What is a bank?

Via Matt Yglesias, Justin Fox writes:

If you borrow short and lend long, you’re effectively a bank. It’s
becoming ever less clear to me what justification there is for nonbank
borrow-short-lend-long-institutions other than regulatory arbitrage.

I cannot sign on to this principle.  Business-to-business trade credit is huge in the United States (it’s not all short term) as is commercial lending, as you might get from General Motors or for that matter Sears or Nordstrom.  Pawn shops are more common than you might think.  If we regulate these lenders like banks we presumably have to give them comparable privileges, which could mean discount window access, FDIC access, and the use of Fed Wire.  Plus they would be subject to other regulations on banks, including restrictions on affiliations with commercial firms.  I don’t want to do that and in many cases I don’t even see what it would mean to do that (how can we stop Sears from affiliating with a commercial firm?).  I conclude that we cannot escape some important legal distinction between bank and non-bank lenders.  Admittedly any such distinctions can become more problematic with the march of technology and the increasing sophistication of regulatory arbitrage.


In the case of a pawn shop and Sears, though (not sure about General Motors), isn't the big difference that they're not doing the "borrowing short" part of the "lending long, borrowing short" formula? If the pawn shop ponies up its own owner's cash/equity to supply a loan, then its ongoing business is less fragile than a bank's, because no one, as far as I know, can initiate a run on a pawn broker, any more than they can initiate a run on Sears (not sure on this one, though -- is Sears heavily in debt?). As far as I'm concerned, the lending isn't the big concern -- it's the coupling of lending with short-term liabilities of very similar magnitude.

Sorry. In last comment, please read "borrow" as "buy". So if you buy stock on margin, you should be considered a bank?

Doesn't business to business credit have the potential to help the companies that are known to be doing well? That seems like a crucial role to be filled when the regular banking industry refuses to make loans.

A run on a pawn shop would occur when everyone came in and paid off their pawn and picked up their tv sets and belt sanders. The pawn shop would have more cash and their back room would be empty.

A pawn shop is not a bank even though it fits that niche for the bottom strata of our society.

A run on a pawn shop would occur when everyone came in and paid off their pawn and picked up their tv sets and belt sanders.

There can't be a run that bankrupts because the pawn shop does not loan those items out to other people. In this type of run, the pawn shop would make a ton of money. The problem with banking is that the bank promises the same dollar to more than one entity. When you start leveraging, you end up promising that same dollar to 10, 20 or 30 different entities. It only takes a small percentage increase in defaults, or a smallish bank run to make the bank insolvent.

As for business to business credit, companies buy and sell on credit to each other all the time. It's a bit easier for companies to operate this way, so shipments can go out before an invoice is sent, a check cut and sent back to the vendor. This is far different than the highly leveraged world of modern banking.

This definition of a bank is too easy. To my a opinion, a bank is an institution that lends long and borrows short AND a contract (possibly legally enforced) that promises "careful" treatment of deposits.

In this sense, regulation is part of the contract between the depositor and the bank or a kind of consumer protection.

One should be free to choose other deposit contracts and thus to lend to non-banks.

Tyler's alarmism that financial regulation will extend to all business, no matter how small, is a silly propaganda distraction.

For the purpose of this additional regulation, only players (and actions) big enough to cause systemic failure are important. If you like a domino analogy, some dominoes are not big enough or close enough to topple others.



Anatomy of a Train Wreck: Causes of the Mortgage Meltdown
October 3, 2008

by Stan J. Liebowitz

Why did the mortgage market melt down so badly? Why were there so many defaults when the economy was not particularly weak? Why were the securities based upon these mortgages not considered anywhere as risky as they actually turned out to be?

This report concludes that, in an attempt to increase home ownership, particularly by minorities and the less affluent, virtually every branch of the government undertook an attack on underwriting standards starting in the early 1990s. Regulators, academic specialists, GSEs, and housing activists universally praised the decline in mortgage-underwriting standards as an “innovation† in mortgage lending. This weakening of underwriting standards succeeded in increasing home ownership and also the price of housing, helping to lead to a housing price bubble. The price bubble, along with relaxed lending standards, allowed speculators to purchase homes without putting their own money at risk.

The recent rise in foreclosures is not related empirically to the distinction between subprime and prime loans since both sustained the same percentage increase of foreclosures and at the same time. Nor is it consistent with the “nasty subprime lender† hypothesis currently considered to be the cause of the mortgage meltdown. Instead, the important factor is the distinction between adjustable-rate and fixed-rate mortgages. This evidence is consistent with speculators turning and running when housing prices stopped rising.

Anatomy of a Train Wreck is included in the forthcoming Independent Institute book, Housing America: Building Out of a Crisis, edited by Randall G. Holcombe and Benjamin Powell.

Stan J. Liebowitz is Research Fellow at The Independent Institute, Ashbel Smith Professor of Economics and Director of the Center for the Analysis of Property Rights and Innovation at the University of Texas at Dallas, and co-author with Stephen Margolis of Winners, Losers, and Microsoft: Competition and Antitrust in High Technology, published by the Independent Institute.


They should have given the Nobel to Stan J. Liebowitz. He's been hollering for many years about the government's drive for "relaxed lending standards" to improve minority and low income home ownership.

A bank is an entity chartered by the government to borrow money without collateral.

Banks do more than just lend long and borrow short.

Banks create money.

Do pawn shops create money?

To put this in another way:

The reason banks need to be regulated *at all* (beyond the normal anti-fraud regulations applicable to all industry) is bank runs.

Bank regulation is based around preventing bank runs, and when they happen, preventing them from having further long-term bad effects.

Since the purpose of bank regulation is to prevent bank runs, any entity which is subject to bank runs needs to be regulated like a bank.

The entities which are subject to bank runs are those which mismatch their borrowing and lending maturities by borrowing short-term and lending that money out long-term.

Therefore all such entities (and no others) should be subject to banking regulation.

Simple, isn't it?

Comments for this post are closed