing is a necessary function of modern banking (or clearing of some sort even if it is using paper ledgers and the pony express), the banks then use their control over this natural monopoly to carve out other monopolies in banking in areas which otherwise have no monopoly tendencies of which to speak.
In addition to electronic ledger and transaction clearing, the other major natural monopoly component of banking is ‘risk management’ or what most of us simply call ‘insurance’. For now, I am not talking about health insurance, life insurance, auto insurance and the like but this applies there too. Instead I am referring to all of the various components of risk management that occur around monetary operations and credit intermediation. For example, with monetary operations there is the risk of bank robbery where someone slips into the physical or electronic vault and takes all of the cash (whether it is the owner of the bank or someone wearing a bandana over his face and passing a note to the teller). That is a risk which must be managed. Similarly for electronic transactions and paper check transactions, there is the risk of fraud where someone without authorization forges a check or uses someone else’s credit card number or PIN number. Likewise, when making electronic transactions we sometimes enjoy merchant dispute insurance where when a dispute arises between merchant and buyer, the electronic transaction system investigates and insures against losses on both sides that might arise due to the dispute.
Those are many of the risks of monetary operations which must be managed. In terms of credit intermediation there are all sorts of other risks involved as well. In general, the credit intermediary must manage the risks that some will want to withdraw their funds from savings earlier than expected or that borrowers will need to extend the terms of their loan unexpectedly or completely default on their loan. Especially when both happen at the same time, the credit intermediary must make sure enough resources have been set aside or otherwise secured to address such an unexpected event. Typically those set aside resources are simply the reserves of the bank, but all sorts of complex and complicated financial arrangements could be deployed to manage this risk. In any event, set aside too many resources and the bank suffers from lackluster earnings. Set aside too few resources and the credit intermediary becomes completely insolvent. When several credit intermediaries become completely insolvent we have an economy-wide financial meltdown.
Note that while my focus here is on the financial institutions, keep in mind that the other sectors of the economy are relevant as well. The situation in manufacturing, consumer spending, consumer credit, government services and so forth all influence whether borrowers need to extend their terms of credit or savers need to withdraw prematurely. So this cannot all be blamed on the financial sector alone. But the financial sector acts as a key fulcrum in our economy and so we need to fix it so that we can facilitate sane economic activity elsewhere. I will say more about this at the end.
Now back to discussing risk management. I elaborate about this risk management because insurance too exhibits tremendous economies of scale. Due to what probability theory calls the ‘law of large numbers’, risk managers become better able to manage risk outcomes, the larger the size of the risk pool. Consider a coin toss. If I ask you predict what proportion of the time a coin will come up heads and what proportion it will come up tails for two coin tosses, it is possible you will be way off. Many would say 1 head and 1 tail. But with only two tosses it could easily be 2 heads or 2 tails because the variance for only 2 tosses is very very high. If instead we flip the coin a million times, we can expect it will be very close to 50-50 heads and tails.
Or to look at a healthcare example, imagine my brother and I decide, just the two of us, to form a health insurance risk pool by paying in premiums to an account so that, in the event of illness or injury, we have funds to cover our expenses. We will have a difficult time managing that risk. We may both become ill very soon and have insufficient resources set aside to meet our needs. Or we may both remain healthy our entire lives and simply die in our sleep without any medical intervention whatsoever. In that case everything we have set aside for medical care we did not need to set aside for that purpose. On the other hand, when 310 million Americans pool their healthcare risks together it becomes very easy, trivial in fact, to predict the needed flow of benefit payments over time. That is the law of large numbers at work and it implies that the risk management has natural monopoly tendencies too since it faces such economies of scale.
So all of the various risk management components in banking also constitute natural monopoly components of banking. Without FDIC insurance, when we deposit funds into a bank, we are also essentially buying deposit insurance from that bank. If the bank fails, then so too does our insurance provider. So in that case, the bank is both a bank and an insurance provider. FDIC insurance therefore provides insurance even if our bank fails. In that case the bank cannot make good on its promise to keep our deposits safe and insured, but FDIC is there in that event and simply forces the failed bank to combine – to coalesce – its liquid assets with another bank. Due to the law of large numbers, larger banks have an easier time managing risk, so typically the FDIC combines the failed bank with a larger bank. Does Simon Johnson – one of the big advocates for breaking apart the banks and the former chief economist for the IMF – not know this? I find that hard to believe. So we are offered a ‘solution’ to our financial mess which is no solution at all, but merely the preservation of the same endless cycle of blasting apart the banks and watching them recombine until we reach the next collapse.
So these two pieces of the financial sector – the electronic payment clearing system and the various associated risk management pools – exhibit tremendous economies of scale. The larger the bank, the more it can average the costs of risk management and the costs of electronic transaction clearing across many customers and greater assets. Smaller banks are more likely to fail and as banks fail, the FDIC brings them into receivership and coalesces those banks back into larger and larger banks. Set a limit on this concentration and the economic collapse merely happens sooner. This is why the banks themselves puzzle over why anyone would want to limit their size, just as a terminator puzzles why anyone would try to stop its termination activities. But the reason we want to avoid enormous oligarchical for-profit banks is obvious to the rest of America: they abuse their monopoly power and privilege at our expense (and if you’re a T200 reading this, we try to stop you ‘cause you want to kill John Connor and recklessly kill everyone else).
So the trick is to separate the natural monopoly components from the rest of banking and to operate those monopoly components as transparent bureaucracies with tight Congressional oversight with equal access to all. Then we do not need to blast apart the big bank. We hardly need any anti-trust regulation at all, if any. Instead the banks are simply forced to compete on an even footing with everyone else: so much so that many of us can simply become our own bankers. Through equal access to the electronic money system, we can make electronic transactions among ourselves, our family, our friends, our customers, and our vendors with great ease, making use of the pervasive internet, cellular phone and computer technologies already in place. When the Federal government provides a simple infrastructure to perform electronic transactions in dollars and portfolio management of dollars and other financial assets, we may never need to step into a bank ourselves again. Moreover, by handling all FDIC deposits internally we remove the adverse incentives created by telling banks to take all the risks they want because the deposits are insured by the taxpayers, citizens, and residents of the United States.
Without the pressing need for banking edifices we can handle our transacting, borrowing, and lending ourselves: only turning to banking institutions in rare cases. The infrastructure which the banks now horde for themselves and leverage to carve out immense banking monopolies for themselves will instead provide equal access to all and the banks monopoly powers over us will end. Equal access to these natural monopoly industries means it is much more difficult to carve out other monopolies in banking or anywhere else.
That is not to say that all of us will have the skills needed to be our own banker. However, such an approach empowers us to help one another. Someone in the family will have the skills to help their other family members. Community groups will be able to form organizations to provide all of the assistance needed to perform the basic operations of banking. Finally, retail banking will still have its place, but the tendency to coalesce into bigger and bigger banks will be gone. The scale of banking would be so reduced that most any retailer, like the corner store, could also provide the banking services for those without the skills to do their banking themselves. A major banking chain or franchise might still proliferate across the country for one reason or another, but the barriers to entry into banking will be so low that such a major player will be in no position to abuse their market position.
What to socialize?
Since the current structure of finance involves combining components with tremendous natural monopoly tendencies with other components of banking which have no such tendency, we end up encouraging banks to grow into banks too big to fail. Moreover, by insuring the deposits of private for-profit banks, we encourage them to take crazy risks with their customers deposits because the FDIC will insure those deposits.
When the US was founded, we had two forms of money: paper notes and coins. Today those two forms of money rapidly diminish in importance as electronic ledger money grows to dominate our transactions. Whereas paper notes and coin were established directly by the Federal government for our use, the ledger money system (first as the checking system) and especially today’s electronic ledger money system was created by the banks themselves with their needs in mind first and foremost. When compared to a system which meets the needs of the general public, the current electronic transaction system is totally inadequate. So socializing the electronic money system with tight democratic oversight and transparent operation can ensure that we all have equal access to the system and pay transaction fees on an equitable basis. And it can also ensure the system serves our needs much more than it does now. We can also have complete control over the authorization of transactions and avoid the current system which favors well-connected vendors over buyers and the banks themselves over the general public.
Making an electronic money system which serves the needs of the public also entails creating an electronic ledger balance system too, so once we take the step toward public electronic money, it is economically desirable for all checking accounts to be operated through a single public system (again due to economies of scale). This could be made decentralized, but the banks would only find it profitable if they had privileged access to the central electronic money system and therefore made money off of the rest of us from their privileged access to the public system. A centralized system of checking accounts means that highly decentralized check processors can simply accept anyone’s check from anywhere and provide cash or facilitate its deposit without delay. Funds become available instantly without any need to find one’s own bank or find the same bank upon which the check is drawn.
Once we create an electronic money system that supports dollar asset balances for checking accounts, it is also trivial to create an electronic ledger system that supports any arbitrary number of portfolio asset balances such as savings instruments, mutual funds, money market instruments, equities, bonds, commercial paper, and so forth. So again economies of scale and natural monopoly tendencies allow us to add savings accounts and all other financial portfolio assets to the system without much in the way of additional costs and certainly much lower average cost per asset and per transaction. So a Federal department of market clearing can simply be the place for all official financial asset balances: money and otherwise. So this approach socializes the natural monopoly component of our monetary system: specifically our electronic money and portfolio management system while providing greater services to manage assets. This would provide checking accounts to everyone in America with no maintenance fees and without overdraft penalties since the electronic money system avoids such overdrafts.
For the other major component of our financial system – credit intermediation – we could make use of this Federally operated electronic portfolio ledger system to originate, buy, and sell financial instruments between and among each other. These instruments are not government run nor government controlled instruments but privately originated and held instruments, but the central electronic system facilitates the origination and circulation of these assets and maintains a clear record of ownership as financial transactions occur. No additional infrastructure is required, yet any two private parties can freely contract with one another to serve their mutual financial needs. Anyone could create a credit intermediation pool or credit union with a few clicks of a mouse and invite others to buy into the credit pool, make loans from the credit pool, and simply make use of the central services provided by the Federal government to do so. Right now each bank reinvents the wheel by creating their own proprietary, trade secret software to do the same thing, but focussing most engineering resources on a central system leads to a better system more tailored to the needs of the general public. Among the many portfolio assets tracked by this system, some might sell foreign currencies, or put options, or stocks, or bonds, and so forth and the central system would simply facilitate those transactions and maintain the electronic balances for each instrument on behalf of all involved (for concerns about privacy, see Bureau of Electronic Clearing Account Types).
However, to enjoy FDIC deposit insurance, depositors would need to move their deposits into the National Credit Union credit pool where the bureau of the National Credit Union would transparently manage deposits and make loans for mortgages, revolving lines of credit, student loans, and state and municipal bonds directly without the need for another intermediary. The primary benefit of local knowledge, important in market theory, is largely absent from these lending operations. While stocks and bonds, involve local knowledge in the sense of evaluating the health of a business or a specific project’s prospects for success, these other lending operations (revolving lines of credit, mortgages, student loans, and municipal bonds) merely involve routinized operations and credit history and credit rating evaluations. Local information can be brought to bear in my plan through community-based micro-re-lending where the community re-lenders achieve stellar credit ratings by working together to insure loans are repaid either through social sanction or working together to retire the debt. And while the electronic ledger system empowers communities or private retail banks to start their own credit pools, such credit pools would not enjoy FDIC insurance and would need to provide clear notice that depositors could lose all of their funds in the private credit pool if the pool becomes insolvent.
However, for the routinized forms of lending, banks simply make decisions today in a completely non-local and impersonal manner by assigning each borrower an interest rate based on a centralized bureaucratic and opaque credit bureau. Of course community banks can provide more personal service through establishing long-term and familiar ties with their customers, but they have little wiggle room because they are forced to compete with large banks enjoying privileged access to credit and electronic money systems So often the favorable treatment at a community bank roughly equates to the impersonal and bureaucratic treatment of a too-big-to-fail bank. These private credit bureaus – in other words, credit rating agencies – also operate as oligarchical oligopoly enterprises where only some creditors have the privileged access to report credit incidents and prospective borrowers are confronted with an enormous and unresponsive bureaucracy to repair errant credit incident reports. Debtors are also prevented from fully controlling access to their credit histories in the event that they want this information kept private.
Such credit histories are also therefore best handled through a public utility since this too is a natural monopoly function (there needs to be only one or a few places where credit incidents get reported and duplicating that service doubles, triples, and so forth the cost of operation). Certainly we can allow other independent credit agencies to form and even perform their own analysis and derive their own credit scores from the National Credit Bureau , but this newly proposed institution will be fully democratized, transparent, and provide equitable-access to all to determine the experience rated interest rates each borrower should pay. And here too, that determination will be made in a manner involving democratic oversight and transparent rules and formulae. Other creditors, debtors, and other financial transactors could also make use of the National Credit Bureau to report delinquencies and to request credit histories and credit scores, but the authorization to access these records would remain solely with borrowers and remain completely confidential without authorization from each person himself or herself.
Social and personal benefits of this sweeping reform
So first these reforms eliminate pools of predation, and eliminate the private for-profit control of natural monopoly sectors which allows these corporations to leverage their natural monopoly control to carve out other monopolies for themselves and make too-big-to-fail banks inevitable. Aside from these structural benefits, there are so many more benefits to this approach that separates the natural monopoly portions from the potentially decentralized and potentially competitive-market segments of finance. I will not go into great detail here, but my issue pages on monetary, financial and insurance reform cover this in more detail. Here I will simply list a few benefits:
- First it strips away massive amounts of bureaucracy as much of the anti-trust and financial regulatory apparatus is rendered obsolete. Not only do we eliminate these layers of government bureaucracy but we also replace all of the giant private banking bureaucracies with a single stream-lined Federal bureaucracy to operate these public services. This Federal bureaucracy need be no bigger than the bureaucracy of a single too-big-to fail bank where now we have dozens of such bureaucracies. In fact this new Federal bureaucracy can be much smaller since much of the bureaucracy in a too-big-to-fail bank is devoted to regulatory compliance and regulatory avoidance. The Federal bureaucracy will not need such over-bloated pieces of bureaucracy and can focus strictly on meeting the objectives set by Congress. With no opportunities for profiteering the focus of the Federal bureaucracy will remain squarely on meeting the needs of the public.
- Surgically removes only the natural monopoly portions of the system, so this approach also affords tremendous opportunities for decentralized, local, and community based financial transactions. Whereas the rate I pay to borrow from the National Credit Union is determined by my credit history (just like for everyone else), community micro-re-lending organizations can create stellar credit ratings for themselves through their local knowledge of borrowers in their community and provide the necessary peer-pressure and social cohesion to guarantee the loan is repaid in full and on-time. These stellar credit ratings for community-based micro-re-lenders fosters greater social cohesion whether geographically or through geographically dispersed affinity groups.
- With Congressional oversight and transparent operation every community can feel secure that their community has not been secretly red-lined where such worries can trigger the entire collapse of home values and an exodus from the community. The National Credit Union can also foster genuine financial literacy and financial responsibility programs in contrast to the current for-profit banking approach where it is clear to many that those needing financial literacy are the bankers themselves. Financial literacy programs now constitute completely see-through manipulative programs because the banks are understood as undermining the savers and borrowers in the system to enrich themselves at everyone else’s expense: particularly through their manipulation of monopoly privilege and complete control of monopoly sectors of the economy. The banks cannot seriously propose consumers raise their financial literacy when the banks themselves promote adverse incentives and adverse selection amongst themselves at every opportunity: something the financially literate know is plainly irresponsible.
- Aligns the interests of the monetary system and credit intermediation with the general welfare of all Americans rather than promoting the enrichment and empowerment of Wall Street at the expense of everyone else
- Turns all Americans into the ‘lending community’ rather than that phrase representing a cynical euphemism for predatory Wall Street bankers.
- Provides equal access for low income Americans to participate in the electronic money systems without overbearing and malicious fees which disproportionately injure these lower income Americans. This way low income Americans are not force into carrying cash and paying ridiculously high ATM and check cashing fees in proportion to the modest size of their transactions.
- Further promotes electronic money as the prime mode of transactions which quietly utilizes existing networks and electronic resources without any further economic, social or environmental costs. Electronic money also avoids the environmental burdens of minting coins, engraving plates, and printing paper notes as well as the environmental and economic costs of transporting the money in heavy and inefficient armored vehicles and securing all of this cash at great expense. Likewise this proposal avoids the environmental damage of a gold standard as proposed by some monetary reformers, which merely adds a social and environmental burden to maintain gold reserves in proportion to the money in circulation with no appreciable benefit whatsoever.
- Any residual ‘profits’ from borrower and lender interest rate differentials or from insufficient fund penalties and other fines goes directly to the public treasury and thus reduces the tax burden on all of us.
By fixing the fulcrum of our economy, we harmonize our economic interactions
By taking control of the natural monopoly monetary, financial, and insurance services situated at the center of all commerce, we enable greater harmony in the operation of the economy. The first way we harmonize these services is by equalizing access to them such as the electronic money system and by all paying the same experience rated interest rates. However, we also harmonize these services when the net revenues accrue to the public treasury. Now all gains from credit intermediation and monetary operations ease the burden of taxpayers instead of enriching those who have seized this monopoly power.
However since these monopoly powers are no longer operated as capitalist for-profit enterprise but as socialist enterprise, they no longer need to operate in a parasitic matter: focussed solely on profiteering. Now these services can focus on fostering responsible borrowing and lending as well as responsible investment and community development. When profiteering is no longer the only goal of credit intermediation there is no reason to rate one community more worthy of mortgage lending and another community unworthy of mortgage lending. When the private banks make these ‘business’ decisions they damn entire communities to perpetual blight all in the name of profits. They also create new opportunities to enrich themselves. By so destroying such a community the private credit intermediation system enables Real Estate speculators to step in and buy up the blighted land, eventually force out the existing community members, and subsequently gentrify the neighborhood. And this whole process, all of it, is merely to enrich themselves, though they sell it as a magnanimous charitable gesture on their part to renew the community. None of the participants in this grift think of themselves as destroying communities. Each simply does the best they can for themselves within the constraints of the system. However, when these same people support a political agenda which implements and further entrenches such a corrupt system – a system designed to enrich them at the expense of everyone else – they can no longer claim innocent egoism.
When the goal of credit intermediation is not merely to make more money, it can focus on fostering responsible borrowing by providing borrowers the tool needed to stay on top of their borrowing. If we can get the wildly perverse distribution of income in the US under control, then borrowing should be largely focussed on financing durable purchases and when it deviates from that we can provide clear early warning signals. A socialized credit intermediary can therefore provide software, public education and take other steps to help inform the public and raise the level of financial literacy.
Given the right tools debtors can receive early warnings of possible future insolvency and take steps necessary to address the situation. More importantly, the National Credit Union itself can take an active role in helping borrowers recognize their situation and offer free assistance to help, such as financial counseling, career building, budget assistance, and connecting borrowers in need to Federal, state, and community services early in the process – long before a borrower reaches insolvency or foreclosure. Private for-profit lenders have no incentive to do so – especially in the case of mortgage lending – because they can often manipulate foreclosures to reap profits even from loan defaults. The National Credit Union can also provide insurance against income-loss for those losing their jobs or otherwise losing the income necessary to service their debt. By taking all of these steps, the National Credit Union reduces the risk of loan default and dramatically decreases the interest rates borrowers need to pay in servicing their loans. A private for-profit credit intermediary cannot profitably offer these services because the benefits are shared with their competitors and these risky borrowers provide cover for higher interest rates for all borrowers and greater profits for the banking sector.
By socializing our monetary system (as the framer’s of the Constitution already intended) and also our credit intermediation system, we harmonize and humanize them. In doing so, we replace a machine interested only in turning value into more value with human-centered services focussed on our monetary and credit intermediation needs. Rather than making us serve this self-aware yet unthinking machine, we reprogram the machine to serve our needs instead. While T2 was only a wild fantasy – obviously Governor Schwarzenegger is never going to change sides to fight for humans rather than the profiteering machine – we can all together demand from our government that it reprogram this machine. We must not believe them when they tell us it cannot be done, because it can be done. I have provided here a poly-alloy skeleton of just how it can be done. Certainly there are more details to be worked out, but the general thrust of reform we need is clear. As John Connor said (or is it will say): “The future’s not set. There’s no fate but what we make for ourselves.”