Believe those who are seeking the truth. Doubt those who find it. Andre Gide


Monday, May 2, 2016

On Cochrane's dream of equity-financing banking

John Cochrane has a dream where the banking sector is financed entirely with equity. The dream is premised on the notion that debt-financed endeavors--especially those using short-term debt--are prone to runs. Run-prone structures can cause, or contribute to, financial crises. The possibility of crisis invites government regulation. Government regulation leads to regulatory arbitrage, much of which occurs in the shadows of the financial market. Which leads to more (now harder-to-monitor activities), leading to ... well, you get the picture. Why not just structure a regulatory framework that permits equity-financed banking ventures, like SoFi, to weave their (run free) magic? It's a good question. I'm not sure what the answer is. But I wonder if it's all as easy and straightforward as Cochrane makes it out to be.

I don't want to nitpick here but, I don't think I'd classify SoFi as a "bank" in the legal or economic sense. True, SoFi is acting as a financial intermediary. But insurance companies and pension funds are also financial intermediaries, and we do not think of them as banks. SoFi is more like a venture capital fund. It sounds like it's doing a wonderful job matching savers to borrowers. But matching savers to borrowers is not (the main) business of banking. Even a simple bond market matches savers to borrowers. We do not need banks to do that.

So what do banks do? We can get a grasp of their business model by comparing the structure of their balance sheets to other financial intermediaries. In many respects, the asset side of these balance sheets looks broadly similar: they consist of cash reserves, bonds (government and corporate) and other securities. Retail banks also hold personal and small business loans, which they typically originate as a part of their business. The differences on the liability side of financial intermediaries are much more striking. Pension funds issue time-dependent liabilities. Insurance companies issue state-contingent liabilities. Banks issue demandable liabilities. In all three cases, one wouldn't be so far off in forming the impression that financial intermediaries are fundamentally just "asset-transformers" (they transform a set of assets into structured liability products that people find useful).

Banks, in other words, are in the business of supplying a particular structured liability product: the demand deposit liability (DDL). It is Cochrane's worst nightmare. That's because the DDL is a "fixed-value promise." Specifically, a DDL promises redemption at (or close to) par for cash. But it's even worse than this because the promise is to redeem on demand (rendering the DDL a form of short-term debt). Worse still, the banking system does not possess enough cash in reserve to honor these short-term obligations in the event that all DDLs are presented for redemption at once (this is what it means to be a fractional reserve banking system). And as if things could not get any worse, they actually do. These bank-created DDL products -- they're used widely as payment instruments. That's right, banks are in the business of creating money (out of their assets).

Before I go on, I want to say something about the manner in which "deposits" is used in discussions of banking. It is sometimes said that "banks take deposits." But what does this mean? Even a Las Vegas slot machine takes deposits (and issues a very unattractive state-contingent liability in exchange, I might add). Well, yes, I can make a deposit of cash at my local bank. And my employer "deposits" my paycheck in my bank account (in reality, just a debit-credit operation on a ledger). But this is probably not the best way to think about "deposits." I sometimes like to say that banks don't take deposits--they create deposit liabilities. Related to this notion, the banking system does not "lend out cash." The banking system funds its assets (including loan creation/acquisitions) by creating DDLs. (At the individual level, banks need to acquire cash to fund their operations only to the extent they want or need to meet some reserve requirement). Cash finds its way into circulation whenever the owners of DDLs exercise the redemption option embedded in the DDL contract. Alright, with this out of the way, let me continue.

It's not been easy to discover the fundamental economic (or social) rationale for banks (defined here as intermediaries that fund their assets, including their loans, through DDLs). Economists have struggled to understand debt, never mind demandable debt. Probably the best theory of bank debt we have is still the Diamond and Dybvig (1983) model. Like any model of debt, certain "financial market frictions" need to be present; else, the Modigliani-Miller theorem holds, in which case we should all be living in Cochrane's dream world (assuming no bad government fairy, of course).

The root frictions appear to be what economists label "private information" and "limited commitment." Among other things, limited commitment renders all sorts of assets, like our human capital, illiquid. In a frictionless world, there is no reason why I shouldn't be able to buy my Starbuck's latte by peeling off a slice of my house or my future earnings. It just doesn't work. That's what banks are for. They measure the value of my house, my future earnings, and they create DDLs that are backed by their assessed value of the collateral I have to offer. They would be performing an equivalent service by acting as licensing agents whose job is to verify the quality of the promises I issue (imagine an Andolfatto-IOU stamped as "BoA approved.") What's not entirely clear is why banks couldn't just get me the money I need by the way SoFi does--by first acquiring state-created money from willing lenders?

To put things another way, if banks are primarily in the business of payment services, why are they not limited to that business? Why are banks permitted to create money? (Why should banks help render my illiquid assets liquid?) Why not make banks hold 100% cash reserves? And then let the financial market handle matching lenders with borrowers, a la SoFi? This is the line taken by those who favor "narrow banking" proposals (see, e.g., Musgrave, 2014).

I have yet to digest all the arguments made by Musgrave and others. But they make enough sense to be taken seriously (so I plan to continue reading). I have a lot of questions. I am not bought into Cochrane's claim that equity is a run-proof security. The equity traded on junior exchanges, for example, does not appear run-proof (one can "run" to your stock broker and scream "sell, sell, sell!" just as easily as you can "run" to your bank to ask for your money). Moreover, there's a lot of evidence to suggest that equity makes lousy money. Gorton and Pennacchi, 1990 claim this is the case because equity is "informationally sensitive," and (senior tranches of) debt is not. Like it or not, most contracts are drawn up in nominal terms. In such a world, it would be terribly inconvenient, I think, to have floating NAV MMMF shares used as an exchange medium. People seem to like fixed-exchange rate systems (which is what DDLs are, after all).

What I would really like to see is how their claims stack up in a formal model. After all, the Diamond and Dybvig model does suggest the possibility of a trade-off. Maturity transformation enhances risk-sharing (when conventional markets are absent or too costly to operate), but potentially exposes the bank sector to self-fulfilling bank runs. A narrow banking regime kills risk-sharing but enhances financial stability. So in some jurisdictions, the switch to narrow banking might be worth making (although, there may be other ways to enhance the stability of fractional reserve banks, like central bank lender-of-last resort facilities, etc.).

I suspect that narrow banks might work relatively well in low-inflation environments, but possibly not so well in high-inflation regimes. The reason is because high inflation imposes a big tax on cash reserves (unless they pay interest, I guess). In such an environment, fractional reserve banks may be preferred as a way to escape the inflation tax by offering a higher rate of return on their DDLs. (Of course, it would be better to encourage a low-inflation regime, but that's not always possible).

So, these are just a few of the thoughts that came to mind after reading about Cochrane's dream. It's an interesting debate and I look forward to reading a lot more about it.

42 comments:

  1. “I am not bought into Cochrane's claim that equity is a run-proof security. The equity traded on junior exchanges, for example, does not appear run-proof (one can "run" to your stock broker and scream "sell, sell, sell!" just as easily as you can "run" to your bank to ask for your money).”

    My answer to that is that there is an important difference between a run on shares and a run on a bank. Banks hold households’ MONEY, and money is essential for daily business. Shares (and other assets) are not normally used as money. If the value of someone’s house suddenly halved in value, that would be a near irrelevant for them in the immediate future, particularly if the loan to value ratio was low. At least it would be irrelevant for the next few years – they might have to adjust their retirement plans though.

    Mervyn King made a very similar point in his “Bagehot to Basel” speech. See his passage (p.2) starting “..we saw in 1987 and again in the early 2000s, that a sharp fall in equity values did not cause the same damage as did the banking crisis.” See:

    http://www.bankofengland.co.uk/archive/Documents/historicpubs/speeches/2010/speech455.pdf

    “Like it or not, most contracts are drawn up in nominal terms. In such a world, it would be terribly inconvenient, I think, to have floating NAV MMMF shares used as an exchange medium.”

    The answer to that is that under a Cochrane system (which is the same as the “100% reserves” system advocated by Milton Friedman) “floating shares” are not used as money (except to the extent that anyone is free to try using absolutely anything as money, including bottles of whiskey, diamonds, etc).

    Under that 100% reserves system, the bank industry is split in two. One half accepts deposits and those deposits are held in a totally safe manner (to reflect the fact that the deposit taker has promised to return 100c in the $ to the depositor). The second half (which is equity funded) lends to mortgagors, businesses etc. So in the case of the US, the dollar would remain the basic form of money.

    For details on Friedman’s system see his book “A Program for Monetary Stability”, Ch3, under the heading “How 100% reserves would work”. Incidentally Lawrence Kotlikoff advocates much the same system, as do this lot:

    http://b.3cdn.net/nefoundation/3a4f0c195967cb202b_p2m6beqpy.pdf

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    1. Thanks, Ralph ... give me some time to read and reflect on your links.

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  2. You've not bought into Cochrane's claim that equity is run-proof? You two must disagree on what constitutes a run. I think Cochrane's point is that even if everyone screams "sell, sell, sell" the company cannot be forced into bankruptcy by the equity holders.

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    1. Yes, correct. Debt has the disadvantage of bankruptcy. But imagine have to quickly dispose of equity to meet payroll. The economic disruption is not necessarily avoided (even if it is mitigated) through the use of equity, is my point.

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    2. You mean issue new shares (or sell treasury shares) to make payroll? Pay the employees with shares. But more importantly, I think those aren't the kind of "runs" that ought to be avoided. Chances are good such a company should fail.

      Or are you imagining an economically significant fraction of profitable companies having to sell their own equity to make payroll?

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    3. Philip, paying your employees in shares won't help if they have to meet their rent in dollars.

      I'm just saying that I can imagine a "run like" phenomenon occurring with equity. "Chance are good such a company should fail" is not the correct answer. I'm talking liquidity here, not solvency. We need to be specific about the the type of trading frictions that exist, before coming down one way or the other on the question.

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    4. You've hit on the key flaw in the "run-proof" argument. The problem with bank failures is the losses to depositors due to a run. While it's true that an investment fund does not go bankrupt due to a stock market run, it is far from clear that the investors who are sold out in the run (defining "run" as a below-fundamental value price) will incur smaller losses or experience a smaller effect on their behavior than in the case of a bank run. The only substantive difference is that the bank "owed" them the money and the investment fund did not.

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    5. I think I see what you mean, but it seems implausible.

      I find it hard to imagine a scenario where a sudden drop in equity prices would be highly disruptive to healthy companies mainly because a large fraction of them rely on selling new shares to meet payroll and cannot do so.

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    6. There is a network effect with money: we don't want to search for sellers who will take our particular form of money, which means that we need to coordinate collectively on a limited number of exchange media. And this has happened: we now have payments networks (Visa, Mastercard, etc.) that accept a limited number of currencies, which all have the nice properties required by Gary Gorton for liquidity.

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    7. Syntheticassets,

      Contrary to your claim that there is no “substantive difference” between the existing system, and Cochrane’s run free system (apart from the substantive difference you mention) there is actually another substantive difference which I set out above – first half of my 2nd May, 8.55am comment.

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    8. I don't get what's magical about money as a liability. Banks offer immediacy and are leveraged. Under current SEC regulations (though not necessarily intended by the Investment Act of 1940) mutual funds too offer immediacy and may be leveraged (through derivatives exposure). Both are subject to fire sales and disastrous losses for investors. (Look up Oppenheimer Core Bond Fund.)

      Given the immediacy offered by investment funds, why does it matter that banks issue money?

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    9. It might be that discussion of liquidity spirals started recently, and you caught on to this idea quickly while others still have a focus on ideas that are better established (like bank runs). But there is also the fact that money is the basis of the payments system, and this makes it a greater concern during crises. I remember some talk that during the Lehman bankruptcy the payments system was at risk of going down without government intervention. Losses from other fire sales might also be quite large, but without causing this particular systemic problem.

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    10. Anwer,

      I get that. My point is that we can for argument's sake grant Cochrane and Musgrave the claim to have stabilized the payments system. They still have to convince us that they have found a workable means of funding business activity. For the purpose of this part of their argument I don't see how the fact that banks issue money is relevant.

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    11. I'm trying to think back to discussion with you a year ago. You pointed out that if we require equity finance for all investments, there is a cash-in-advance constraint: funds must be raised before they can be invested. And then you note that monetary finance is a good way to relax this constraint. But the option of monetary finance only exists because of the way that our payment system is structured around banks. Am I missing something?

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    12. You're not missing anything. But I tailor my arguments to my audience. I'm assuming that the proponents of 100% reserve banking don't have the same understanding of banks that I do -- and that explaining that view is too much for a blog comment.

      --syntheticassets (csissoko)

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    13. Yes, everyone is using a different mental model. With some people I would omit the word "bank" from the discussion and ask them to consider differences between ETFs and closed-end funds, and their comparative effects on systemic stability. Instead of talking about "money" I would simply ask if ETF liabilities should be standardized. Ah but here a reference to banking history would be useful.

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  3. ...also, I'd be interested in what you think of Chari and Phelan (2014) JME "On the social usefulness of fractional reserve banking." This paper and Cochrane are fairly persuasive.

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    1. I'll try to get to it when I find some time, thanks.

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  4. David: " In such a world, it would be terribly inconvenient, I think, to have floating NAV MMMF shares used as an exchange medium. People seem to like fixed-exchange rate systems (which is what DDLs are, after all)."

    I think that's the key. If two monies have fixed exchange rates (ideally, fixed at one) then both can circulate side-by-side, with people not caring which one they accept. "Will that be Bank of Canada dollars (currency), or Bank of Montreal dollars (debit card) sir?"

    On 100% reserves: it amounts to de-facto nationalisation of the asset side of commercial banks' balance sheets. The central bank buys banks' assets, in exchange for currency. As we approach the Optimum Quantity of Money, with 100% reserves, the government-owned central bank owns all the assets in the economy (assuming people are never satiated in liquidity, always preferring to hold more liquid to less liquid assets). There's a 3-way trade-off between: 100% reserves; Optimum Quantity of Money; and Communism. (I did a post on this once, but can't find it.)

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    1. Nick,

      I’m baffled by your ideas as to what 100% reserves consists of. Your description bears no resemblance to the system advocated by Milton Friedman and which he called “100% reserves”. Nor does it bear any resemblance to the system advocated by John Cochrane, Lawrence Kotlikoff, Positive Money and others, all of whom advocate much the same as Friedman.

      That system involves splitting the bank industry in two. One half just accepts deposits, which are kept in a totally safe manner. The other half lends to mortgagors, businesses, etc, and that half is funded by equity. The latter assets (i.e. loans to mortgagors etc) are certainly not, as you suggest, “nationalised”: they’re the property of the latter equity holders.

      As to the deposit taking half of the industry, it’s assets consist of base money (and perhaps also short term government debt, as advocated by Friedman). The ultimate owners of those assets are depositors.

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  5. My post was about the lending side of banking. There is, as David notes, a deposit taking side of banking. In my world, deposits are backed 100% by government debt. With $20 trillion of government debt outstanding, which the Fed could transform to overnight reserves, there is no need for “money creation” to be funded by lending. Since we are already holding that government debt, there is no change in flows, and no reduction of credit available for lending by making all deposits backed 100%.

    What is not established, and what sofi etc. deny, is some link — that something about lending, as opposed to stock market investing, building factories, etc. necessitates that lending be financed by short term runnable debt.

    "I am not bought into Cochrane's claim that equity is a run-proof security. The equity traded on junior exchanges, for example, does not appear run-proof (one can "run" to your stock broker and scream "sell, sell, sell!" just as easily as you can "run" to your bank to ask for your money)"

    This is a huge misconception (and addressed directly in “run proof financial system.”) When you run to your broker to sell, sure, you can sell; if we all do, we can drive prices down. But by selling stocks, you cannot force the company into bankruptcy. It is free to ignore the stock price decline. There is no promise from the company that you get your money back.

    This is precisely the point. We need a financial system in which people can lose money, assets can go down, but you can’t run to get your money back FROM THE COMPANY and force it in to bankruptcy if it does not comply.

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    1. But when investors in funds that have liquidated at fire sale prices learn how much they have lost, investors may decide they don't like investing in financial assets through investment funds. (BTW Illinois 529 plan is a good example of this in 2008, so you can probably chat to some colleagues about the experience of being in a fund subject to forced liquidations. And then imagine what investors would do if the only safe alternative is to finance government rather than business -- since money put in "run-proof" banks doesn't flow to business.)

      I don't see how the problem is different substantively from depositors deciding that they don't like holding their money in bank accounts.

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    2. I don't think it's true that investors selling the stock can't force a company into bankruptcy. A good deal of "banking" type service is about funding short term mismatches between cashflows in and out (I assume companies will have some sort of fixed liability like, as mentioned by David, payroll).

      We are then talking about a company covering a shortfall by issuing new equity, perhaps then buying it back when cash rich. If the equity value is driven down by mass selling then the company can go bankrupt, not because the old equity holders ask to redeem their equity at par, but because they can't raise enough money to meet payroll.

      As David correctly points out, the issue is liquidity, not solvency.

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  6. You are right that "equity-financed bank" is a misnomer, or a contradiction. In fact Cochrane wants the US Treasury to serve as our bank, by preventing others from issuing competing payment media. That doesn't yield a very elastic money supply. He says that we don't need elasticity, because $18T is more money than anyone could ever need, conceivably. I commented on his blog that he should reconsider that number: it's only about a quarter of world GDP.

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    1. “That doesn't yield a very elastic money supply.” Well if an elastic and privately issued money supply served a purpose, I’d be all for it. Unfortunately the reality is that the major gyrations in the money supply brought about by private banks simply stoke booms and exacerbate recessions. I.e. private banks act in a pro-cyclical fashion.

      Central banks then have to counteract that with countervailing changes in the amount of base money: witness the huge increase in the amount of base money since the crisis - all down to interest rate reductions and QE. In short, we’d be better off without the elasticity that comes from private banks and putting “elasticity decisions” – to coin a phrase - in the hands of central banks.

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    2. Ralph I see that as another missing dimension of elasticity. Banks make loans in dollars, which are quite fixed. Indeed the Keynesians warn us about deflationary spirals, where the debt obligations actually grow in real terms during economic downturns. Instead of preventing banks from issuing money, it should be a better, more loss-absorbing money that is connected with aggregate output.

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  7. "They would be performing an equivalent service by acting as licensing agents whose job is to verify the quality of the promises I issue (imagine an Andolfatto-IOU stamped as "BoA approved.")"

    Isn't that called a Banker's Acceptance?

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  8. Good post.

    Cochrane’s idea is a variation on the generic idea of the Chicago Plan of the 1930’s. It’s basically a bifurcation of existing banking into one entity (or entities) that offer demand deposits, and a complementary banking system that offers other types of liabilities or equity, although I guess Cochrane is interested in the equity only variation.

    The demand deposit entity(s) has government credit on the asset side. The companion system has private sector credit for the most part. These two systems must clear payments with each other, so that depositors can switch between holding demand deposits and funding private sector credit.

    The equity only version is an extreme case. Other versions allow matched term funding (not demand deposits) of private sector assets, so that liquidity risk is substantially reduced - but not entirely eliminated due to credit risk on private sector assets and eventual repayment obligations. The general idea of the Chicago plan and its descendants can be interpreted as tightened versions of what banks already do in managing liquidity risk according to their asset liability profiles. In that context, book equity is considered to be the best form of long term liquidity protection over a continuum of funding sources – consistent with Cochrane’s idea.

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  9. Let us imagine an economy with no fractional reserve. Let's say everyone uses precious metals.

    People sometimes lend or borrow this metal money, but the overall supply and demand of these services may be far from optimal. This economy could be in a permanent credit crunch with everyone paying a big cost of opportunity for investments not made and services and goods not available.

    A group of benevolent aliens lands and sets up a lending business. They have access to unlimited backing - a 20 mile asteroid made entirely of precious metals. But they do not want to flood the market with credit. That would only create overinvestment followed by bankruptcies. They effectively control the market interest rate and try to keep it in a range that promotes sustainable growth.

    The benevolent aliens also notice that the market for savings is not performing so well. People want better instruments to set aside some of their income towards retirement. So they provide that. They obviously also end up as the preferred provider of payments and transfers to people can stop carrying purses full of heavy metals.

    But nobody knows that the alien ship suffered a malfunction. They are stranded and cannot get to their asteroid or anywhere else. They have enough deposits from their savings and transfer activities that they can continue lending. Nobody needs to know - unless there is a run on their bank. Their (now fractional) metal-backed notes are an effective currency and everyone enjoys the increased liquidity and savings services they provide.

    In what ways is this scenario similar to our current banking system and in what ways is it different?

    One obvious difference is that our bankers are not exactly benevolent aliens and neither are the regulators supposed to keep them in check.

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  10. "But this is probably not the best way to think about "deposits." I sometimes like to say that banks don't take deposits--they create deposit liabilities. Related to this notion, the banking system does not "lend out cash." The banking system funds its assets (including loan creation/acquisitions) by creating DDLs. (At the individual level, banks need to acquire cash to fund their operations only to the extent they want or need to meet some reserve requirement). Cash finds its way into circulation whenever the owners of DDLs exercise the redemption option embedded in the DDL contract. Alright, with this out of the way, let me continue."

    What happens if no one wants to hold demand deposits? That means the borrowers who receive the demand deposits immediately redeem the demand deposits for currency and everyone uses currency.

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    1. The usual reason people do that is that there is some question about the solvency of the bank. Cochrane's narrow banking proposal aims precisely to eliminate that possibility.

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    2. What if there is no question about solvency? Everyone believes the bank is solvent.

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    3. That probably means that the bank is losing customers to other banks that provide better services. Cochrane would be very happy with competition in finance. His proposal is meant to prevent banking panics and rapid withdrawals.

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    4. What if there is no question about solvency and everyone wants to use currency and no one wants to use demand deposits? That means the bank is not losing customers to other banks.

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    5. Yes, this is one of the problems with negative rates: many people decide that it's better to keep their money under the mattress than at a depository institution. But rates still haven't fallen so low for this to be a big problem, so far.

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    6. What if there is no question about solvency and everyone wants to use currency and no one wants to use demand deposits?

      With a bank, there will probably be a shortage of currency. Will the central bank use its lender of last resort function to supply more currency?

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    7. That's a good question! If the central bank actually does this, it will basically own the banks and we end up with socialism. Can you see any way out?

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    8. Under my scenario along with an ECB type central bank, entities sell demand deposits to the commercial banks for currency. The commercial banks do not have enough currency. The ECB type central bank uses its lender of last resort function and provides the currency. Instead of the commercial banks needing to shrink their balance sheets to attempt to get more currency, the commercial banks sell those demand deposits to the ECB type central bank. That means the ECB type central bank expands its balance sheet, while the commercial banks do not need to shrink their balance sheets. This maintains the fixed exchange rate between currency and demand deposits.

      The ECB type central bank ends up owning all of the demand deposits. I would not consider that owning the commercial banks.

      Now for the real kicker, does the price inflation target have anything to do with the lender of last resort function?

      Sorry for the late reply.

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    9. It might be useful to widen the discussion using Perry Mehrling's concept of dealer of last resort. Bank shareholders own the loan origination business - they profit every time someone borrows money to buy a house. Someone needs to buy the securitized loans - we can let the central bank do this during a crisis. It can keep buying MBS later on if it has trouble generating sufficient inflation. Ultimately, the central bank owns a lot of the real estate, maybe a lot of corporate debt as well. Is that how it works now?

      Instead of buying that toxic junk, I would much rather have the central bank buy a lot of gold and keep it in its vaults. Stabilize things by signing a gold treaty with other central banks. Inflation and nominal interest rates might rise, and then it can go back to its normal job of fiddling with interest rates to stabilize the macroeconomy. If they want to get fancy they can use Nick Rowe's gold window in combination with Scott Sumner's NGDP futures contracts to do NGDPLT.

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    10. Why does someone need to buy the securitized loans?

      Before talking about gold targets or NGDP targets, my question above needs answered.

      Now for the real kicker, does the price inflation target have anything to do with the lender of last resort function (of the central bank to the commercial banks)?

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    11. If the banks keep the loans, and also denominate deposits in dollars, then they need a lot of equity to absorb potential losses. Securitization seems to facilitate the search for cheaper forms of funding. Government funding might a relatively efficient form, because the central bank enjoys convenience yield on its liabilities, which are always information insensitive. The government doesn't need to worry as much about solvency because it issues base money.

      All I can say about inflation targeting is that government taking on the risk of these loans interferes with that goal. I would much rather have a stable base money, and have banks issue a macroeconomic derivative that pays in terms of this stable base, than have the base fluctuate because the central bank is working too hard as a backstop. But I am not a central banker and am relying heavily on my own model of how this works, and people with direct experience could probably say a lot more.

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    12. "I would much rather have a stable base money, and have banks issue a macroeconomic derivative that pays in terms of this stable base, than have the base fluctuate because the central bank is working too hard as a backstop."

      It seems to me that if the conditions of lender of last resort function of the central bank to the commercial banks are:

      1) Valid demand deposit and

      2) Solvency and

      3) Price inflation target

      then the system works one way.

      If the conditions of lender of last resort function of the central bank to the commercial banks are just:

      1) and 2) but not 3) then system works a different way.

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