*Jimmy Stewart is dead*

So says Larry Kotlikoff, in his new book, entitled Jimmy Stewart is Dead: Ending the World's Ongoing Financial Plague with Limited Purpose Banking.  It's lively and polemic, and suddenly it lurches into a proposal to reform financial intermediation:

Under limited purposes banking the banks are themselves simply financial intermediaries, while their mutual funds represents mini-banks, if you like, all of which are subject to 100 percent capital requirements.

Explained another way, you hold liquid securities directly and cut out the middleman of the lending bank.  It's like expanding the idea of a checkable money market mutual fund to cover the retail banking sector.  Here is his short Op-Ed on the idea, here is a Business Week article, and here are numerous endorsements for the book.  See also Bob Litan on "narrow banking." 

I used to advocate a version of this idea myself, but I no longer think it is a good reform proposal, for a few reasons: 

1. There aren't enough safe, liquid assets to cover the stock of bank deposits.  There would be even fewer safe, liquid assets if fiscal conservatives had their way.  And we've now learned that the commercial paper market can seize up and shut down and AAA securities aren't always so safe.

2. Holding T-Bills eliminates the need for the bank intermediary and the resulting problems of moral hazard.  But remember — these ends are achieved only by lending that money to the government.  What's the old saying?: out of the frying pan, into the fire…

3. A lot of what current banks do would be replicated by non-bank commercial lenders and the risk of the banking sector would be transferred somewhere else.  Ideally, these non-bank lenders would engage in greater "maturity-matching," but if banks will exploit the moral hazard problem won't these lenders exploit it too?  The financial crisis very much changed my mind on this question.  Can't such lenders, to policymakers, appear "too big to fail" in the same way that standard banks do?  Are General Motors, AIG, and GE Credit really the path to future financial sector safety?  Maybe there is room for improvement, by using more commercial lending, but it is murky and I no longer see a clear gain in this regard.

Here, by the way, is a Bert Ely critique.


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