This article covers my position on establishing a new National Credit Union as one reform of our overall financial system, including the elimination of the Federal Reserve and the dispersal of its various powers across various governmental branches and departments. This National Credit Union proposal is tightly related to my overall vision for financial reform covered in separate articles. This includes my proposals for Monetary Reform, a National Credit Union, and a National Credit Bureau. All of these various reforms are also closely related to my views on inherent natural monopoly industries and the crucial need to operate such sectors of the economy as transparent bureaucracies with strict democratic oversight in order to ensure a fair and level field for all other businesses and consumers. There are only a handful of such natural monopolies, but if we continue to allow them to be run by private for-profit oligarchs, we will continue to watch our democracy fade away.

Benefits of Reform

  • Allows the public to reap all of the benefits of their own credit funds.
  • Ends the usury of Payday centers, not by outlawing them, but by providing a favorable borrowing option for disadvantaged borrowers.
  • Aligns the incentives of the borrowers, lenders and the credit intermediary in a way that creates social harmony and economic stability
  • Eliminates most fees associated with saving, borrowing, and lending and restores interest rates to a reasonable level which rewards the responsible behavior of borrowers.
  • Potentially decreases the tax burden for all Americans.
  • Places financial services in a decentralized way into the hands of individuals, families, households, and communities, rather than granting a special privileged monopoly position to banks and other financial institutions.
  • Simplifies financial, monetary and real estate transactions and eliminates bureaucratic waste in these economic sectors.
  • Government is inherently capable of providing more comprehensive insurance of credit markets, can use its spending and taxing powers to dampen wild swings in credit cycles, and can use its power to originate money to also moderate credit crises in a way private for-profit oligarchs could never do.

Understanding the Components of Interest

Many aspects of credit intermediation exhibit strong monopoly tendencies. In particular a large part of credit intermediation involves risk pooling insurance, shared infrastructure, and other factors that enjoy immense economies of scale as operations scale up. This is why many of the executives working in these industries see regulation as such an intrusion into their operations. It is really more efficient and more stable for these bureaucracies to be as large as possible so that only one insurance company exists, only one credit reporting agency exists and only one credit intermediation exchange exists. However, once we admit that these are natural monopolies and thus should be operated by monopolies, we certainly do not want to allow them to be operated privately as for-profit monopolists. Rather they should be transformed into transparently operated bureaucracies with tight democratic oversight from Congress and the Executive branch.

Credit intermediation simply involves channeling funds from those who want to save (because they currently spend less than their current income) to those who want to borrow (because they currently spend more than their current income). Borrower and lender could simply pass the funds between themselves without intermediation at all, except for the difficulties of finding one another and also that there are many other functions that must take place as well.

An intermediary simply pools funds from savers and make them available to borrowers while providing reserves and other insurance funds to protect against certain risks (the diamonds)

An intermediary simply pools funds from savers and make them available to borrowers while providing reserves and other insurance funds to protect against certain risks (the diamonds)

First there is a customary interest payment. This customary interest payment serves as an inducement to ensure that savers use the credit system rather than simply hoard their funds in their mattress, a jar, or their checking account. This payment must be billed, collected, reported on, and so forth.

Second, there is a cost in maintaining records of lending and to manage the typically monthly payment of interest. Such overhead has tremendous economies of scale as well so that as the quantity of funds grows the same infrastructure for managing those funds can be used without much increased costs.

Third, the borrower might repay the loan early and therefore any presumed interest income for the lender would be lost unless their is an insurance fund against such losses. Alternatively the burden might be placed on the borrower such that the borrower had to pay the promised interest for the loan regardless of how quickly the loan was paid back. While early loan repayment is not a major problem, it is a slight problem when trying to match fixed return rates between savers and borrowers. Imagine the case where a saver purchases a 5 year certificate of deposit with a 3% rate of return . If those funds get loaned to a borrower for a 5 year loan then the income stream the saver expects is provided for by that loan. However, if the borrower unexpectedly repays the loan early than resources must be expended to find a new borrower to borrow those repaid funds and somehow funds must be obtained to continue making the interest payments the buyer of the certificate of deposit expects.

Fourth, there is a need to insure against events where the lender might not be able to service the debt obligation or completely defaults on all debts. This component represents a major component in interest rates paid by most borrowers. It also serves as the basis for credit rating agencies which provide the information insurance companies call ‘experience rating’ (rating someone based experience of past behavior related to a particular risk: in this case the risk of non-repayment of loans).

Fifth, a credit intermediary wil typically skim some profit off of the top of all of this as well. So not only does the lender (saver) make a return on the lent funds, but so too does the credit intermediary.

Sixth, a saver might want to be able to withdraw funds at a moments notice and so funds must be set aside to insure against that risk too. FDIC largely serves this function.

Finally, aside from the overhead, the customary interest passed between borrower and saver, and the various insurance funds that hedge against various risks and losses, a key part of credit intermediation is profit. Since credit intermediation is an inherent monopoly, that profit component is a monopolist’s profit. So credit intermediaries enjoy a monopoly privilege of monopoly profit at the expense of the public.

CreditInterestComposite2

A borrower’s and lender’s interest rate can be broken down into all of sorts of component parts: various insurance premiums and discounts, overhead, interest proper, and profits (the percentages are purely hypothetical but are in the vicinity of real-world percentages for low-risk borrowers)

So let us imagine two different types of credit intermediaries: 1) A private monopoly bank; and 2) A Federally run National Credit Union. Both need to insure against various types of risk. Both need to cover overhead to maintain the underlying credit intermediation infrastructure. Both necessarily involve bureaucracies to determine their compliance with their charter, manage actuarial calculations, and so forth. Both need to transfer a portion of the borrower’s interest to the saver to induce the saver to save their funds. The big difference is in the profit component. In the case of a private for-profit bank the bank benefits from the inherent monopoly quality of credit intermediation to be able to dominate both borrowers and savers to charge monopoly interest rates to borrowers and to leverage their monopoly power to pay drastically reduced interest rates to savers. On the other hand, for the National Credit Union, there are no adverse incentives to gouge on interest rates. Instead such profits can be potentially reduced to 0% or a reasonable profit might be skimmed off of the top, but those profits go to the public treasury and ease the burden of taxpayers.

Conclusion

In any event, a major portion of credit intermediation is a complex combination of insurance risk pools where the greater the size of the risk pool – in other words, the greater the size of the insurance fund – the closer we come to achieving financial stability.

Moreover, the greater the size of the credit pool, the lower the costs of overhead. This is the tension expressed by private too-big-to-fail banks where they insist that regulation gets in their way of lowering costs, establishing a surer footing in their risk pools, and generally making credit intermediation more efficient. Therefore we have a tension between on the one hand, the natural monopolistic tendency where it would be far better and more efficient to eliminate regulation to let these banks become a single monopoly, against, on the other hand, the sense that such a privately-run monopoly is patently unfair to everyone else participating in finance.

It is unfair because of the last remaining component of the interest on credit: the profits. What remains then is the size of the profit or taxes skimmed off of the top of the credit pool. For a profit-driven monopolist their monopoly position grants them special powers to extract an enormous differential between the interest paid savers and the interest charged to borrowers. In contrast, a National Credit Union can select a level of profit in response to public debate and democratic deliberations. For example, the National Credit Union might charge no interest rate profit differential but instead simply provide funds to borrowers for the bare cost of those funds (including insurance risk premiums). In that case, the general class of all borrowers and all savers enjoy the service of credit intermediation without any intermediary skimming funds off of the top. On the other hand, the public might prefer to impose a reasonable profit rate on top of the credit intermediation but still lower than the private profit-driven monopolist and those funds would get passed to the public treasury and reduce the burden of taxpayers. While such debates represent a proper realm for public policy, none of it is possible if the inherent natural monopoly industry is turned over to private profit-driven monopolists.

None of the benefits of private enterprise exist for the monopoly industry. The typically favorable byproducts of profit-driven enterprise in a competitive enterprise turns into a vicious tendency adverse to the consumers of the service (in this case, borrowers and savers), as the monopolist gouges the borrowers and savers to gather greater and greater profits for itself.

You might say that we do not actually have a monopoly banking system, we have several dozens or even hundreds of major banks. While we do indeed have many banks, a few major banks operate as industry leaders within each oligopoly industry locale. Moreover these oligopolies collude in a legalized cartel – the Federal Reserve System. And such an artificial oligopoly actually makes matters worse. Rather than allowing the natural tendency toward a single monopoly credit intermediary and the efficiencies such a monopoly enjoys, the cartel leverages its power over the market to accommodate the inefficiencies of many separate banks and to boost not only the overhead, but also the monopoly rent-seeking profits of each member bank. The maintenance of an artificial oligopoly through government regulation and Federal Reserve system collusion means that borrowers, lenders, and taxpayers are all gouged even further by this system.

So it is essential with credit intermediation – as with all natural inherent monopolies – to socialize this service and operate it through a transparent bureaucracy with tight democratic oversight or we merely encourage oligarchy.

Establishment of a National Credit Union

To provide a more stable foundation for our financial sector I propose we create a National Credit Union. Like the socialization of the monetary system and our system of electronic ledger checking accounts, a National Credit Union will socialize our base credit system including all FDIC insured savings accounts, revolving lines of credit, and home mortgages. These types of credit all benefit immensely from economies of scale and none of them involve the intricate labors associated with intimate project evaluations (such as in bond underwriting).

Savings instruments (credit pool shares) include:

  • Value insured savings instruments (withdraw at any time without penalty)
  • Other short-term savings instruments (3o-60 days where early withdrawal could involve some penalty or other loss in value)
  • Medium-term instruments (180 days, 1 year, 2 year, … 7 year)
  • Long-term instruments (10 year, 15 year, 30 year)

Lending instruments (credit instruments drawn on the pool) include:

  • Revolving line of credit
  • Revolving line of credit with 28 day grace period
  • Business bridge loans
  • Medium-term mortgages
  • Long-term mortgages
  • Student loans

The National Credit Union would also take steps to match savings and loans of various durations so that, for example, a loan of ten years duration was supported by a savings instrument of 10 years duration. Such matching of credit instrument terms goes a long way toward stabilizing credit markets. The National Credit Union would also rely on the interaction of all borrowers and all lenders in the market to determine the most suitable prevailing interest rate between borrower and lender: raising the prevailing interest rate to induce greater savings and discourage borrowing and lowering the rate to discourage savings and promote borrowing as needed to equalize the credit market for various credit durations.

If the public deposits into Federally insured savings accounts are insufficient to cover the various revolving lines of credit, mortgages and other such loans, the National Credit Union could sell other debt instruments to financial investors. However, the National Credit Union would enjoy a legal monopoly in these various unsecured and secured (e.g., mortgages) loans requiring no project evaluation.

In the event that borrowing skyrockets or savings dry up – forcing a precipitous rise in interest rates – the Congress could authorize the injection of newly originated money into the National Credit Union to avert an economic crisis. However, this is quite different from the current situation where the Federal Reserve regularly manipulates market interest rates because it has foolishly intermingled our monetary system with our credit system. The requirement of 100% reserves on checking accounts means such credit manipulation becomes far less common place.

This new form of monetary policy has many advantages over our current monetary policy. First, it is controlled democratically by Congress rather than by a quasi private banking cartel like the Federal Reserve. Secondly the benefits of new money do not accrue to the same private bankers who decide to originate new money, but instead the decision is made democratically by Congress and the benefits accrue to the general population and the aggregate of all borrowers who avoid an unforeseen and precipitous rise in interest rates that would devastate borrowers, credit markets, and the economy in general. Third, the newly originated money is used to issue credit instruments owned by the National Credit Union and where interest payments accrue to the public treasury rather than the current situation where newly originated money is used as welfare for the rich to support private investors and which make the public treasury the debtor and interest payor to the private holder of these debt instruments. This last point is crucial since it ensures the infinite stream of interest due from the public – because of the use of newly originated money for debt instruments – is owed to the public treasury as creditor rather than a private creditor.  This means the public largely owes itself the stream of interest payments rather than owing a third-party private financial oligarch.

Re-lending and Community Microlending Re-lenders

Community microlending re-lenders can achieve and maintain stellar credit ratings through community cohesiveness and cooperation. In that way, a person can go to their community microlending re-lender and get even more favorable interest rates for home mortgages, durable purchase loans and other loans. The role of the community re-lender is to provide greater scrutiny of community members as to their credit-worthiness than a monopoly credit rating bureau can achieve. Moreover, the community can also bring social pressures and encouragement to borrowers to keep them current in their debt-service.  The community can even provide monetary guarantees for debt-service to maintain its stellar credit history. While these community microlending re-lenders are similar to the microlending pools found in many parts of the World, these re-lenders provide borrowers with some of the lowest interest rates possible, whereas community microlending pools often involve usurious interest rates.