December 28th, 2010
in Op Ed
Guest Author: Derryl Hermanutz is a student of economic philosophy and frequent commentator on the subject. This essay was originally written as a discussion comment on Dirk Ehnt's recent article “The ECB as Lender of Last Resort.”
The excellent article by Dirk Ehnts raises a number of thoughts about LOLR (lender of last resort) situations and the efforts to avoid bank insolvency. Yes there would be dislocations and economic chaos if systemic insolvency of banking systems in Europe and America were acknowledged and those failed banks taken into receivership for systematic liquidation. But who, pray tell, would possess the cash to buy the liquidated assets in a systemic insolvency resolution? All assets would clear at fire sale prices and the few people possessing money would buy up our economies for a song. This is not a practical solution. Follow up:
Successful Financial Enterprise: Make Bad Loans and Get Bailed Out
So the issue becomes, who gets the bailout money? So far the answer has been: Wall St and Eurobanks get the trillions. This is fundamentally unfair to the rest of the economy as well as being moral hazard writ large. Bankers are once again paying themselves record bonuses for their stellar performance--at acquiring bailout funds and receiving regulatory forbearance. These are megabillion welfare cases, not ‘successful’ private enterprise banks.
Banks are the Primary Criminal Element in the Crisis
While it may be true that individuals made bad economic decisions, taking liars loans and borrowing more than they could ever pay back, they were at best secondary perpetrators. They were aided and abetted by the primary criminals who felt they had to “dance as long as the music was playing”. And many individuals did borrow in good faith and honestly, only to get swept under in a tsunami of lost or reduced employment and income. Many individuals were true victims and many banks were the primary perpetrators.
Why not Aid the Victims?
The problem is that all the bailout money has gone to the supply side of the monetary equation, the banks who made loans that are now non-performing. A more equitable solution to bad loan systemic insolvency would be to take the same trillions that are being given to the banks, and give the money directly to all American households as $1000 per month “solvency checks”, with a provision that anyone with bank loans must devote all of their check to paying down their debts. This would restore practically all loans to performing status. All Americans get the checks, so we’re not rewarding failures at the expense of the financially prudent.
Spending on the Demand Side would Still Aid the Banks
Debt repayment extinguishes the money along with the debt so there is no addition to the money supply when solvency checks are devoted to debt pay down. There is only debt reduction. As loans are written down on bank balance sheets, the amount outstanding approaches the current market value of the real estate or other assets held by the banks as collateral against the loans. Once loans outstanding = market value of banks’ collateral assets the banks are no longer insolvent.
This program bails out the banks by bailing out the demand side of the monetary equation, the debtors. Americans with little or no debt could devote their checks to savings or investments or to increased consumption. Investment and consumption create demand in the domestic economy which is stimulative. With low employment and capacity utilization economic stimulus should not be inflationary.
The Fed can provide nearly free money to fund the solvency checks by buying 0 – 0.5% interest Treasury bonds through the primary dealer network, in the same way it is currently buying old Treasury debt from the banks, and the banks use the Fed’s new money to buy new Treasury debt.
Dark Pools and Black Holes
At present there are way too many US dollars concentrated in ‘dark pools’ and used for domestic and global speculative ‘investments’. Speculation is entirely unproductive, a zero sum casino of financial assets where one player’s gains can only come as some other player’s losses. These pools are large enough that the victims of speculation are national currencies and economies and commodities markets. Normally the same money that was created as a loan and spent into the economy by a borrower will eventually be earned back out of the economy and returned to the bank to pay off the loan. Creation of the loan added to the money supply, repayment of the loan extinguishes both the debt and the money which reduces the money supply. That is how money supply works in a balance sheet banking system like ours where the money is created as “bank deposits” and those deposits are extinguished with loan repayments.
But if loans are repaid with new money created by the Fed to buy Treasury’s solvency bonds, the old money that was created when the original loan was made is still out in the economy where it can contribute to CPI inflation (if it’s in the hands of spenders) or asset hyperinflation if the money is in the hands of dark pool speculators. These pools should be reduced via taxation, maybe a scaled up version of a Tobin tax or a more targeted tax. Tax revenues taken in this way could be used by Treasury to redeem it’s solvency bonds from the Fed, which would extinguish the money by taking it out of the economy and using it to repay debt as should have been done in the first place if all that money had been reinvested in America’s productive economy where it could have been earned as incomes by debtors who could then have repaid their bank debts from income rather from their solvency checks. As is, the money ended up in the financial casino economy where it is not accessible to most Americans who owe bank debt.
Instead of stimulating the economy monetary efforts have aided the banks and liquidity created has poured into a speculative black hole (Wall Street) while Main Street is left holding a deflating bag.
The ECB as Lender of Last Resort by Dirk Ehnts
The Great Debate©: Supply Side or Demand Side by Casey Mulligan and Menzie Chinn
The New Feudalism by Derryl Hermanutz