Abstract
This chapter selects a few radical reform proposals that may contribute to a more robust regulatory approach, and discusses their weak and strong points to improve their effectiveness and mutual compatibility. A careful examination of these proposals shows that none of the reforms here considered is sufficient by itself to mend the system. However, some of these proposals may be included in a package of measures to reform the financial system and its regulation according to a design capable to change the direction of its structural change towards a sustainable direction. The evolution of the financial system is the result of the dialectical interaction between financial institutions and democratic bodies. In the last decades, the participants in this evolutionary game have confronted each other on a growingly uneven playing field bending in favour of increasingly powerful financial institutions. We have to change the rules of the game to empower the democratic institutions of the necessary authority to orientate the financial system towards the public interest.
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Notes
- 1.
Frederick Soddy (1926), winner of the Nobel Prize in chemistry, was the first to propose a plan of this kind. The distinguished professor of economics at the University of Chicago Frank Knight almost immediately picked up and developed Soddy’s idea involving many colleagues in its development and propagation (Knight 1927). Not surprisingly, the idea acquired much greater influence after the collapse of Wall Street in 1929.
- 2.
The second condition prescribes that “the financing of new bank credit can only take place through earnings that have been retained in the form of government-issued money, or through the borrowing of existing government-issued money from non-banks, but not through the creation of new deposits, ex nihilo , by banks” (Benes and Kumhof 2012, 4).
- 3.
See in particular Simons et al. (1933).
- 4.
The late Minsky discussed the viability of a revival of the Chicago Plan in the mid-1990s. See the unpublished paper 73 by Minsky (1994), and the following unpublished papers 51, 59, 60 drafted in 1995, all available in the Minsky Archives at the Levy Economics Institute of Bard College. His initial critical support to an updated version of the Chicago Plan became eventually more cautious if not sceptical (see on this issue Kregel 2012).
- 5.
The monopoly of money creation attributed to the government would lead to a significant reduction in the interest burden of government finances and to a dramatic reduction of (net) government debt.
- 6.
A case in point is that of the so-called political cycles (see e.g. King 2017, 262).
- 7.
As Benes and Kumhof (2012, 17) assert, “To summarize, the Great Depression was just the latest historical episode to suggest that privately controlled money creation has much more problematic consequences than government money creation.” The Great Recession has recently confirmed this assertion.
- 8.
- 9.
See Vercelli (2017).
- 10.
After the Wall Street panic of 1929, Fisher was compelled to recognise that the velocity of circulation of money is much more volatile than he believed in the past. In particular, he understood that in the trough of a serious crisis the velocity of circulation of money undergoes a breakdown due to the process of debt-deflation (Fisher 1933). This prompted Fisher to embrace, develop and promote the Chicago Plan. Recent compelling evidence about this point has been produced by Koo (2011).
- 11.
In their influential contribution to banking theory Diamond and Dybvig are more drastic: “100% reserve banking is a dangerous proposal that would do substantial damage to the economy by reducing the overall amount of liquidity . Furthermore, the proposal is likely to be ineffective in increasing stability since it will be impossible to control the institutions that will enter in the vacuum left when banks can no longer create liquidity ” (Diamond and Dybvig 1986, 55–68).
- 12.
Among the other most influential recent versions of the Chicago Plan, I signal the Narrow Banking plan (Kay 2009), Kotlikoff’s (2010) Limited Purpose Banking, the Positive Money and NEF plan (Jackson and Dyson 2012). See also the supportive arguments by Wolf (2014), and the criticisms by Dow et al. (2015).
- 13.
Benes and Kumhof (2012, 55) assert : “Our analytical and simulation results fully validate Fisher’s (1936) claims. The Chicago Plan could significantly reduce business cycle volatility caused by rapid changes in banks’ attitudes towards credit risk, it would eliminate bank runs, and it would lead to an instantaneous and large reduction in the levels of both government and private debt. It would accomplish the latter by making government-issued money, which represents equity in the commonwealth rather than debt, the central liquid asset of the economy, while banks concentrate on their strength, the extension of credit to investment projects that require monitoring and risk management expertise.”
- 14.
As Cochrane rightly emphasises, commercial banks are only a small part of the financial system (Cochrane 2014, 21).
- 15.
See Chap 5.
- 16.
The name for this sort of insurance is technically correct because, differently from the usual commercial insurance, there is no redistribution between the insured subjects, eliminating this crucial source of moral hazard. The name “pawnbroker for all seasons”, however, is not a particularly attractive “logo” for this new role of the central bank since in common language the word “pawnbroker” may still have, as it had in the past, negative overtones.
- 17.
King means by alchemy “the belief that all paper money can be turned into an intrinsically valuable commodity” (ibidem, 8).
- 18.
This is what happened in the repo market at the beginning of the Great Recession (see, e.g., Gorton 2010).
- 19.
See Appendix section “The Post-crisis Regulation of Shadow Banking in the United States”.
- 20.
Of course, NFBs could also buy other high-grade assets, for example, US treasuries.
- 21.
Gorton and Metrick rightly advocate that lawmakers and judges “prevent a third type of totally unregulated repo, by making clear that the special bankruptcy protections offered to repo would simply not apply outside of the first two types” (ibidem).
- 22.
The so-called “Tobin tax” focuses on currency transactions for stabilising currencies on a global scale. Later on, Tobin expressed a more cautious point of view on this proposal mainly for the difficulties he envisaged in its implementation. As Cochrane has recently pointed out, these problems may be overcome by an apt use of new technologies (Cochrane 2014).
- 23.
A 2011 Eurobarometer poll questioning more than 27,000 European citizens found that most of them were strongly in favour of a Financial Transactions Tax, by a margin of 61%–26%.
- 24.
According to the European Commission, it could raise €57 billion every year. The residence plus issuance condition implies that the EU-FTT would cover all transactions that involve a European firm, whether it carries out these transactions in the EU or elsewhere. This condition prevents firms to avoid this tax by moving their transactions offshore.
- 25.
As I argued before, a completely safe asset does not exist. However, in most circumstances, the safest assets are created by the state.
- 26.
As is well known, a public good is a non-excludable and non-rivalrous good, as there is no way to exclude someone from its use, while its use by one individual does not reduce its availability to other individuals.
- 27.
As we have seen in Sect. 7.2, John Cochrane, leading exponent of mainstream financial economics and uncompromising supporter of free markets, in his thoughtful contribution in support of narrow banking did not hesitate to recognise that the state has a natural monopoly in money creation for reasons similar to these mentioned in this section (Cochrane 2014).
- 28.
See Brown (2013).
- 29.
As Brown observes, “North Dakota has more banks per capita than any other state, because community banks have not been forced to sell to their Wall Street competitors” (Brown 2014, 3). This example shows the efficacy of the principle of check and balances also in the banking activity. On this point, see Chap. 8.
- 30.
Levine (2011) mentions three basic factors that explain the growing impact of regulatory capture in financial regulation. First, the financial sector is a large contributor to political campaigns. Second, many senior regulators use the revolving door by moving from the financial sector into public office and then returning to private financial institutions. Third, “Regulators interact primarily with people from the financial services industry, which might be the same people with whom they worked or went to graduate school. Human nature suggests, therefore, that regulators might identify with this financial services ‘community’ and seek to please and service ‘their’ community through their regulatory policies” (Levine 2011, 20–21).
- 31.
- 32.
The confirmation by the Senate does not seem sufficient to guarantee an effective participation of the majority of citizens through their elected representatives.
- 33.
This point has been rightly emphasised by Omarova (2012) who produced an alternative proposal capable to overcome this shortcoming. I am going to examine this proposal later in this section.
- 34.
See Sect. 8.5.
- 35.
See CFPB (2011).
- 36.
Since 2011, more than 730,000 complaints have been published in the CFPB database (Freking 2017). CFPB supporters claim that it is a “vital tool that can help consumers make informed decisions” (ibidem).
- 37.
Eder et al. (2017).
- 38.
When Cordrey resigned in November 2017, Trump nominated as acting director Mick Mulvaney, director of the office of Management and Budget and vocal critic of the policy pursued by the CFPB under Cordrey; in December 2018 he nominated Kathy Kraninger who was expected to continue the same mild approach of her predecessor.
- 39.
Kane clarifies that “Taxpayers’ equity position is inferior to that of ordinary shareholders in at least five ways. First, taxpayers cannot trade their positions away if they see problems coming down the line. Second, taxpayers’ downside liability is not contractually limited, but their upside gain is. As a firm recovers, the value of its government guarantees approach zero. Once this happens, further gains go entirely to the shareholders. That is why shareholders of zombie firms are attracted to negative present-value projects with heavy upper tails. Third, taxpayer positions carry no procedural or disclosure safeguards. Fourth, taxpayer positions are not recognised legally as an equitable interest. That means that protected firms can exploit taxpayers without fear of class-action lawsuits. Finally, managers of zombie firms can and do further abuse taxpayers by blocking or delaying recovery and resolution” (Kane 2013, 79–80).
- 40.
According to Kane, the trustees operating in different SIFIs might be expected to organise a standard-setting association and eventually the office of SIFI trustee could evolve into a self-governing profession (ibidem).
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Vercelli, A. (2019). Proposals for a Radical Reform of the Financial System. In: Finance and Democracy. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-030-27912-7_7
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