The Liberal Youth Forum

The economists have started proposing serious post-credit-crunch bank reforms:

http://www.tnr.com/politics/story.html?id=6c4548ef-91c2-47b5-a357-c83bc5212cae

The idea from these two (from Boston Uni and the National Center for Policy Analysis) is to institute Limited Purpose Banking. This would turn banks into mutual fund managers, restricted (limited purpose) to matching savers to borrowers via these mutual funds. They would not be able to borrow themselves, or invest themselves in financial assets. Unable to take on financial bets - they can in a sense never fail.

"Banks would operate exclusively as pass-through mutual funds. Specifically, they would be permitted to one and only one set of activities: create mutual funds, sell shares to these funds to the public, and use the proceeds to purchase assets. These mutual funds would provide as much credit as the economy needs, allow us to engage in as much risk-taking as we want, and provide maximum liquidity."

"Under LPB, people who seek to lend money to home buyers would simply purchase shares in a mutual fund investing in mortgages, with the money going directly to the mutual fund (not to the bank sponsoring the fund) and from there to the home buyer in return for his or her mortgage. Those wanting to lend to companies would buy mutual funds investing in commercial paper. Those wishing to finance credit card balances would buy mutual funds investing in those assets. Credit is ultimately supplied by people, not via some magical financial machine. And every dollar people want to lend would be provided to borrowers via mutual funds."

"A new mortgage, commercial loan, credit card, issuance of stock, new real estate trust, etc. would be initiated by a bank, sent to the FFA (and private parties, as desired) for rating, income verification, and disclosure, and then sold by the bank to mutual funds, including mutual funds that the bank itself markets to the public. Once funded, the new securities would be held by the owners of the mutual fund--in other words, by people."

"Since they would no longer be allowed to buy financial assets or borrow to invest in securities, banks, as broadly defined, would, over time, pay out their cash flow to their owners as dividend payments. The owners, in turn, would use these funds to purchase mutual funds issued by the banks. So the transition to LPB is gradual with respect to unwinding existing bank assets and debts, but immediate with respect to issuing new mutual funds. Banks become zombies with respect to their old practices, but gazelles in exercising their new purpose."

It's an interesting idea certainly, and an old one - it used to go by the name "narrow banking" - but I don't think people are quite willing to dump savings accounts and bank accounts and instead put all their cash into mutual funds. Nonetheless it's good to see someone propose something different from the future instead of trying to rebuild Babylon.