Should firms be able to bet with your money?

The White House issued a statement on financial regulatory reform outlining two parts of their proposal. This one in particular seems like a very good idea:

1. Limit the Scope-The President and his economic team will work with Congress to ensure that no bank or financial institution that contains a bank will own, invest in or sponsor a hedge fund or a private equity fund, or proprietary trading operations unrelated to serving customers for its own profit.

Megan McArdle describes it this way:

banks that have access to the discount window will not be able to trade for their own account. That means no prop [proprietary] trading desk. No owning hedge funds or private equity funds. No investments of any kind to make profits for your shareholders. Financial institutions can make profits by servicing clients, or they can make profits by investing for their own book. But they can't do both....

Indeed, if they pass this thing, they should probably call it the Hey Goldman Sachs! You're Not Going to Be So Profitable Any More Act of 2010.

She has reservations as to whether or not such a proposal is enforceable, but if it is then it seems like a positive step.

I still think resolution authority (that is, a way for failed firms to go out of business in an orderly manner) is the key to regulatory reform, but this proposal could compliment that authority.

If firms want to gamble, they should do so with private money. Preventing them from doing so with public money seems like sound policy.

FDIC & Moral Hazard

On a recent episode of the EconTalk podcast, Columbia professor Charles Calomiris argues that deposit insurance is at least part of the source of financial crises. He argues that deposit insurance frees banks from competing along dimension of risk.

His take is arresting, interesting, and worth consideration. He also discusses how the rich are able to essentially receive unlimited deposit insurance through certain sophisticated financial arrangements.

Megan McArdle, for one, is not convinced:

The sticking point for me is twofold. The first is that we had crises before there was moral hazard--really, really dreadful crises, crises far worse than the one we're having now. I just don't see how you can look at the 1930s and name the FDIC as the decade's biggest financial problem. Or this decade's biggest financial problem. The closest our era came to a really devastating financial crash along the lines of the 1929-1933 period was in the total unguaranteed institutional money market funds.

Nor do I find the central story of how the FDIC induced this moral hazard very compelling. Supposedly, ordinary depositors don't bother to check the soundness of their banks because they don't actually have skin in the game.

Anyone making this argument cannot have met many ordinary depositors. If you stripped away my mother's FDIC protection, she wouldn't do any better of a job at evaluating Citigroup's finances.

While I was initially taken with Calomiris' claim, I'm back in the unconvinced camp. In fact, I'm not sure deposit insurance is for the benefit of depositors at all. It seems to me what deposit insurance really does is free banks from the threat of a run and subsidizes borrowing.

When banks make loans they have to get the money from somewhere. They 'borrow' it from depositors, bundle it together, and make loans. The need to repay depositors on demand can obviously be a problem when you are in the business of loaning out most of the money you take in as deposits.

The assurance of a government guarantee on deposits decreases the likelihood that most or all of the depositors will show up on any given day demanding their money back. If this was a real danger, banks would have to offer higher interest rates to attract and retain deposits. This, in turn, would lead to higher interest rates on the money they lend out. In essence, deposit insurance is subsidizing borrowing, not depositing.

In order to be profitable banks still have to compete along the dimension of risk in that they have to make loans that ultimately perform. Deposit insurance though, allows banks the flexibility of managing their portfolio of loans without having to worry about mobs of depositors at their door demanding their money. A phenomenon that history has shown can destroy a bank and cripple an economy.

Sense out of the Senseless: Healthcare Edition

Megan McArdle produces a great and short summary of the arguments surrounding the healthcare debate on both sides. The incoherence is staggering.

First up the Republicans:

Medicare costs too much, and also, shouldn't be cut.

I realize why this is politically popular (old people vote) but you can't be against unsustainable spending on entitlements and against cuts to make the spending sustainable, unless John Kerry switches parties when I wasn't looking.

Then the Democrats:

Small- and medium-sized businesses are groaning under the weight of their health care costs. Also, starting next year, we're going to force them to give you much more generous coverage from your employer, such as coverage for non-dependent "children" up to the age of 26.

The President has committed to turning his attention to jobs. From this approach though, it seems they are going to work on killing more jobs before they get around to saving or creating any. Or maybe they are going to kill them just so they can bring them back. Either way I don't think this is the change we've been waiting for.

Go read the whole thing. McArdle's got nine points. Each of which would be a laugh riot if the consequences of this entire enterprise weren't so deadly serious.

McArdle on Health Care Reform

Progressives are watching the whole health care legislative process with utter dismay as it produces a monster of a bill that not even its mother could love--and trying to love it anyway, on the grounds that it's a start. But this ridiculous hodgepodge, this hypertrophied Rube Goldberg apparatus, is not some startling aberration of the political process, induced by some Republican dark magic. This is the kind of thing the American political system produces. This is why all of our programs have a substantial element of the inexplicable and bizarre.

This is my new favorite four sentence description on the legislative process.

Go read the whole thing here.