05 April 2023

CEPR's Kotlikoff, Millar: Fixing banking for real

In this blog, Laurence Kotlikoff and Rick Miller argue that banking as we know it is dying. It’s time to arrange a smooth transition to limited purpose banking and end financial panics with their massive economic damage once and for all.

Our banking system is built to fail. On average, it fails every 15 years. Right on time – fifteen years after the Global Financial Crisis – it’s failing again. Silicon Valley Bank (SVB) and Signature Bank, alive and well a month ago, are now dead and buried. They placed 2nd and 3rd in our nation’s great pantheon of bank failures. 

First Republic, our nation’s 18th largest bank, is on life support. Eleven mega banks just gave it mouth to mouth with a $30 billion deposit. Buying deposits, not stock was a kiss of death. The news further cratered the bank’s credit rating – to junk – and tanked its stock. A year back, a share of First Republic fetched $170. Today, it’s worth $14. 

The financial crisis is spreading overseas. UBS just “purchased” Credit Swiss – for peanuts. This was no First Republic. Credit Swiss was Switzerland’s second largest bank with clients in 50 countries. Switzerland’s central bank lent the paper tiger $54 billon, but to no avail. Within days, Credit Swiss’ 167 year-old history was history. 

Which august or newbie bank is next to say sayonara? First Republic’s funeral is surely being arranged. How about Charles Schwab? It’s now bleeding $20 billion a month in deposits. Morgan Stanley just downgraded the company. Its stock is also in freefall. Charles Schwab is the 8th largest US bank! 

Anyone else in trouble? How about over half of the 4,236 FDIC-insured commercial banks? They are, experts say, all insolvent on a mark-to-market basis. 

One thing is clear. The run is accelerating. Since SVB’s uninsured creditors tweeted FIRE! and rushed from that crowded dark theatre with its tiny exit, $550 billion in uninsured deposits have fled our “sound” banking system – over half to money market funds with the rest to JP Morgan and other money centre banks. And much of the money going to the money centre banks is being parked in mutual funds of those banks or swept into such funds overnight. But $550 billion is small potatoes compared to the $8 trillion in uninsured deposits ready to take flight in the seconds it takes to send a wire. 

The three musketeers – the Treasury, the FDIC, and the Fed – could try to end the contagion by having the FDIC insure all deposits. But nervous keystrokes could force the FDIC to hand out trillions to depositors whose banks go belly up. And, truth be told, the FDIC is broke. It had $128 billion in reserves at the end of December – less than the total deposits in SVB and Signature. (Given the failures of those banks, its assets are now less than $100 billion.) A run to beat all runs would force the Fed to print those trillions for the FDIC. The ensuing fear of hyperinflation would lead all depositors to grab their money and head to IKEA. Furniture beats worthless paper. 

Sound over the top? Not if you’re Argentine. As each financial crisis hits, the government reassures the public that its bank deposits are insured. Yet everyone runs expecting inflation. Then the government limits weekly withdrawals. Eventually, you get your pesos back – after they’re worth centavos in purchasing power. 

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