Thursday, June 10, 2021

Why won't banks take your money?

 Banks to Companies: No More Deposits, Please, says the puzzling headline at WSJ. 

Why would bankers not want to take any amount of deposits, park them in reserves at the Fed or short term Treasury bills, charge fees and a slight interest spread, and sign up for an early tee-time at the local golf club? Sure "net interest margin" or other metrics might not look good, but money is money and more money is more money. 

The answer: 

Top of mind for many big banks is a rule requiring them to hold [sic] capital equivalent to at least 3% of all assets. Worried about the rule’s impact during the pandemic, the Fed changed the calculation in 2020 to ignore deposits the banks held at the central bank, but ended that break this March. Since then, some banks have warned the growing deposits could force them to raise more capital, or say no to deposits.

This is a fascinating little insight into the crazy world of our Fed's risk regulation. 

Taking deposits and investing in reserves is a risk free business. The Fed should be encouraging narrow banks, not harassing the few that try, or squashing narrow-banking activity. Perhaps the Fed is so unsure of its regulatory tools that it must put a capital charge in on this clearly risk free activity. But looked at either way it does not validate the usual cheerleading for the fine-toothed dirigisme of the hundreds of thousands of pages of bank regulation that they cannot recognize this simple fact. On to regulating climate and inequality... 

In recent months, banks including BNY Mellon have focused on moving clients from deposits into money-market funds, which are common cash-like investments. Assets in money-market accounts, even ones run by the same bank, are treated differently under bank capital rules, alleviating some of the regulatory pressure.

The money-market funds, in turn, need new places to park all that new cash and earn some interest. But rock-bottom interest rates have pushed them into storing it back at the Federal Reserve overnight...

Proving the point. Just hang a sign "money market fund" on the same activity and it needs no capital. 

To be clear, I think banks should be required to issue lots and lots more capital to fund risky investments. And deposits should flow to reserves via narrow banks that need essentially no capital. Perhaps it is the commingling in bankruptcy that forces a 3% capital charge on narrow banking within a bank. Still, the affair reveals just what a mess the whole effort is. If they can't get this one right, imagine what the rest looks like. 

26 comments:

  1. It's so called free money that they that to back with capital. What does it say that even in this case of pure profits banks would still rather not raise capital and prefer to forego those earnings? What is the big reason for this?

    ReplyDelete
  2. Top down rules do not seem to be becoming more rational over time, in contradiction to standard progressive assumptions. Be it health care, education, or bank regulation.

    ReplyDelete
  3. Remember just 6 years ago when ONRRP facilities were supposedly a source of potential risk?

    Perhaps 6 years from now they'll realize reserves and narrow banks are not risky.

    ReplyDelete
  4. Where will all that cash be parked at last? Do they leave banks at all?

    ReplyDelete
  5. Or the FOMC could simply sell off the $5 Trillion + in government bonds that it currently holds.

    Oh wait, that might cause interest rates to rise and force Congress (with $27 trillion in debt outstanding) to raise taxes, cut spending, or sell equity.

    Nevermind.

    "To be clear, I think banks should be required to issue lots and lots more capital to fund risky investments."

    One more regulation John, that's what you think we need?

    ReplyDelete
    Replies
    1. John has said several times that a requirement for more equity would allow us to have far fewer other regulations on banks. An equity cushion provides much better systemic risk reduction than countless other regulations on the books.

      Delete
    2. The Donk,

      1. John has always phrased his recommendation as more "capital" not more equity.
      Capital can be raised through either the sale of equity shares or borrowing.

      2. John has never indicated which other regulations should be eliminated, and so even an equity requirement is just one more regulation tacked on top of all the others.

      3. More "capital" in banking does not address the federal government's fiscal position.

      4. More "capital" does not address the role of the FOMC or the Federal Reserve.

      5. If banks MUST sell equity, then who MUST buy it?

      For example, what is the incentive for me as a resident of Baltimore, MD to buy the equity shares of a bank in Denver, CO?

      I think it makes more sense for the federal government to sell equity to any any US taxpayer that wants to purchase it rather than mandating that banks MUST sell equity.

      From a Libertarian perspective, risk by choice is a lot better than risk by mandate.

      Delete
    3. This comment has been removed by the author.

      Delete
    4. See "towards a run free financial system," "equity financed banking" and "a blueprint" here https://www.johnhcochrane.com/news-op-eds-overview/crisis-and-regulation. I favor eliminating regulatory bias toward short term debt, measuring capital by debt/market value of equity, and a smooth tradeoff; more equity, less asset regulation, and a tax on short-term debt.

      Delete
    5. John,

      "Equity-financed banking
      First, and most importantly: banks and similar financial institutions will get their money almost entirely by selling stock or by retaining earnings—rather than paying earnings out as dividends —and by long-term borrowing."

      First, what is a bank? Is a car dealership / manufacturer that does vehicle financing a bank? How about an insurance company? How about the quasi-government entities (Freddie Mac, Fannie Mae)? How about the federal government itself?

      Second, any long term debt instrument eventually becomes a short term debt instrument as the payments are made. A 30 year bond eventually becomes a one year bond. It is impractical for every type of loan (mortgage, car loan, etc.) to be perpetual since none of us are going to live forever. So no matter what you do, you are going to have some short term debt.

      Third, what constitutes equity? John mentions the two obvious - sale of equity shares and retained earnings. Are demand deposits considered equity ownership in a bank? Should demand depositors have a voting stake in how a bank is managed?

      "Second: short-term, run-prone financing will be absent. Short-term debt is the poison in the well. Our crisis-free economy will treat it as such."

      Again, long term debt eventually becomes short term debt. Eliminating short term debt basically eliminates all types of debt except the perpetual variety. Would you lend someone money to buy a house or a car or start a business with a perpetual loan?

      "Those wishing to have immediately available, completely liquid, fixed-value investments will still have them. Banks may still offer deposits and checking accounts. However, such liabilities must be backed 100 percent by short-term Treasuries or interest-paying reserves, in ways that are completely insulated from bankruptcy of the parent company."

      First, short term Treasuries are poison in the well (as you describe it) in the same way that any other short term debt is poison in the well. Second, the interest payments that the central bank makes on reserves come from the debt instruments that it holds (no the central bank doesn't just print up the interest payments).

      Finally, all of the other issues above are not addressed:

      1. Which regulations / agencies should be eliminated (Quasi-government agencies?, Deposit insurance?, FOMC?, Federal Reserve Board of Governors, others)

      2. Should the federal government always run surpluses, rely on short term debt financing (poison in the well), rely on long term debt financing, other?

      3. Since banks MUST sell equity, then who MUST buy that equity?

      Delete
    6. Interesting statement from "A Blueprint for Tax Reform" by Michael Boskin
      in the same volume.

      "It is important that the corporate rate and the top personal rate be quite similar, if not identical. When even a modest gap arises, huge volumes of capital will shift in or out of the corporate organizational form, depending on which rate is lowest, in order to legally avoid the higher tax."

      Apparently, no one got that memo (Donald Trump, Paul Ryan, Kevin Hasset, J. Cochrane, etc.).

      US Corporate Tax Rate - Prior to 2017 - 37%, After 2017 - 21%
      Top US Income Tax Rate - 37%

      John Cochrane's take:

      https://johnhcochrane.blogspot.com/2017/01/corporate-tax.html

      "My view: the corporate tax should be zero. Not just a zero rate, but the tax should be abolished."

      I fail to see how the document compiled by Mr. George Shultz is a "Road Map", when it's contributing authors can't agree on a direction to go.

      Delete
    7. The corporate income tax should be zero, and so should the personal income tax rate. Find everything with a consumption tax or VAT. It can be progressive if you'd like. All this clearly stated by me and many others. If you would ask rather than criticize, I would be happy to explain it all.

      Delete
    8. John,

      "If you would ask rather than criticize, I would be happy to explain it all."

      Okay, I am asking...under your program for monetary reform - how are you defining a bank? Does that encompass any company that handles financial contracts (commercial bank, brokerage, investment company, insurance company, vendor financiers, quasi-government agencies, the federal government itself) or is your definition limited to loan originators?

      I am asking, if short term debt is the "poison" that should be "taxed", how do you reconcile that statement with the fact that all debt (other than perpetual) eventually becomes short term debt and that you recommend that deposits must be backed by short term Treasury debt (more poison)?

      I am asking, which regulations / agencies should be eliminated (Quasi-government agencies?, Deposit insurance?, FOMC?, Federal Reserve Board of Governors, others)?

      From Mr. Boskin's portion:

      "There is considerable research showing that moving toward a broad-based, integrated progressive consumption tax would significantly increase real GDP and future wages."

      I am asking - Japan has a VAT and yet Real GDP has stagnated. Please name the countries that have benefited in terms of Real GDP from the the introduction of a broad based consumption tax and the time frame this benefit has occurred?

      Finally, I am asking - if banks MUST sell equity, then who MUST buy that equity?

      If you read above, all of these questions (and others) have already been asked.



      Delete
    9. Final questions:

      If a corporation should not be taxed separately and distinctly from individuals, then why should individual owners in a corporation receive legal benefits - for instance limited liability - that they have not paid for?

      https://en.wikipedia.org/wiki/Limited_liability

      For that matter, why should a corporation be recognized as a distinct legal entity at all?

      See:
      https://en.wikipedia.org/wiki/Corporate_personhood

      Delete
    10. "If you would ask rather than criticize, I would be happy to explain it all."

      Still waiting for an explanation.

      Delete
    11. "If you would ask rather than criticize, I would be happy to explain it all."

      Still waiting for an explanation.

      Delete
    12. "If you would ask rather than criticize, I would be happy to explain it all."

      Still waiting for an explanation.

      Delete
    13. "If you would ask rather than criticize, I would be happy to explain it all."

      Still waiting for an explanation.

      Delete
    14. "If you would ask rather than criticize, I would be happy to explain it all."

      Still waiting for an explanation.

      Delete
    15. "If you would ask rather than criticize, I would be happy to explain it all."

      Still waiting for an explanation.

      Delete
    16. "If you would ask rather than criticize, I would be happy to explain it all."

      Still waiting for an explanation.

      Have you started to figure things out yet?

      Question: Why did oil and gasoline become the predominant fuel for motorized
      vehicles? Answer: Because of War. Prior to World War I, there was a fairly even mix of electric powered motor vehicles and gasoline power vehicles. That all changed with the outbreak of War.

      Question: Why does the federal government sell bonds to finance deficits? Answer: Because of War. Recognizing that you as purchaser of government securities could be conscripted / forced into military service at any time during a war, you are only going to purchase something from the government that has a high probability of payment to you or your heirs even in the event that you are injured or killed in action. Post Civil War, these were pensions that were given to soldiers who had served.

      Everything you ever learned about economics and public finance has been shrouded by the fog of war - hence the term "War Dog Economist". It's not entirely your fault. All of your professors and teachers in the field were intimately involved in one or more wars that the US was engaged in and so their perspectives were informed through their own experiences.

      Delete
  6. John,

    "To be clear, I think banks should be required to issue lots and lots more capital to fund risky investments.

    To be clear, the Chicago Plan was rejected by Congress in 1939 and hasn't gotten any better with age.

    Time to get over it.

    ReplyDelete
    Replies
    1. That's why Keynes wrote the General Theory. UK treasury wouldn't do the sensible thing!

      Delete
    2. The sensible thing for any Treasury (UK or in the US at that time - Andrew Mellon) would be to sell equity claims against future tax revenue rather than bonds.

      In that way risk is taken by choice rather than forced down the throat of the populace via devaluation, inflation, or outright default.

      But try telling that to numerous generations of war dog economists (J. Cochrane included) and all that you get is incoherent ramblings and blank stares.

      Delete
  7. Can you explain the last paragraph? I have many questions:

    1. Wouldn't a narrow bank decrease the supply of deposits for banks, thereby decreasing the amount they can lend?

    2. What would you do to make bank lending take on more risk?

    3. What commingling are you referring to?

    4. By "3% capital charge" is this a reserve requirement? Or something else?

    Thanks!

    ReplyDelete

Comments are welcome. Keep it short, polite, and on topic.

Thanks to a few abusers I am now moderating comments. I welcome thoughtful disagreement. I will block comments with insulting or abusive language. I'm also blocking totally inane comments. Try to make some sense. I am much more likely to allow critical comments if you have the honesty and courage to use your real name.