A Free-Market Alternative to Modern Banking
Digital money like Bitcoin opens up possibilities for banking without central planners or a lender of last resort, where interest rates and reserve requirements are driven purely by the market.
The ultimate foundation of all economic activity is consumption by all layers of the economy, and the best foundation for that consumption is durable cash flow. In this context, the old adage that a house built on sand will eventually fall is extremely appropriate.
When we allow the vast majority of our nation's deposit-base to be exposed to investment risk on a systemic basis, we undermine durability and create fragility. This fragility enfranchises myriad risks that I need not go into now; as bankers, you are well aware of them. As well, I need not remind you of the massive negative systemic compounding effects that can arise. The systemic nature of this attrition was made abundantly clear only a few years ago. Unfortunately, the government's past and present attempts to control this systemic attrition are doomed to failure.
"Past performance does not guarantee future returns." We market participants see this disclaimer everywhere we turn. So I ask: how is it that we have allowed our government to attempt to guarantee liabilities created through investments made by proxy on credit via the banking system? This is the conundrum that many well-meaning government programs attempt to answer.
In a free-market economy it is imperative that we allow our citizens to engage in those risk-reward trade-offs that they find acceptable for their own unique situations. This activity must be restricted, of course. This is the true role of government: to establish and protect the framework which provides the context for relatively fair economic competition and risk-taking, with certain focused interventions to advance those goals which oftentimes are not given appropriate credence by the free-market mechanism. The heavy hand of government intervention and regulation must be applied sparingly and in a focused manner, lest we risk disrupting the free-market mechanism that has made America great. Thus, any solution to the fundamental problem of deposits' exposure to investment risk must be primarily achieved through a free-market mechanism. My proposal is the creation of a new type of company with a name familiar to bankers: the Depositary.
My Depositary (distinct from the depository we know) would function purely as a money-handling institution, rather than as an investment proxy as modern banks do. In other words, the Depositary would not invest client money in any way. A Depositary client's money would simply be held and handled in exchange for fees. These fees would be structured to account for different types of clients, activities, and volumes. Services provided would include the necessities and conveniences of modern financial life: cash accumulation, cash movement, and other sundry services. A premium over similar services currently offered by modern banks would be warranted, given that a Depositary does not in any way expose its clients to investment risk. However, there is always the potential for unforeseeable catastrophes like earthquakes, fires, terrorism, and other such events. Thus, it would make sense for there to be some type of insurance for these Depositaries. Given the potential scale of the quantity of cash, it might make sense for the Depositary insurance to be provided through a governmental or quasi-governmental program.
However, it is important to point out that the Depositary would coexist alongside the modern banking mechanism. Credit remains an integral component of the democratization of wealth creation, and so we must be neither too liberal nor too conservative in our economic framework. I believe that this free-market alternative to modern banking will provide a better environment to naturally achieve that balance.
As with any idea, implementation is often harder than conception. How could the deposit-base leave our highly leveraged banking system without creating financial chaos?
I believe the key lies in a proper velocity. A velocity that is too fast would risk spawning the same problems as experienced in any bank-run. One that is too slow would risk giving the process insufficient financial mass to create a true offset to investment risks in the economy. I believe that achieving this optimum velocity resides in cooperation between banks and government. The two must come together to establish a rubric of appropriate relationships between the downsizing of assets, the control of expense ratios, the character of risk exposures, and liquidity needs. Once this is established, the banks would enact their own divestiture programs to reach the goal of divesting those deposits whose owners do not want investment risk associated with them. The evolution would happen gradually yet meaningfully. Regulatory burdens would be lifted from the banks in stages as thresholds are met. This would give managerial and monetary boosts to the banks as they evolved. FDIC insurance would likely still be required for the banks during this evolution. Once it is completed, though, clients who choose to remain exposed to the banking industry would find their "deposits" transformed into true investments. Banks could pursue a range of options to enact these transformations: preferred or common equity, debt instruments, securitized products, and the like. However, these funds would now constitute investments and would no longer require FDIC insurance. They would be subject to the same regulatory oversight as other investments of the same type.
Eventually, the banks would complete their evolution into what they truly are: investment proxies. Some might choose to focus on traditional loan origination on behalf of depositors willing to undertake investment risk, some might choose to focus on the securities markets, and some might choose a combination. Of pivotal importance, however, is that no longer would the government be placed in the unhappy position of attempting to solve the conundrum I mentioned above: ensuring the integrity of deposits invested by proxy even though "past performance does not guarantee future returns."
What must not be discounted is the cumulative beneficial macroeconomic effect of allowing those who wish it the option to eliminate investment-risk from their deposits. By facilitating the buildup of cash reserves segregated from the credit markets, we would protect the real economy from the volatility of the financial sector.
Samuel Zavaletta is a full-time individual investor in the equity markets based in Austin, Tex. He has a long position in Great Southern Bancorp (GSBC).