American Document/Have We Seen the End of Banks?
Brookes, Warren T.
AMERICAN DOCUMENT Have We Seen the End of Banks? by Warren T. Brookes Acouple of years ago, the Cato Institute's Catherine England, who has written brilliantly on banking reform, was asked: "What...
...The only thing sustaining it is government franchise, regulation, and deposit insurance...
...This essay is adapted, with permission, from the May 1991 issue of the Durrell Journal of Money and Banking (P.O...
...When deposit insurance was created in 1935, U.S...
...GM and Ford, not to mention GE and Sears, are major players in the mortgage-backed securities industry, and thirsting for more of that kind of credit gold...
...well-capitalized banks could attract lots of depositors...
...The system is as obsolete as socialism in Eastern Europe, and for the same reason...
...Today it's 1.5:1, and falling...
...In 1979, faced with soaring interest rates and double-digit inflation, Americans began to take their money out of insured thrift accounts and put it in uninsured money market funds...
...On the third line he checked to make sure that the documents were being received...
...Although some of the shift can be attributed to the obsolescence of the banking rules laid down by Congress in Glass-Steagall and McFadden-Douglas, it is the telecommunications revolution that has made the traditional bank a dinosaur...
...During the Iraqi invasion, Hissham Razzuqi, vice president and manager of the $10 billion Gulf Investment Corporation in Kuwait City, realized he had to act to protect his holdings from being seized...
...That one can move a whole bank by telecommunications should be no surprise...
...The only way that we can protect ourselves is through heavy-handed regulation and tight limits over what banks can lend for or invest in...
...And they have become major providers of the short-term commercial paper that is rapidly replacing the traditional commercial bank loan...
...Most of that aggregate is pure information, infinitely mobile, and definitely faxable...
...As an illustration, on March 8, 1991, the U.S...
...Many large real estate agencies now finance deals Warren T. Brookes, who died last December, was a nationally syndicated columnist for the Detroit News...
...When we looked out of the windows we could see Iraqi helicopters flying by...
...While this action failed to bring long rates back down, it did arrest their rise, and halted the surge in commodity futures prices, which had jumped from a CRB index of 211 to 221, before falling back to 217 after Fed firming...
...Mrs...
...It is easy to blame the mess on lax regulators and greedy politicians...
...unemployment rate jumped an alarming .3 percent...
...wholly outside of the banking sector...
...The traditional notion of banks as the center of economic activity for their communities is now simply absurd, but this devolution of power is not just a phenomenon of banking...
...But deposit insurance made capital irrelevant to the depositor and—since it socialized risk—unattractive to the investor...
...In 1991 they fell to less than 16 percent...
...For the top 5-10 percent of the public—who control at least 85 percent of the total financial assets—banks have become nothing more than convenient processors of information...
...If the market thinks the Fed's policies are too loose, and thus potentially inflationary, it will drive up long rates even as the Fed lowers its short rates...
...Actual physical money in circulation, including gold and silver, never has been more than a small fraction—six or seven percent—of the total $3.4 trillion in total bank liabilities, or of the $3.3 trillion that makes up the broad M-2 monetary aggregate...
...Furthermore, it can circumvent or destroy almost anything governments devise to thwart it...
...Central governments are less and less able to control the behavior of their citizens, let alone whether they spend, save, or invest...
...It is inconceivable that we should let banks sell stocks and bonds, market real estate and insurance, and perform the other services we now get from investment houses and underwriters...
...Not only are GM and Ford already the second- and third-largest financial institutions in the U.S., writing most of their own car loans and leases and supplying lines of credit to dealers and suppliers...
...That means they are less and less able to prevent markets from asserting their power over domestic economies...
...With only modest changes in the law, both companies could provide a full line of banking services nationwide, and it probably wouldn't take them that long to get up to speed...
...England was right...
...For new technology, as George Gilder has pointed out, not only makes untold successes possible, it also rapidly exposes failure...
...The rising yield curve spread that results will, in turn, instantly expand banks' incentives to create credit, further reinforcing an inflationary effect and taking some of the power of money creation away from the Fed...
...As assistants ran computer printouts of all of GIC's books, Razzuqi opened up three phone lines to GIB...
...Every loan made by a bank is guaranteed by you and me...
...That lowers the value of the currency, and forces the Fed to bring short rates back up into line...
...But the bond market immediately sold off, driving long rates up by nearly 15 basis points, defeating the Fed's policy action and raising the yield spread to 230 basis points, the largest since 1988, when the last inflationary outbreak took place...
...With that stroke we began consciously to replace the private risk capital of bank equity with the public capital of insurance...
...We should not be surprised that as we have moved into the telecommunications age, banks whose only function is to trade in money (information) should have become the most endangered of the traditional institutions...
...Of the $3.7 trillion in home mortgages, nearly $2 trillion, or 53 percent, are now held outside the banking system...
...One Chrysler should have been enough, shouldn't it...
...When we made it impossible for banks to fail, we made it impossible for them to succeed, especially when the information systems of the world were liberated by technology...
...Often as not, right beside it is the trend of the dollar against the yen, the deutsche mark, and sterling...
...If it were not for $100,000 deposit insurance, how long could banks compete with uninsured money market mutual funds...
...A few years back, Walter Wriston observed that those who worried about the loss of the gold standard had failed to see that we were now on a new international "information standard" in which the ability of the world's depositors and investors to control the actions of banks and governments was rising steadily, while the power of governments and their central bankers to spring monetary surprises—inflations or devaluations—was diminishing...
...Since no one has invented the perfectly omniscient banker, you and I are exposed to intolerable losses and further invasions of the treasury...
...Banks Obsolete...
...Commercial and industrial loans fell from 31 percent of all bank assets to 19 percent between 1980 and 1988...
...It doesn't always work quite as instantly as this, but the lags between policy mistakes and market retribution grow shorter with each new microchip and each new futures instrument, destroying the notion of the independence of central banks from the market place...
...Between 1981 and 1988, the banks' share of private credit supplied to domestic non-financial business fell from two-thirds to less than half...
...What about housing...
...The process started when we decided we could not afford to have any banks fail their customers and created the deposit insurance system...
...economy if our banking system were to collapse...
...will continue to be a large country without a banking system...
...For thirty-five years following World War II, no one cared about the price of gold...
...He can access any financial market, move investments into any instrument, and exchange dollars for marks and paper for gold at will...
...If we don't turn banks and S&Lsloose, the banking system will disappear, but without a serious reform of deposit insurance, and the end of "too big to fail," this kind of further deregulation cannot, should not, and will not happen, and the U.S...
...Information Standard...
...This means a growing number of individual investors now have as much or more information on money, credit, and the financial markets as all but the most sophisticated bankers, and certainly as much as any of the 12,500 local bankers around the U.S...
...Predictably, the bankers themselves—the apparatchiks and nomenklatura in this socialist system—are resisting real reform...
...CI 36 The American Spectator August 1992...
...On two of them he faxed the bank's key documents—account statements, its primary letters and lines of credit, and its capital paper—transferring the possession of these documents in effect to another bank, nearly 280 miles away...
...non-financial market came from credit market instruments...
...Then he calmly rescued his bank one page at a time...
...And they are drumming up support...
...The net result of that tragically failed policy is at least $150 billion in insolvent institutions...
...And just as socialism—which depended on the power, credibility, and solvency of the central government—was rendered obsolete by an information marketplace that made capital more fungible, so a socialized banking system will fail as well...
...When the thrift industry became essentially insolvent in 1979, some $400 billion began to move out of insured thrift accounts into uninsured money The American Spectator August 1992 35 market accounts...
...The share of domestic private non-financial credit provided by credit market "instruments"—from junk bonds to commercial paper—rose from 25 percent to 51 percent...
...Illustrative of the role of telecommunications in the obsolescence of traditional banks was the way a Kuwaiti bank used the fax machine to move itself overnight to Bahrain...
...Faced with this shift, Congress and an already insolvent thrift industry refused to recognize it for what it was—the beginning of the end of thrifts as a government-constructed financial entity, and the rise of a whole new form of financial institution...
...Today, the banking system is suffering from one of the longest silent runs in its history, losing 14 percent of its demand and other checkable deposit accounts (after inflation) since 1986, as people and businesses continue to move their money out of traditional bank accounts into non-traditional locations...
...Hundreds of billions of dollars of financial transactions rocket around this planet of ours every day electronically, and almost entirely in the form of information transfers...
...bank capital averaged well over 13.5 percent, even in the depth of the Great Depression...
...The Fed hit the panic button and lowered the Fed Funds rate 25 basis points...
...Banks, after all, have always been primarily in the information business...
...Take away the latter and you have destroyed the former...
...had become a very large country without a banking system...
...The information revolution has altered our naive ideas about money, and is now moving world financial markets toward the kind of marketThe American Spectator August 1992 33 based monetary rules that conservatives (especially gold-standard conservatives) have long cherished...
...Now if a bank is nothing more than an information system, then by definition every information system can be a bank, and every owner of an information station—from a desktop computer to a mainframe terminal—can be a banker...
...Today it is on nearly every TV news broadcast...
...In 1960 the ratio of bank loans to commercial paper floated by companies and their investment bankers was 10:1...
...Unless politicians and bankers are prepared to give up at least a significant portion of their safety net and accept the freedom to fail as the price of success, the bank industry is doomed...
...England has written, "Bankers' inability to adapt and innovate . . . has left them with a shrinking pool of customers and thereby has reduced their importance in the evolving financial services industry...
...We socialized ownership, too, because the only way that taxpayers can assume this new risk is for the government to regulate it intensively...
...And what does this augur for ordinary banks...
...The only "deposit insurance" bank depositors used to have was the level of capital at risk in the institution...
...by Warren T. Brookes Acouple of years ago, the Cato Institute's Catherine England, who has written brilliantly on banking reform, was asked: "What would happen to the U.S...
...Why put your money in a system where your capital has to subsidize less solvent competition...
...The Fed had to allow the Fed Funds rate to ease back up to 6.25, where it stayed for the next two weeks or so...
...As Razzuqi told Institutional Investor, "It was really difficult because we kept having to repeat pages...
...Instead, it was the open invitation of risk-free investment that created an avalanche of deposits, and a failure to understand the speed with which information technology was revolutionizing the financial systems of the world—a world in which traditional banking institutions, including the thrifts, have become anachronistic...
...As Iraqi gunships began bombing the nearby palace, Razzuqi holed up in his skyscraper, called Gulf International Bank, GIC's sister organization in Bahrain, and asked them to set up a temporary headquarters for his bank...
...As Mrs...
...And under present accounting rules, there is no way to know the precise market value of all loan assets—even the tightest regulation will be too late to catch some insolvencies...
...Instead of forcing these institutions to compete in the new marketplace, government propped them up, not only lifting the lid on passbook and certificate-of-deposit rates (which was necessary) but also more than doubling the insurance coverage to keep large accounts in thrifts and away from more attractive options in the financial markets...
...By definition, we are not insuring deposits, we are insuring loans (because that is where most, if not all, deposits eventually go...
...Consider the automobile industry...
...Box 847, Berryville, Virginia 22611...
...It is equally inconceivable that we should invite into this fully insured enterprise commercial corporations like Sears and GM and Ford or GE to participate in our tax-supported guarantees...
...Today it averages less than 6 percent...
...This trend will worsen unless banks adapt to the information revolution and unless the non-bank banks are allowed to show them the way...
...Even when the Fed tries to raise or lower interest rates it can do really only what the financial (information) market will let it do...
...From time to time nearby gunfire forced him to take cover and stop sending, but by the end of the morning all of the essential transmissions had been completed...
...For all intents and purposes, banks are wards of the state, quasi-governmental entities wholly dependent on the bureaucratic process, and thus the inevitable victims of its breakdown...
...T his is dangerous, for the freedom to succeed requires the freedom to fail...
...34 The American Spectator August 1992 The microchip is increasingly putting the global marketplace within reach of every individual with the skills to understand it...
...They have so roused their party bosses in Congress that even the timid deposit-insurance reforms called for by Treasury Secretary Nicholas Brady are in trouble...
...They also have virtually unlimited access to the world's financial and credit markets...
...It is now a charming anachronism...
...While most of them applaud the idea of offering a broader range of financial services, as the Treasury reform proposes, they are absolutely unwilling to give up even a strand of their elaborate deposit insurance safety net...
...Commercial and industrial borrowing and lending can be done by companies themselves...
...Nevertheless, by early afternoon the bank had been moved to Bahrain, where it was reestablished...
...Checking accounts and other depository services can now be handled through money market funds, cash management accounts, or plain old credit cards...
...Bankers no longer run the world, the world runs the bankers—sets their interest rates, raises or lowers the value of their paper currencies, raises or lowers their level of capital equity and determines their solvency...
...That is the central issue of what passes for the bank reform recently debated in Congress...
...By 1990, with junk bonds reviving and the banks in a regulatory crunch, well over 70 percent of all private credit supplied to the U.S...
...Outstanding non-financial commercial paper rose from $13 billionto $129 billion between 1976 and 1989...
...Her answer: "Not all that much...
...In this picture, nothing is more obsolete than the red-brick bank with the Ionic columns, which takes our money and lends it out, issues and processes checks, and moves money around the nation in batches of paper...
...Anyone who dares to suggest that maybe we ought to limit total insurance to $100,000 per individual, that it might be worthwhile to establish "haircuts" on uninsured accounts, that we should tamper with the concept of "too big to fail," is accused of trying to "undermine the confidence" in the whole system...
...Their capital backing dwarfs that of most banks...
...Money as Information Money itself has never been anything but a medium of exchange, and thus—in its most elemental sense—an information system that equilibrates the values of goods and services...
...Let's briefly recapitulate why this is so: By raising deposit insurance back in 1980 to 100 percent of S&L deposits and more than 80 percent of bank deposits, we effectively underwrote the entire financial system with taxpayer guarantees, notwithstanding bankers' fatuous contention that it is their fees that prop up the, FDIC...
...Faxing a Bank...
...The episode vindicates economist Dave Hale's recent jest that, while Kuwait was a very large banking system without a country, the U.S...
...To put it bluntly: In the last two decades banks have faded from preeminence to a secondary role in the credit life of our economy, and that trend is accelerating...
Vol. 25 • August 1992 • No. 8
