True fix for financial system

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silvervarg's picture
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True fix for financial system

Economy professor Larry Kotlikoff (Boston University) announced a suggestion on how to fix our financial system.
As I originally read this from an non-english source I will not quote that source, but add links to similar information in english at the bottom of this post. 

His main problem to solve was "How to you prevent banks to crash?"
We are not talking about a bailout with taxpayers money. He is seeking a way to prevent the crash in the first place.

Today all banks are at a major risk with investments and very little free cash.
Any normal bank today will fail if a majority of customers want to withdraw their money, called a "bank run". 
This is because of the fractional reserve banking system.

The fix he suggest is "Limited purpous banking".
Every dollar deposited in the bank must be backed by obligations or similar papers.
All loans credibility is evaluated by a goverment agency.

Bank speculation will not stop completely, but it would not be allowed with customers deposited money.
Banks can till speculate with there own money. E.g. money from issued stocks, true profit etc.

He has put this and a lot more in a book called "Jimmy Stewart is dead".

So, my question to you is:
It this guy right?
Is there a way to slowly turn the current banking system into this to prevent bank crashes?
It will not fix all our financial problems, and the transion will be difficult to say the least. If this is doable it will at least put us in a much better position that not doing any major changes. 


darbikrash's picture
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Re: True fix for financial system

A controversial topic around here.

Clearly, some type of reform/regulation is needed, as it is apparent to most that despite claims to the contrary, there is in fact a structural propensity for cyclical crashes (we have seen this movie before) and the question, for many of us, is what is the least intrusive way to accomplish this.

Economist Steve Keen’s latest work provides an interesting alternative to the distasteful (and largely unsuccessful) business of trying to regulate the supply side of the problem. He draws the not inaccurate analogy to characterizing modern bankers as essentially drug pushers, with debt as the drug of choice. Their job is to get consumers addicted, and to create as much debt as possible.

As with the subject of illicit drugs, as long as the demand is there a supply side capacity will always appear given sufficient profit motive.

His approach is to strangle the demand side, by creating disincentives for speculative borrowing. This is controversial for two reasons, the first, is that Libertarians and other conservatives will never accept that some type of market regulation (supply or demand side) is necessary to restrain the cyclical propensity of capitalism, instead arguing that it was government intervention  that caused it in the first place. Secondly, the conventional wisdom at least on this forum, is that the root cause of our predicament is debt based money creation, and not simply unregulated capitalism. 

Just this week, Dr. Keen has released a 53 minute video discussion summarizing his work which is well worth watching in it’s entirely if one is interested in a thorough rebuttal to both of these controversial points. His position is simply that Ponzi borrowing (using debt to make investments in speculative assets that do not in and of themselves cash flow i.e. require asset appreciation to make money) is the root cause of the financial crisis. His arguments include what appears to be a well documented and airtight discrediting of the concept of debt based money creation as being unsustainable.

I hesitate to even make this post as this subject has been so thoroughly controversial on this forum, but the video I reference contains new information that may well put this matter to rest once and for all.

My reform proposals are therefore directed, not at how money is created, but at how it can be used. Briefly, I argue that banks are always going to want to create as much debt as they can (under whatever system of money creation we have). So if we’re going to stop the use of money for speculative purposes, our reforms have to affect the willingness of borrowers to borrow, rather than expending energy on ultimately futile attempts to limit bank lending directly.

Bankers especially might not like this analogy, but it’s apt: banks are effectively debt pushers, and trying to control bank lending at the source is like trying to control the spread of illegal drugs by directly controlling the drug pushers. While ever there are drug users who want the drugs, then there’ll be a profit to be made by selling drugs, and drug pushers will always find ways around direct controls.

So if you want to stop the spread of drugs, it’s far more effective–if it’s at all possible–to reduce the desirability of the drugs to end-user




We need something like that in finance to counter the successful campaigns that bankers have run to give debt as “sexy” an image as tobacco companies once gave cigarettes, even though–in another apt analogy–it causes financial cancer: the uncontrollable growth of debt is very much akin to the exponential growth of a tumour that ultimately kills its host.

The metaphor is not perfect of course, since a certain minimal level of debt is a good thing in a capitalist society. Productive debt both gives firms working capital, and finances the activities of entrepreneurs who need purchasing power before they have goods to sell.

But debt that funds simply speculation on asset prices is very much akin to a cancer. And like the cigarettes that cause lung cancer, growing unproductive debt gives a “hit” that makes the borrower addicted to more debt: when debt is growing,  the debtor and society in general feel better. It enables the borrower to make profits from speculating on asset prices, since the rising debt drives up asset prices; and the spending this capital gain allows spreads into the wider economy, creating a genuine but ultimately terminal boom. The boom can only continue if debt continues to grow faster than income, but at some point this guarantees that the debt-servicing costs will exceed society’s capacity to pay, and the cessation of debt growth causes a crisis like the one we are in now. 


Why Credit Money Crashes

Click on the video titled “Why Credit Money Crashes” at the top of the page.

strabes's picture
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Re: True fix for financial system

His arguments include what appears to be a well documented and airtight discrediting of the concept of debt based money creation as being unsustainable

Glad you added "what appears to be" in the otherwise strong claim that his arguments are "airtight" and end the debate for good.

1) Steve does not incorporate into his model that the money supply is held on private balance sheets.  If he did, he would see the rather elementary fact that it must grow exponentially.  He needs to be asked, given his model with constant debt, how would the privately held elite banking industry continue to drive exponential returns for their capital holders.  They couldn't, so I've never seen a more powerful argument for an industry that should to a large degree be a utility. 

2) Glad to see he has stepped up his dialogue a notch in calling them drug pushers.  Yet then he advocates leaving the pushers alone and sort of a "just say no" policy to decrease demand.  He's gotta be kidding, right?  He thinks Nancy Reagan is the solution?  Those types of things are precisely what don't work given the power of market incentives.  If the most powerful, most important industry in the world is the equivalent of a drug pusher, then it must be fundamentally restructured and not just regulated differently.  But he's an economist, a profession which depends on having a complex banking system the people can't understand, so I doubt he'll ever make the final leap even though I can tell he wants to since he's calling them pushers.

JAG's picture
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Re: True fix for financial system


Incredible presentation from Dr. Keen. Though I'm very familiar with his work, I have never seen it presented so comprehensively before. Absolutely the best 53 minutes I have spent since watching the Crash Course so long ago. Thank you for bringing it to my attention.


darbikrash's picture
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Re: True fix for financial system
strabes wrote:

Glad you added "what appears to be" in the otherwise strong claim that his arguments are "airtight" and end the debate for good.

Strabes, I’m not here to argue debt based money creation , or evangelize Dr. Keen (or anything else),  nor defend his position. Each of us must “do the math” and come to his or her own conclusions  regarding the sustainability of debt based money. I have, and as far as I am concerned the case is airtight. Others will likely conclude differently.

We all know were this is going, with the tedious point by point rebuttal of each “claim” followed by yet more circular arguments debating how money is created, each contributor certain that he and he alone has uncovered the fundamental oversight that allows the conclusion of debt based money sustainability as being an impossibility.

I’m afraid this tired old refrain is fresh out of excuses and loopholes.

Regarding the comment of “just say no” Keen does offer some tangible guidance here, and it’s not in concert with Nancy Reagan’s altruistic approach. As mentioned, he advocates demand side action, specifically, one initiative is to limit speculative borrowing on real estate by establishing an upper mortgage limit of 10x the (potential) monthly income of a given property.  Now if a buyer wants to purchase a property that costs more than 10x the projected monthly rental revenue, than he certainly can, it’s just the banks would not be able to provide a mortgage above this value.

You can see that this would rather simply regulate the maximum pricing and seek to attenuate cyclical real estate bubbles, but I’m sure this will never fly in America because of the aforementioned hysteria regarding government intervention and regulation (funded of course by the financial institutions and other multi-nationals).

Actually, the position of Dr. Keen is not at all far from Dr. Martenson’s position, as they essentially claim the same thing. Keen says credit money does not have to crash- but usually does, and Dr. Martenson says credit money must always crash. So I guess one point of view is that the difference is in minor semantics only. (Note Dr. Keen is also a strong believer in Peak Oil)

In the context of our current situation,  both interpretations ultimately lead to the same thing.

The difference is that some of us are interested in what the fix is, for when such a time comes as corrective action becomes palatable to the America public. This means accurately assigning root cause blame, and building from validated scientific knowledge the next generation of capitalism, hopefully free from constraining and counterproductive ideologies. Keen points out (and demonstrates numerically) that simply eliminating Ponzi speculation from our economy is in and of itself sufficient to allow a healthy and growing macroeconomic landscape- a position which is antethical to free market proponents. This rather simple concession is not achievable in the current political climate, so perhaps Dr. Martenson is right after all.

As I am mindful that the last guy to disagree with the Crash Course conclusions of debt based money creation was kicked off this site, this is all I shall say on this matter, other than to thank JAG for pointing me in the direction of Steve Keen in the first place over a year ago.

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