Too Fed to Fail

[The Minsky Moment]

http://rajivsethi.blogspot.com/2013/11/the-payments-system-and-monetary.html

About forty minutes into the final session of a recent research conference at the IMF, Ken Rogoff made the following remarks:

We have regulation about the government having monopoly over currency, but we allow these very close substitutes, we think it's good, but maybe... it's not so good, maybe we want to have a future where we all have an ATM at the Fed instead of intermediated through a bank... and if you want a better deal, you want more interest on your money, then you can buy what is basically a bond fund that may be very liquid, but you are not guaranteed that you're going to get paid back in full.

Prof. Sethi goes on to elaborate further.

Basically the proposal is to get private banks out of the business of managing the payments system and give that responsibility to the Fed.
What that does is eliminate the need for a vast system of deposit guarantees and related regulation.  Consumers are given clear options between 100% safe deposits and non-guarateed investments.
The other advantage in theory is that Too Big to Fail is solved, moral hazard vanishes, and there is no need for capital regulation.  The lower regulatory load compensates the banks for their loss of the ability to fund themselves with govt insured deposits.

Problems I see are:

1) political infeasbility.  The Ron/Rand Paul audit the Fed nutters go ape.  And the anti-keynsians (read the entire GOP and decent swaths of the Dems) oppose for the very reason Sethi likes the idea: it facilitates the ability to monetize debt-financed stimulus on the debtor side.

2) it doesn't end up solving TBTF for the same reasons that Lehman's collapse was problematic even though Lehman wasn't a deposit taking bank.  The government still has a interest in preventing total disruption of asset markets, even if there is no direct impact to the payment system.  And it is very likely that during a boom period, ordinary consumers will move balances from the safe Fed accounts to private bank investment accounts - putting huge pressures on the government to bail out those institutions.  One way to deal with these problems is to only bail out indirectly by infusing cash into debtors as per Sethi's proposal, but that brings us back to #1.

[Legbiter]

I like it, a nice barbell strategy. You can either have near-total safety or here-be-dragons high risk investment, with corresponding interest rates and payoff.

Middle-of-the-road seems to be all respectable and able, but once every century or so, it goes spectacularly bust. 

[Scipio]

I may just be a stupid general practice lawyer, but why is this proposal superior to reinstating Glass-Steagall?

[Razgovory]

I may just be a stupid general practice lawyer,

Well, I wasn't going to say, but I'm glad someone did.

[Admiral Yi]

...and all types of credit except bond issuance, including consumer credit and small business loans, disappear.

[mongers]

...and all types of credit except bond issuance, including consumer credit and small business loans, disappear.

And that would be an overall plus, right ?

edit:
silly me, I forgot you need unsustainable consumer booms to bribe the electorate and fuel politics (18-24 mth election cycles) 

[Admiral Yi]

And that would be an overall plus, right ?

Oh yeah, anything that keeps the little man down is OK in my book.

[mongers]

And that would be an overall plus, right ?

Oh yeah, anything that keeps the little man down is OK in my book.

I wasn't suggesting you thought it was, but that I thought it was. 

[Admiral Yi]

I wasn't suggesting you thought it was, but that I thought it was.

You can see how I might be a little confused, seeing as how you directed the question at me and put a "right" at the end. 

[fhdz]

...and all types of credit except bond issuance, including consumer credit and small business loans, disappear.

Why? I read the article and didn't see anything that would indicate non-Fed banks ceasing to exist.

[Jacob]

Yeah, would consumer credit disappear if banks lost the "safe deposits" business? Presumably they'd charge whatever interest the market could bear for their services as long as there was a market for consumer credit...?

[fhdz]

Yeah, would consumer credit disappear if banks lost the "safe deposits" business? Presumably they'd charge whatever interest the market could bear for their services as long as there was a market for consumer credit...?

That's how I read it. Maybe Yi has different thoughts on the matter.

[Admiral Yi]

Why? I read the article and didn't see anything that would indicate non-Fed banks ceasing to exist.

No, you're right.  They would presumably turn into non-bank lenders like those mortgage lenders that are always advertising.

The problem, rather, is whom the Fed would lend to and on what terms.

[fhdz]

Why? I read the article and didn't see anything that would indicate non-Fed banks ceasing to exist.

No, you're right.  They would presumably turn into non-bank lenders like those mortgage lenders that are always advertising.

Specialized lenders, like mortgage "banks" and etc.

The problem, rather, is whom the Fed would lend to and on what terms.

What are your thoughts on how they could do it and avoid economy damage?

[DGuller]

I remember Sberbank.