Swiss Referendum on 100% Reserves

A Swiss group has collected the 100,000 signatures necessary to require a national referendum on requiring banks to hold 100% reserves.

In a nut shell, the proposal extends the Swiss Federation’s existing exclusive right to create coins and notes, to also include deposits.  With the full power of new money creation exclusively in the hands of the Swiss National Bank, the commercial banks would no longer have the power to create money through lending. The Swiss National Bank’s primary role becomes the management of the money supply relative to the productive economy, while the decision concerning how new money is introduced debt free into the economy would reside with the government.

After interest in the 1930s Chicago plan of Fisher and Simons died off, Murray Rothbard and other libertarians were virtually the only people calling for 100% reserves. More recently, however, the idea has almost become mainstream. Consider Martin Wolf’s FT column:

Printing counterfeit banknotes is illegal, but creating private money is not. The interdependence between the state and the businesses that can do this is the source of much of the instability of our economies. It could – and should – be terminated.

…Banks create deposits as a byproduct of their lending. In the UK, such deposits make up about 97 per cent of the money supply. Some people object that deposits are not money but only transferable private debts. Yet the public views the banks’ imitation money as electronic cash: a safe source of purchasing power.

Banking is therefore not a normal market activity, because it provides two linked public goods: money and the payments network. On one side of banks’ balance sheets lie risky assets; on the other lie liabilities the public thinks safe. This is why central banks act as lenders of last resort and governments provide deposit insurance and equity injections. It is also why banking is heavily regulated. Yet credit cycles are still hugely destabilising.

What is to be done? A minimum response would leave this industry largely as it is but both tighten regulation and insist that a bigger proportion of the balance sheet be financed with equity or credibly loss-absorbing debt.

…A maximum response would be to give the state a monopoly on money creation. One of the most important such proposals was in the Chicago Plan, advanced in the 1930s by, among others, a great economist, Irving Fisher. Its core was the requirement for 100 per cent reserves against deposits. Fisher argued that this would greatly reduce business cycles, end bank runs and drastically reduce public debt. A 2012 study by International Monetary Fund staff suggests this plan could work well.

Similar ideas have come from Laurence Kotlikoff of Boston University in Jimmy Stewart is Dead, and Andrew Jackson and Ben Dyson in Modernising Money.

Hat tip on the Swiss proposal to Dirk Niepelt who offers further comment.


And this could never have been conceivable as a realistic proposal without QE and the Great Recession.

The firms which gave you the Great Recession were AIG (an insurance company with a unit which had gone whole hog into credit default swaps, a financial instrument that did not exist prior to 1995), Fannie Mae (government sponsored mortgage maw), Freddie Mac (ditto), Lehman Bros. (a securities firm with about five or six lines of business), Merrill Lynch (ditto), Bear Stearns (ditto), Citigroup (a universal bank heavily involved in the capital markets and for which 2/3 of their deposits were domiciled abroad), Countrywide (a non-bank mortgage lender), Washington Mutual (a savings bank), and Wachovia (a bank with a retail brokerage appended). Only the last two were conventional deposits-and-loans banks and their problems could have been dealt with by extant institutions using extant practices (i.e. by the FDIC). Washington Mutual had spent a decade and a half taking advantage of perverse incentives in the Community Reinvestment Act to get its mergers approved, and had grown quite large as a result. Fractional reserve banking is not what blew up the financial system, so 'responses' to the recession which incorporate nostrums like that under discussion are non sequitur. No clue what you fancy the reaction to QE to be,

Don't forget the Reserve Fund and the other money market funds. (Definitely not banks, and with no outstanding debt.) The day I say Paulsen at his most ashen was the day Reserve failed and people feared that the entire commercial paper market would collapse.

That was a knock-on effect of Lehman's implosion.

I don't agree. If the Lehman CP had been held by a bank, it would have been a big nothing. It was the failure of a money market fund that froze the CP market.

The way I see it is with our current fractional reserve banking system failure of fractional reserve bank leads to weakening of all the other fractional reserve banks and 100% reserve banking would end that. So would some forms of free banking, which I think would be better.

I think as a practical matter, I. e, in the real world 100% reserves would mean that a deposit of 1,000 Swiss francs would require the bank to deposit 1,0000 Swiss francs in the Swiss National Bank. Right?

If so, the bank can't lend the money. Am I right in concluding that the Swiss National Bank will have a monopoly in lending Swiss money?

Would that mean the end of financial intermediation?

I have seen theories that there are two types of banks: deposit banks which hold people's money in safekeeping, usually at a fee; and credit banks which lend out the money. With 100% reserves where is the income from a a bank accepting deposits?

I thought libertarians hate the Fed. Why are they for 100% reserves?

What's the idea? Is it that if the bank borrows $1 from a depositor, it must keep $1 on hand, as cash, with which to repay him? So a bank acts largely, or partly, as a vault? Is that it?

What then does it lend to borrowers: money it's lent by the government/central bank?

Perhaps the goal is a clear separation between passive deposits versus investments?

Yes, honesty in such voluntary contractual arrangements would be a bare minimum.
"Investors" know their money is being used by others and there's risk involved, bank depositors do not.

Fractional-reserve banking (far less than 100% reserves) is fundamentally fraudulent and contradictory to a free market. A specific $100 can not have multiple individual owners with full legal claim to it.

Bank depositors are systematically deluded, believing their bank is safely storing their deposits. But the bankers both lend out those same deposits and create far more "money" out of thin air. A nominal bank with $1000 of real deposits can loan out $10,000 by "legal" creation of demand-deposit/checking accounts with phantom but spendable Dollar balances.

A very sweet deal for bankers-- they don't have to earn /save money before they can lend it out -- they simply counterfeit money with government blessing and vigorous encouragement.

Your money ain't there with fractional reserve banking. Most people are clueless on how the banking system really works, including Congress and the President.
Janet Yellen understands it perfectly and knows her job is to keep the con-game going as long as possible, while funding astronomical levels of government debt.

I think a fractional reserve system works OK for all parties involved till you have massively correlated loan risk events.

I think the economy has changed over the last decades in ways that increase these correlated risks.

I think a fractional reserve system works OK for all parties involved till you have massively correlated loan risk events.

Right, so once you figure out that such a system creates "massively correlated loan risk events" as a matter of course, you see that it's a dumb system. The other term for it is "maturity transformation" and it is stupid.

"Yes, honesty in such voluntary contractual arrangements would be a bare minimum. “Investors” know their money is being used by others and there’s risk involved, bank depositors do not."

Regarding the US, everyone's account is Federally guaranteed up to $250,000 and you can get multiple accounts in different ownership categories each of which is covered up to $250K. So, median bank depositors have no risk. And it's doubtful if very many people with balances significantly above $250K aren't aware of the minimal risk involved.

Bank depositor's money is being used by others. There is risk involved. It's just that this risk is being borne by the taxpayer rather than the depositor. Bank depositors who are taxpayers and taxpayers who aren't depositors have plenty of reason to be unhappy about this state of affairs.

"It’s just that this risk is being borne by the taxpayer rather than the depositor."

Yes true, that's why I said "median bank depositors have no risk".

This proposal doesn't significantly change the level of risk. Both, the taxpayer risk and the depositor risk remain approximately the same.

In the USA, banks pay FDIC to insure depositors. So long as the premiums reflect actual risk, it is the depositor who pays for his own insurance.

So long as a bank's assets (its loans) are worth more than its liabilities (depositors' accounts), a bank is still solvent as it can sell its loans to raise money with which to pay off depositors (although a central bank may be necessary to insure liquidity, so depositors can be paid off promptly).

Moral hazards have been created by governments which have rescued insolvent banks, and are perhaps implicit in the assumption that general funds are likely to be used to pay off depositors if FDIC's funds runs dry.

BTW, a risk inherent in over-regulating banks is that banking activities migrate to so-called "non-bank banks," that is, entities that do much of what banks do but outside a government's regulatory framework. An obvious (if old) example was the migration of bank deposits into non-insured money-market funds, way back when interest rates soared and government tried to limit banks' losses by imposing a ceiling on the rate of interest banks could pay their depositors.

Who "does not know" that banks lend depositor's money out?

Who, having been first informed by your ominous warnings will run to withdraw their deposits to end this fraud?

Who prefers to pay a bank to hold their funds rather than receive interest? How is a deposit account different from buying a short term bond?

How frequently have banks failed to produce depositor cash on demand?

Like so much of the other Randian nonsense, you live in a fictional world. There are many risks involved with financial markets, but your sixth-grade understanding of the problems were resolved by deposit insurance, capital requirements, and overnight lending of reserves decades ago.

Like every other reactionary, you long for the days of yore without measuring why we left them behind.

You are a fool. The system is a failure and a fraud, your sixth-grade civics-lesson understanding of it notwithstanding.

"Like so much of the other Randian nonsense, you live in a fictional world. "

You seem to be missing the obvious facts, that this is a Swiss referendum. Which means it's hardly a fictional world. All of the talk about the effects of something similar on the US banking system is merely idle speculation, and you seem to be taking it far too seriously.

Imagine if someone asked to borrow your car.

OK, so far so good. But imagine they could somehow re-lend the car to 10 different drivers.

You are not sure if the drivers are safe driver or reckless drivers, but even if they are fairly safe, the risk of a car crash is increased.

While such a system is kind of neat - creating cars out of nothing, that extra risk of car crashes is something.

I also wonder if a lot of people really don't know that banks lend out their savings to more than one person.


So there are 100,000 fools in Switzerland. What does that prove?

"OK, so far so good. But imagine they could somehow re-lend the car to 10 different drivers"

Err no. A bank doesn't 'relend' your $100 to ten people. A bank can only lend your $100 to one person. Let's follow it more carefully:

Process begins when someone puts $100 into their account at the bank.

The bank keeps $10 in reserve (say a 10% reserve requirement). It loans out $90 to a business person.

The business person takes his $90 check and puts it in his bank. Maybe it is the same bank or maybe it is a different bank. It doesn't last long. This loan is part of some expansion project so he quickly cuts a $90 check to some supplier (say a painter). The painter takes his paycheck and puts it in another bank.

Now assuming this money is likely to sit still for a while, the process begins again. The bank takes $9 and holds it in reserve and issues $81 in loans to other people.

The deposits in the system count as money supply but only in a fictional world is the actual deposit creation process result in ten times the initial deposit. Along the way all it takes is someone to use their checkcard and zero out their account and the process will stop before you hit ten times. Even if that doesn't happen, the process of using a loan, making payment to someone, and then a new loan being created to someone else will take time. Only in a fictional world where an infinite number of transactions can happen in a finite period of time will you get the full multiplier effect.

Second, the bank doesn't get to create money. It gets only to receive deposits. Suppose the first bank in the process was very questionable. A person might be willing to take their money as a loan but wouldn't leave his own money in that bank. So while he leaves the loan department with a check for $90, he only puts that check in his own bank.

So when he walks into his own bank with a $90 check to deposit how does that bank know that check is 'created' money via the deposit process versus, say, just a regular payment the businessman received from a customer? It doesn't, which makes this fraud charge pretty questionable.

He said "multiplier effect"—everyone drink!

Its an analogy, and its hard to lend 0.9 of a car.

A nominal bank with $1000 of real deposits can loan out $10,000 by “legal” creation of demand-deposit/checking accounts with phantom but spendable Dollar balances.

No. It can't. Try constructing the bank's balance sheet and you'll see. What it can do is lend out $90 (or some other large fraction) of the $100.

@RWJ but historically if you wanted your money to not be lent out you put it in a bag. People then knew that they were putting their money at risk.

But how about if currency was first claim equity in the bank who printed the currency?

But if the bank's job is just to take your cash and hold on to it, you can forget getting any interest. Just the opposite, you will have to pay to keep your money there.

"“Investors” know their money is being used by others and there’s risk involved, bank depositors do not." Depositors must be really stupid where you live.
"Bank depositors are systematically deluded, believing their bank is safely storing their deposits. " Where do these morons suppose their interest comes from, then? Why do they think banks give loans, and with what?

Would this require massive securitization of loans? Or I guess all loans could be backed by equity.

Also wouldn't this require negative interest rates on deposits (or fees).

Narrow banking is another word for it, and not only Martin Wolf (in his book, "Shifts and Shocks" but also Paul Krugman endorse it. The banks becomes just a middlemen, with no ability to create more loans via the multiplier 1/1-x where x<1. So if a person wants to take a 30 year loan out to buy a house, there as to be a depositor who is wiling to buy a 30 year note. Banks don't act as intermediaries to match liabilities and assets, just middlemen. That's my understanding. It's safer and needless to say it should cut down the amount of loans lent out, unless the government steps in and starts supplying loans directly to consumers.

That's a big "unless." The government (US) is already lending huge sums to college students, many of whom won't repay the loans, and to others as well. The last thing we need is politicians getting votes by promising loans on good terms to many other groups. As badly as the banks may have behaved, the government is unlikely to do better.

The political will in the U.S. already demands a government role for ensuring widespread access to affordable housing loans; if policies to prevent banks from assuming the risk inherent in those loans cut off the current paths to that credit, there isn't really a question of whether and where the flow of credit will reroute.

And it also provided a handy scapegoat for their policy failures.

The central bank since 2008 has managed to paint itself as the savior as it ran around diligently buying up the mistakes of these foolish business people. Great story. Removing the middleman won't help the situation but will put the blame where it belongs.

"The government (US) is already lending huge sums to college students, many of whom won’t repay the loans, and to others as well "

Evidence? Most student loans are repaid, even ones that end up going delinquent still end up being repaid and/or interest/fees far exceed true losses on student loans.

A request for evidence demands evidence.

"Most student loans are repaid, even ones that end up going delinquent still end up being repaid and/or interest/fees far exceed true losses on student loans."

Let's see it. If I'm reading this correctly seems to indicate a 3 year default rate of about 10% or less.

Even when default happens, the gov't often gets back more than was originally borrowed. You may recall this MR post:

Keep in mind while it is easy for someone to become delinquent on their student loans it isn't at all that easy for someone to simply stiff the gov't for their lifetime. You can't make your student loans go away easily in bankruptcy and unlike other types of debt like credit cards, the gov't can do things like keep your tax refund. Unless you die young or spend your entire life never making a serious living, chances are you sooner or later you're going to pay off your student loans and when you do the interest and penalties you pay will more than offset those who don't.

Interesting, from your data I think it's really debatable whether or not government backed student loans are a good thing. But looks pretty strong that the government is getting it's money back.

A 30 year note from some guy I don't know? I would have no interest in that. I would just put my money in Treasuries or corporates. Mortgage rates would have to go into the double digits under that proposal before anyone got interested. Meanwhile, the bank would be charging me a fee to hold my deposit and process my checks. So every week I would have to call my broker, sell some Treasuries, and go to the bank and deposit just enough cash to cover that week's checks. I'm not seeing what I'm gaining.

IRL, what would happen is that new financial intermediaries would arise, people would flock to them, and eventually political and economic pressure would force the government to backstop those new institutions. That is pretty much what happened with money market funds, no?

Not really following this at all. There are few people willing to loan out their money for 30 years, but always plenty of people willing to loan out for 1 year. So I start my "Home Plus Inc." company. I issue 30 year mortgages at 4% but sell one year notes at 1%. I pocket the difference. I'm not acting as a bank since I'm not taking deposits. Of course I run the risk that rates will rise in the future, that my mortgages won't pay out, that at some point when I try to re-up my notes I won't find buyers but if I was careful and smart I could use some of that 3% spread to buy various types of hedges that would insure me against those risks...

Yet nonetheless this still seems to be able to generate a crises. If some massive financial panic meant that no one wants to buy 1 year notes...even though I have a decades long record of safety and reliability, I could be tossed into bankruptcy. Eliminating fractional banking hasn't seem to solved the problem.

@Boonton - if you have customers dumb enough to give you money, then all power to you. What don't you understand? Same with y81's comment--there's plenty of people, mostly institutions, that are mandated to invest in 30 year notes. These notes would be attractive to these people if they were guaranteed by a GSE like a Fannie Mae.

I'm not following why customers would be 'dumb' to invest in such an enterprise? How is the enterprise I described any dumber than, say, buying 1 year notes from on the assumption their new drone delivery system will make them billions or notes from on the assumption that billions will keep looking at ads a year from now?

My point here is that there's no reason to think 100% banking would require a 30 year borrower to be paired up with a 30 year lender. A 30 year loan could be assembled by borrowing on 1 year terms 30 times.

As for what institutions are mandated to invest in, presumably any radical change in our financial systems would alter mandates.

The government is going to guarantee every home mortgage??!! Whoo-hoo! Mother of all bubbles, here we come.

That's how the banking sysem started. Like Rahul said, you would have a system where demand deposits are 100% depositor's money (which would require a fee structure) and an investment side, where savers deposit money to earn returns. Credit would be tight and the economy would be much smaller. Some, me included, would call this 'sustainability.'

The real question is, given a free choice, how much of money would get parked in the fee-based-deposits.

Although voters love to scream murder when fractional reserve banking burns them once in a while, they are also addicted to the benefits it brings when the going is good.

Very few people can pass a free lunch. When the guy next door is making interest on his money how many people will consciously choose the for-fee deposit option?

"The real question is, given a free choice, how much of money would get parked in the fee-based-deposits."

Probably about the same that is currently parked in "checking" accounts. Savings accounts would probably disappear (or at least drop down significantly from what they are). And all the money in CD's would probably transfer over to the investment side. However, I suspect that might well increase risk. And currently a lot of seniors use CD's (with FDIC coverage) and assume they have close to 0% risk. So this could cause political problems.

There are people who are still in fee based transaction accounts. We call them "poor."

It costs several hundred dollars a year for a bank to operate one checking account. Those costs have to be paid. If not by fees, then they are paid by the net interest margin of lending the funds.

While I'm quite sure that our financially ignorant populace by and large may not know that banks lend out their money, they operate AS IF they do know. In answer to your intelligent question, few people having learned the mystical secrets heretofore known only to the banking cult and their anarchocapitalist foes would abandon the exchange.

There is much to criticize in banking. The slim chance of a liquidity run is near the bottom of the list. That fear demonstrates only a tenuous grasp of the facts.

To be fair, I don't think the fees charged by banks to the "poor" accounts reflect the true costs. Basically, the banks charge them the current fees because they can.

If we were to massively move to a fee-based banking system my estimate is the actual fees would be far lesser than several hundred dollars a year.

The fee-based transaction accounts might also act as loss-leaders to bring in the investment accounts by the same customers.

This may be a stupid question, but would the economy necessarily be smaller? Assuming the central bank creates the right amount of money, I would (simplistically) think it should be the same size.

In the past, it was smaller as creating money involved digging gold out of the ground or other difficult activities, but with fiat money that's not necessarily true.

As far as I can make out, the objections to this idea seem to boil down to people trusting central banks to control the actual money supply less than they trust private banks. Which seems absurd given that central banks are supposed to be controlling the money supply indirectly at the moment and private banks are obviously trying to do things (maximise their profits) that aren't well correlated with ensuring the correct money supply. (The objections tend to be that money will be too tight and there'll be hyperinflation)

Access to credit is the most important function of the banking system. Without banking there is an incomplete market for the expected value of your lifetime earnings.

Without credit intermediation, economic growth will be constrained because fixed costs will be enormous barriers to entry.

Debt can certainly be unwise for some people in some situations, but believing all debt is bad per se is a childish understanding of how markets make things possible. What's odd is that the people opposing the creation of and free operation of markets worship similar markets. What would they say if fractional reserve banks spontaneously arose? Who would police them in the absence of regulation?

Oh, I remember. Banks DID spontaneously arise in history.

If it were not legally allowed, then banks could operate this way until the first bank run.

Then they would be in jail for fraud, no?

Or at least when the final accounting was done and they had sold the same product to two or more people.

In China, they had people borrow against physical metal. When the bankers came to pick up their collateral after default they found the same metal had been used in several loans as collateral.

Would that be fraud?

If so, why not the reverse?

Very interesting. I suspect this is like fire...a nice tool that can also be destructive.

@Willitts - seems you have an idealistic notion of how banks operate. In practice they don't operate as you imagine but simply give money to existing corporations, smoothing out their payroll, and giving money to Fannie Mae/ Freddie Mac backed home buyers or super rich folks who don't qualify for government loan guarantees. Banks don't give money to startups, nor to new companies, nor to anything "risky". That's either self-financed or financed by VCs and the stock market. The US would lose very little IMO with narrow banking.

I would think that it would lend money that it gets from investors. They would presumably charge to mange people's demand deposits. I think it could work.

Cash is an asset of the bank. Deposits are a liability. The accounting equation is Assets = Liabilities + Equity. If the cash assets must equal the deposit liabilities, what you're left with are assets on one other than those generated by deposits and liabilities other than deposits, plus equity.

So shareholders could contribute capital which is then loaned, or the bank could issue debt (bonds, loans from other banks, etc.).

How would the transition look like? The banks call in early massive amounts of extant loans?

You can grandfather existing loans to make the transition smoother, seems to me.

What's the average loan duration in the banking system?

I don't know, but I'd speculate it's relatively short. Maybe 7 years for some large purchase, Car loans, etc. So the average would be lower than that. In any case, it's likely that a 90% transition would be less than 10 years and probably less than 7 years. You would probably have some odd ball cases hanging out for decades, but they wouldn't be significant.

It might also hinge whether you are averaging over loans or over loan amounts.

My guess is that the odd ball long duration loans will be of massively high value. e.g. industrial projects.

How do sinners and saints get to Hell and Heaven on Judgment Day?

It's interesting how much of Austrian economics can so easily be mood affiliated to the left.

You could try, but you would fail.

Is there any plausible benefit to this idea?

I can understand high reserve requirements, but 100%?

Is there any plausible benefit to this idea?


There are certainly *plausible* benefits. There just don't seem to be any *justifiable* benefits.

I don't see any benefits. Rothbard's argument against this was that fractional reserve banking is fraud, because you're telling people you'll pay them on demand but you can't do that for everyone -- it relied heavily on the idea of there being a commodity money that was actually just being stored. It was a natural rights argument. It was only a secondary argument that private credit creation results in malinvestment.

However, it isn't clear why this must be the case unless private credit creation is unconstrained, i.e. there is no natural limit. But there is a natural limit -- unless we commit to bailouts. In principle there shouldn't be any difference between a bank deposit and any other type of credit -- although it may serve as money, it isn't actually money because there is the possibility you won't actually be able to collect on it (loan default in the case of a loan, or the bank fails in the case of a bank desposit), so it is discounted.

Wolf's real problem with this situation is this: "Yet the public views the banks’ imitation money as electronic cash: a safe source of purchasing power." He neglects to note that the public reasonably views bank deposits as cash because of deposit insurance and near-certain bailouts. The risk of loss is zero up to $250K and still low above that.

Don't know what there is to do about it, but I think these concerns are misplaced. Fractional reserve banking is not fraud (and to the extent it is or ever was, this could be remedied by altering the contract, i.e. you might lose all your money by placing it here -- which I suppose would bring deposits under the securities laws) and if we're worried that it is unduly expansionary, we need to take a hard look at credit and lending in general, because it isn't any different (see negotiable instruments -- money given to one person in exchange for money-like note with less value than face value but with value nonetheless).

Exactly. How does the natural world define 'fraud?'

Anarchocapitalists live in a mystical world developing from ex nihilo axioms of right and wrong. Galt's Gulch wouldn't make it through the first winter.

Rothbard’s argument against this was that fractional reserve banking is fraud, because you’re telling people you’ll pay them on demand but you can’t do that for everyone

Why not, as long as you have a source of liquidity?

Effectively eliminating depositor risk is non-beneficial?

Like I said, it's not nearly sufficient to justify the costs to the system, but it's pretty clearly a benefit.

I think it has more to do with the situation where foreign inflows and the imbalances they have caused have been the driving force in Switzerland for a while. I'd call it a decoupling from the globalized financial system.

We imagine that all this stuff is about lending money to businesses and people. The real problem is sovereign lending. If Greece needs a loan to pay for their latest interest installment, someone can pony up the cash, deposit in a Swiss bank, the bank can then lend the money to Greece. Or if France wants this year's perpetual deficit financed, someone has to deposit enough cash to lend to them. The Swiss will do fine with the transaction fees, very fine indeed, but their whole economy won't be destabilized by the extreme flows that have been occurring.

And if the ECB wants to print a pile of cash to cover all these things, they can deposit it into a Swiss bank, and Portugal, Spain, Italy, France, etc. can apply for a loan against what has been deposited.

It won't happen of course.

I think that the benefit is that the failure one bank will not weaken the others.

I never understood how a government monopoly on money is a libertarian idea. But I am sure I am just missing something.

As I understand the philosophy, the libertarian idea is that the market decides what commodity becomes "money."

Banks in other countries will be more than happy to take over Swiss bank business.

As of late this has been the plan of the left to control the profligate bankers from pursuing their reckless ways. A less radical approach is to apply the 100% reserve requirement only with respect to new deposits - to give banks less incentive to grow. At least one commenter appreciates the irony of the mood affiliation of left and right.

I suppose the mood affiliation is confirmation that radical left and radical right are not that far apart.

left to control the profligate bankers from pursuing their reckless ways.

The London Whale worked for JP Morgan, not my local bank. Just deal with the casino bankers and leave the rest of them alone.

If banks are required to have 100% reserves, they would no longer be banks. They would be funds, like Vanguard or Fidelity.

A lot has been written on this subject under the term " Special Purpose Banking"

If all banks were converted to funds, then the depositor (investor) would purchase shares in various assets, like securitized mortgage pools, securitized credit card debt, or pooled assets (like bonds, equities).

The difference is that the depositor would accept all the risk, and the institution would merely be a facilitator of the purchase(a broker).

So are bank depositors willing to transfer investment risk from the institution to themselves? I don' t think so.

That's not entirely accurate. Banks that simply take and hold deposits would be just depository institutions, i.e. institutionalized vaults. Many would shift into a fund structure to work around the reserve requirements, but it would involve significant restructuring of their businesses.

Your argument seems exactly opposite of what I read these proposals to imply.

These proposals all aim to reduce depositor risk, not to increase it. I think it reduces the bank to a multi-location vault & a clearinghouse. It separates the depository function of a bank from its investment function.

How wise or effective that is, I do not know. I don't think it is impossible though: Isn't this the way banking started out before they figured out fractional reserves?

So are bank depositors willing to transfer investment risk from the institution to themselves? I don’ t think so.
Many people own bond funds and equity funds. So yes they are willing to take risk. No system is risk free USA treasure bills have inflation risk as do demand deposits.

Wait-what? We're eliminating banking but encouraging securitization? That seems exactly opposite to what both the left and right crazies (Bernie Sanders, Arnold Kling) advocate.

Well, at least something I can vote on that I give a shit about. Idiot proposal.

There are two ways this could "work," and neither seems like a good idea to me.

First, banks are required to keep all depositor cash in the vault. This greatly reduces the supply of credit to businesses and stymies economic growth.

Or, second, a bank deposit becomes, like other commentators have said, a claim on a pool of investment assets like stocks, bonds, and commercial paper. But then the savers will start treating those deposits as safe, like money, and we will get "runs" on these funds in times of distress unless the government guarantees them. See, for example, what happened to money-market mutual funds in 2008. And then we're right back where we started.

The first proposal reduces growth, yes, but if that's what depositors want, so be it.

Besides, the vault-mode isn't the only mode: All this does is gives customers the conscious choice to differentiate the holding function from the investment function of a bank.

A customer might still want his cash to be invested for higher returns but then he's actively accepting the associated risks. In reality we will see some mix of deposits-to-investments develop.

What ratio will be the natural ratio, I'm not sure.

Is there something wrong with 110%?

If 100% reserves are combined with (like there is today) minum ratios of capital, we will end up with something very similar to 110% reserves.

In the case of a run, there would be downward pressure on the price of the asset in the market. But it would not effect the institution...only the investors.

In the case of the money market run of 2008, there was downward pressure on that asset ( I don' t recall the name of the money market mutual fund involved)to "break the buck", but since the institution did not own the asset, the institution was stable.

So the depositor ( investor) bears the risk. Not the institution. If the FDIC were insure the value of these ( deposits) investments the FDIC would have to insure the entire market

It comes down to this fact. If banks are required to hold 100% reserves, they are no longer banks, and the depositors would bear all the risk. I think that is a good thing. But the typical depositor would likely just put their money under the mattress or in a safety deposit box.

Equity holders in the entity would bear the risk too.

It is sad to see this groundswell of support for prohibiting banking in its most traditional form, that is, the use of demandable debt to finance bank loans and investments. The sad truth of the matter is that the idea rests on a complete misunderstanding of the root causes of banking instability and crises. Unsurprisingly, many of its main exponents have been U.S. economists, whose understanding of banking has been skewed both by their tendency to generalize from U.S. experience (and very limited awareness of the experience of other countries) and by the misunderstanding of that experience. The U.S. banking system was uniquely crisis-prone, thanks to misguided legal restrictions of one form or another to which U.S. banks were subject over the years. There was nothing inevitable about the crises to which the system was exposed both before and since the Fed's establishment; and there's no merit to the view that such crises are a problem inherent in fractional reserve banking. That's true as well for recent experience. I am happy to supply sources on these points if asked.

The state of theory on the topic has sadly been no better than the awareness of the historical facts have been. The Diamond-Dybvig model is merely a model of the myth of inherent instability--and a Rube-Goldberg-ish model at that--uninformed either by the evidence or by a proper understanding of the nature of banking contracts. As for the suggestion that deposit-financed bank lending will simply be taken up by other sorts of intermediaries, that's the sort of thinking that comes from a very naive application of finance irrelevance propositions --akin to the foolish though popular reading of Coase according to which he is supposed to have claimed that it doesn't matter at all how property rights are assigned. (Kashyap's "Banks as Liquidity Providers" is a good antidote.)

Any fool can solve any one problem. Too many traffic fatalities? Ban automobiles. To much e-coli? Enforce vegetarianism. Banks fail or a run upon? Turn them into base-money warehouses. Easy. Way too easy.

So are Canadian banks the same as US banks, just historically lucky in not being unstable, or, as Calomiris claims, are they better regulated? I tend to think more the former than the latter.

Luck had nothing to do with it. It is actually simple to trace the U.S. crises to particular regulations--restrictions and branching, bond-deposit requirements for note-issue by national banks; the structure of U.S. bank reserve requirements. Canada didn't constrain ts banks in these ways. It is not, in other words, simply a matter of claiming that, since Canada had fewer crises, its regulations must have been better. We know why they were better.

As for numbers of banks, Canada around 1893 had about 30, with about 2000 branches. Entry was limited, but branch branch alone, and Canada's smaller size, account for the much of the difference between it and the U.S. Absent restrictions the U.S. might have supported a few dozen--perhaps as many as a hundred--important note-issuing institutions; it is doubtful that it would have supported many more. Back in 1890 the U.S. had several thousand note-issuing national banks, none of which had any branches.

The Swiss are indeed worried at the size of commercial banks, just UBS & Credit Suisse are 3 times the annual Swiss GDP. Add cantonal and other banks and Switzerland looks like Cyprus. , Regulators were aiming at 5-6% of Basel III leverage ratio.

However, Alex should have read the info in Français or Schweizerdeutsch before getting too excited.

5) Quel sera l'impact de la monnaie pleine pour les clients des banques ?

Dès le passage à la monnaie pleine, tout l'argent de tous les comptes qui servent au trafic des paiements, sera de la monnaie pleine protégée par la Banque nationale. Les banques commerciales devront gérer ces comptes comme des dépôts de titres. L'argent appartiendra aux titulaires des comptes et ne sera pas perdu en cas de faillite de la banque, mais il ne rapportera pas d'intérêts. Ceux et celles qui préfèrent percevoir des intérêts plutôt que d’avoir de l’argent sûr, pourront toujours mettre leur argent sur un compte d'épargne ou dans d'autres investissements contre intérêts.

"tout l'argent de tous les comptes qui servent au trafic des paiments", this only applies to money stored on personal accounts. Savings accounts and many more financial products are out of the scope of this proposal. The question now if which fraction of the capital of Swiss commercial banks comes from personal accounts. In the end, the effect of the proposal is to leave an account type out of the calculations of Tier 1 ratio. This proposal is for survivalist that think deposit insurance is not enough.

Finally, other Swiss people have a very different perception of CHF ups and downs:

I wrote too many words. For short, if the proposal wins it only affects a single financial product (personal accounts) among the many offered by commercial banks.

How would a banker react if he found out I pledged the same piece of collateral to 10 banks?

I'm going to simplify a bit. AIG was an insurance company. How did it get involved in the crisis? AIG sold insurance, a payoff in case of losses, to, among others, banks. Why did banks buy insurance from AIG? They wanted a hedge against losses on some of their riskier investments. Also, mainly, the banks wanted to make more money by avoiding posting collateral on trades, etc. In other words, banks wanted to avoid restrictions placed on them by Basel II, etc.

When some of these risky investments were downgraded, AIG was asked to provide more collateral against losses. Since they couldn't do this, they faced bankruptcy, unless, of course, the collateral could be supplied by the banks, which is called a run. If AIG went bankrupt, banks would no longer have insurance against losses on these risky investments. Losses to banks are partially guaranteed by govt deposit insurance, and implicitly guaranteed by lobbying.

I wrote this explanation based on comments on blogs I posted while the events were happening. The internet provides me a record of most of my comments posted on blogs, etc., since Aug of 08. I would say the comments previously posted provide more than enough evidence of why we need narrow banking, since people with some knowledge of banking, and I mean this sincerely, don't even seem to know what happened in 2008. In my view, the crisis was severely lessened when Citigroup, a bank, was saved in late Nov of 08 by the govt virtually guaranteeing all losses. If banks were not the cause of the crisis, why did a bank need a massive bailout?

It was a liquidity crisis - tight money. The Fed, obsessed with inflation, didn't print enough new money. And unfortunately the euro was far too tight at the same time. We began a recession in December 2007, but the periphery of the eurozone preceded us into recession. Once the ECB raised rates in July 2008 the european banks rushed to get their hands on dollars and boom.

The Fed was not 'obsessed with inflation', and readily provided more liquidity through Term Auction credit starting in the Fall of 2007. The rap on the Fed was that paying interest on reserves was contractionary.

The stupid reversal of the mark-to-market rules in place for 70 years, which happened in 2007, was perhaps the primary fuel that turned a banking shock into an existential crisis. Before 2007 bank shocks (like the S&L crisis) were not so damaging. Had that rule not been changed in 2007, there would likely have been no need for any bailouts, or certainly not at the scale we saw.

When Congress leaned on FASB to change the MTM rule back to how it had been before, the stock market (read: banking system) IMMEDIATELY stopped dropping, had a sharp reversal (March 9, 2009) and never looked back. The fever broke that very day.

Mark-to-market was instituted ca. 1993, replacing book-value accounting.


I was off by a year though, it was 2006.

With regard to derivatives, this was issued in June of 1998

This academic article was published in 2005

The money quote is as follows:

Until recently, a thorough-going marking to market of financial assets
and liabilities has been limited by the lack of reliable prices in deep and
liquid markets. Loans, for instance, have not been traded in large enough
quantities to give reliable prices. The lack of standardisation has also been
an impediment to marking the loan book to market. These practical hurdles
account for the “mixed attribute” nature of IAS 39.
All this is about to change. The advent of deep markets in credit deriv-
atives is removing the practical barriers to marking loans to market. The
price of a credit default swap can be used to price a notional loan correspond-
ing to the standardised counterpart of such a loan ,much like the price of a
futures contract on a bond which indicates the price of a notional bond.
Thus, whereas the debate on full-blown marking to market has not yet
taken place, it is easy to envisage such discussions taking place in the very
near future. Our paper is an attempt to anticipate this debate, and air
some of the issues at stake. Due to the double-edged nature of marking to
market mentioned above, it would be reasonable to suppose that the conduct
of financial institutions will be changed irretrievably by mark-to-market ac-
counting. Mark-to-market accounting has already had a far-reaching impact
on the conduct of market participants through those institutions that deal
mainly with tradeable securities, such as hedge funds and the proprietary
trading desks of investment banks.
However, even these developments will
pale into insignificance to the potential impact of the marking to market of
loans and other previously illiquid assets

Yes the paragraph you just quoted supports my take:

"All this is about to change. The advent of deep markets in credit derivatives is removing the practical barriers to marking loans to market."

That was written in the 2005 paper. What was about to change was called SFAS 157:

This happened in 2006. Just stop trying to win every exchange dude. You're wrong on this one. No shame in that.

Yes the paragraph you just quoted supports my take:

No it doesn't. Deposits and loans banks were not the epicenter of the insolvency problem, universal banks, securities firms, and the secondary mortgage market made up the epicenter.

And you wonder why the audience here thinks you are a foolishly consistent hobgoblin. You're flat out wrong. Securities firms, universal banks, and the rest all had MTM problems with their assets. It was a huge factor in the crisis. It's right there in black and white. Not that it matters that you don't get it, we're talking history here, it doesn't matter one iota that you don't understand this.

AIG sold insurance, a payoff in case of losses, to, among others, banks. Why did banks buy insurance from AIG?

AIG Financial Product Unit sold credit default swaps on mortgage pools (without having a clue about the composition of those pools, which were massively infested with subprime loans). Unlike others involved in those side bets, they only sold protection rather than buying and selling. Pretty irrelevant to the crank discourse against fractional-reserve banking (which is known, without redundancy as 'banking').

Fortunately, the 100% reservers haven't yet realized that credit cards are money, so there are no plans to force credit card companies to maintain 100% reserves.
This means that the extreme tight money conditions created by the 100% reserve requirement will be offset by people using their credit cards.

Why would I want to deposit my money in a bank if the bank can't pay me for doing so?

1. They can protect it better than you can.
2. It simplifies making payments.
3. The bank probably isn't paying you much to do so - 0.1% p.a., maybe 0.5% p.a. Which, given that the money isn't staying around for long (what is the average amount in a current [checking] account, I wonder?), isn't much. If you've got an average of 5000 pounds in your account, you're gaining an amazing 25 pounds a year at 0.5% interest.

You could still put it in a savings account, on the understanding that they will take your money and loan it to businesses and would-be homeowners, with the bank giving you some of the interest. If you're using a mutualist bank, that could well be a large majority of the interest...

As they say, there is still a red flag waving over the London School of Economics.

Wolf and British economics generally, place much more confidence in the ability of the state to regulate and drive the economy than most other countries. There is an implicit distaste for the market in most of Wolf's writings these days in the FT. Seems to be a cultural weighting towards the central plan of a regulatory body or government owned entity.

That may have something to do with the quality of the civil service. John Derbyshire, who grew up in England but lived for considerable periods in the Far East (in China, Singapore, and Hong Kong), has said that the U.S. has just about the worst corps of government employees he's encountered anywhere. Building public bureaucracies is not what we do. Megan McArdle has offered the opinion that the SEC is an abnormally professional agency. Well, Harry Markoplous broke his pick trying to get them to take an interest in Bernard Madoff, in large measure because he was attempting to make his case to a lawyer. Lawyers are verbalizers and often innumerate, and the young woman he was talking to did not have the sense to seek counsel from someone who could understand the proofs Markopolous was offering. That's command-and-control regulation as its practiced in this country, which may be one reason you have systemic differences in disposition toward it.

Yes 100% reserve banking is the way to go to get rid of the moral hazard of "too big to fail". This is the fact that banks will attempt to leverage as much as possible on the basis that the people lending to them (both bond purchasers and short term depositors) know that they don't have to do an due diligence because the state will bail them out. Leveraging is great for making great profits, leading to bonuses, but it makes the financial system very fragile.

For those who think that this is somehow increasing Government control - actually it is lessening it. Currently, due to the moral hazard problem, regulators have to spend a great deal of time and effort trying to figure out if banks are covertly over leveraging them. Buffet spoke about this once about how unrealistic it was to expect a relatively poorly paid regulator with no financial interest in the matter to not be fooled by highly paid merchant bankers with a very material interest. With this proposal we won't need regulators, just a law that if broken leads to criminal convictions by the people breaking the law.

As Alan Greenspan discovered, you can't rely on the bank shareholders in the banks to fight the overleveraging battle either - they are also directly on the side of the moral hazard existing.

This is just Austrianites goofing around again with the low Swiss referendum threshold, but it's funny how variously and weirdly this idea is understood.

These guys would really wish that that nobody be able to create money by requiring that money be only gold (since they already lost that referendum, it's a bit odd to be pressing this one). It's Wolf who wants money creation to be a government monopoly.

What may be unclear given the weird way it's explained is that commercial banks would still issue demand deposits. But they would have to keep 100% of the cash on demand deposit in reserve deposits or in their vault. The central bank would control the maximum possible amount of demand deposits by controlling the base money supply, but the actual amount of deposits would still depend on people's choice whether or not to hold paper currency or deposits.

I haven't looked at this particular proposal, but usually proponents want also to restrict how time deposits can be used so that the time commitment of the investment can't exceed the time commitment of the deposit.

It would of course radically change the nature of banking. I tend to think it would lead quickly to the creation of pseudo-banks offering fractionally reserved de facto deposits.

The banking industry began with the storage of precious metals. This is no longer the case as money as we know it is pixels stored in a server somewhere. Banks once loaned equity against collateral, a system that survives in pawn shops, who take possession of the collateral, which is redeemed when the loan is repaid with interest. The pawn shop doesn't operate on a fractional reserve system, all the moneys it loans are the equity of the shop owners. It doesn't store customer's money. The idea that banks are needed to store money is technologically obsolete in the current financial system.

"The banking industry began with the storage of precious metals." No it didn't:

Comments for this post are closed