Misunderstanding Banking is Helping Bankrupt an Entire Society

Much has been written since the JP Morgan trading fiasco and the big Congressional hearing last week – some of it enlightening, but most of it confusing some of the basic elements about banking and money in general.  I was reading this piece yesterday on Bloomberg about the responsibilities and the “job” of banks.  It got me thinking about how badly people confuse the role of banks in our system.  So I thought I’d chime in.

Banks are, at their core, profit seeking establishments that serve as the lifeblood of a complex payments system in the monetary system.  Banks make a profit by having liabilities that are less expensive than their assets (well, it’s more complex than that, but let’s keep things simple here).   They compete for deposits and business by offering various products and services.  In the USA banks are almost exclusively owned by private shareholders (as in, not the government or public sector).   Like most other private profit seeking entities the goal of a bank is not just to service the smooth facilitation of this payments system, but to to make money for its owners.  Most of the time, these two functions do not conflict, but at times the risks banks take can indeed jeopardize the functioning of the system.  Despite all the bad press that banks receive the progress surrounding their various services have actually had a positive impact on the world (for the most part).  Bank accounts, credit cards, debit cards, investment services, business hedging services , etc are all elements that make the institution of money more useful and more convenient.  Seeing as money is a tool and a social construct it makes sense that banks have evolved products and services to help facilitate the ease of its usage (all in the name of competition and profit generation, of course).

But we have to ask ourselves the question again.  What is Wall Street’s job?  Wall Street’s job is simple.  It is to increase earnings for their shareholders.  It is not to provide jobs for the private sector.  It is not to make sure the US economy is running smoothly.  It is not to make sure you feel good about your day to day life.  It is to generate a profit for its owners.  This is the essence of private banking.  To generate a profit.  But banks play a unique role in our capitalist system.  I’ve explained before that banks are not the engine of capitalism.  They are simply the oil in the machine.  As the oil in our machine, banks must be functioning smoothly in order for the machine as a whole to be functioning smoothly.  So when big banks do bad things that threaten their well-being parts of the system begin to malfunction.  And sometimes when these mistakes are big enough the contagion leads to the entire machine malfunctioning and requiring a major repair (hello 2008!).

But make no mistake, your local bank is not your best friend or a public purpose serving charity.  For instance, when a bank extends a mortgage (a word literally meaning “death security pledge” from the latin root “mortuus” for death and germanic “security pledge”) they are not doing you some charitable service to help you buy your home.  They are rating your credit risk and evaluating you as a potential profit engine for their shareholders.  That might not be the most pleasant way to think about it, but it is what it is.  A bank is not a charity.  It does not really care if your mortgage results in jobs or happiness for you.  Of course, it would be great if this did because that might result in more future business, but the bank does not need these things from you in order to generate a profit.  It really just wants to manage its risks in a way that helps to generate a profit for their shareholders without excessive risk.  Obviously, the debtor finds the mortgage advantageous, but don’t confuse this service for charity work.  It’s just good old fashioned profit seeking and offering a service where one is needed (in this case, the debtor being able to obtain money they could not otherwise currently obtain).

The business of private banking is largely about risk management.  A good bank manages risk by understanding how the various business components threaten the stability of the overall bank and align with this goal of generating a profit.   And as we ripped down the regulations structuring the amount of risk these institutions can and cannot take (in addition to making the risk taking business more complex) we realized that banks just weren’t very good risk managers.  This is not surprising to anyone who has been around markets for a while.  Investors and people in general are irrational, inefficient and poorly suited to manage the risks associated with complex dynamical systems.  So, for some reason, we all seem shocked when these profit seeking entities take excessive risks and prove to be poor risk managers.  And since we would never blame ourselves (the home buyers for instance) we blame the banking institutions.  And we write silly things about how they’re not doing their “job” or how they’re all out to screw the whole world.  It’s just not that black and white.

From a social perspective, this is all an extraordinarily interesting discussion.  Money is a social construct and a simple tool that helps us achieve certain ends within our society.  But money is something that is to be earned within our society (or utilized by the government in a democratic manner that is in-line with our goals as a society).  So there’s an interesting reality at work within the banking system.  Banks, as loan originators, act as a way to obtain access to money for someone who has not yet earned money.  And in return, they are charged a fee for “borrowing” this money that is technically not yet theirs.  If there was no interest fee attached to loans the demand for this money would obviously be through the roof and it would render it worthless.  Likewise, if banks make credit standards too lax, fail to properly asses risks and make credit plentiful they can create an imbalance within the system (by lending to people who can’t service their debt) that threatens the viability of the monetary system through the risk of excessive debt, defaults and inevitable de-leveraging (as we’re seeing now).  In this world of “what have you done for me lately” and “get rich quick” (or more often, appear rich quick!) you have a messy concoction of borrowers who want their McMansion YESTERDAY and lenders who are willing to give you the money to obtain that McMansion TODAY so they can generate a bigger profit TOMORROW.

To me, none of this is a conflict though and does not mean the system, at its core is corrupted or failing.  Banks are private profit seeking entities who play an important role in our society, but are not public servants and should not be public servants (a government managed loan system would almost certainly be a disaster waiting to happen).  Obtaining money is a privilege, not a right.  And a private profit seeking banking system serves to regulate the ability to obtain money before one has necessarily earned it (though there are certainly instances, such as some forms of government spending, where money is rightly distributed by political choice).  But because banks deal in distributing the social construct that binds our society together we have a responsibility to oversee that money so as to bring the interests of these profit seekers in-line with the interests of society as a whole.  So to me, it is not the capitalist profit motive that is evil here.  Nor is it the greedy consumption driven actions of the borrowers that is evil.  These are crucial elements of a healthy functioning monetary system.

I think we need to recognize that money is a social construct that is to be protected by the society that creates it.  But we must also understand that, while private profit seeking banks are a superior alternative to a government managed loan system, these banks will inevitably be poor risk managers at points during the business cycle.  There is plenty of blame to go around for the current debacle that is the US economy.  Home owners were greedy in the run-up and the profit seeking banks were quick to turn that extra demand into higher earnings per share.  This production/consumption component is a healthy functioning part of the capitalist machine.   But when it involves the very oil that greases the engine we must understand that this is a component of the economy that requires great oversight and better regulation.  I fear we still do not have this despite the recent changes.  And the result is that this boom/bust cycle is likely to continue causing people to believe the very essence of capitalism is corrupted when in fact, it is the users and their misunderstandings who have abused the system.  In failing to properly oversee the institution of money we have allowed it to fail us.

In sum, it is the misunderstanding of the essence of money that is evil here, not the system itself.  We have misunderstood the essence of money as a tool and a social construct and how it relates to modern banking.  And in doing so, we have allowed both borrowers and lenders to abuse that social construct.  And with 8% unemployment and a floundering economy it is not just the banking system that appears bankrupt, but our society as a whole.  Better oversight of the institution of money might not be able to fix our current problems, but it can certainly ensure that future generations don’t have to suffer through these same events.


Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  1. Amen. To reduce the dependency on banks we need to get rid of all taxlaws that encourage taking on (more) debt.

  2. Not tortured or too long. I enjoyed this. To be honest, it’s these types of articles that help me better understand MMR and where you are coming from. Often times when you’re disagreeing with someone in comments sections (mostly at MMR now), I’ll find myself not agreeing with you.. or at least not understanding “what you’re getting at” But, again, it’s these types of write ups where I think.. ‘ok ok, I see what Cullen is saying now.’

    Take from this what you will, and I mean no offense, but I feel in disagreements with MMT people you spend too much time explaining what MMT is wrong about, and not enough time clarifying what you are saying. Does that makes sense? And so in articles like this, where you take the time to clarify and elaborate, I appreciate it.

  3. I don’t know why you’d think that comment is offensive. But I’ve pretty much realized the divide between MMT and MMR is wider than oroginally perceived so explaining “sides” is pretty futile at this point. I talk to Tom every now and again at MMR because I enjoy his reasonable and rational discourse, but arguing about this stuff with most of them is a waste of time to be honest. This piece has nothing to do with MMT and I’m certain it will annoy some MMTers since they view banks as serving public purpose, but the purpose of this post is not to challenge MMT views. It’s to clarify what I just believe is the reality of modern banking and its role/relationship within the economy.

  4. Sure. Well even if you don’t think this piece has anything to do with MMT, for those of us still trying to understand both MMR and MMT, and where they are in agreement and in disagreement… whenever you clarify the reality of modern banking and its role/relationship within the economy, as you understand it, it helps someone like me understand a point of disagreement between MMT and MMR.

    I don’t think explaining sides is futile or a waste of time. It may be for you, because presumably you feel you fully understand MMT and what you disagree with about it. But for those of us still trying to figure both out, it’s helpful to read more nuanced explanations of the disagreements.

  5. Personally, I think agreeing or disagreeing with MMT is simple. If you like the Policy ideas then you are willing to overlook some of the other failings in the theory. If you’re concerned with purely operations (as I am) then fitting the policies to the operational becomes problematic since the policies inherently require systemic changes. Personally, I’m not into the politics and policies so arguing about an “inherently progressive” view of the world has become pointless. Also, since I’m not promoting a policy agenda I really don’t care about recruiting “followers”. To me, it’s all about teaching a message about the way things are. If you want to use that understanding to enact change then good luck! I certainly won’t stop you. Just don’t twist the operational to fit a policy agenda. :-)

  6. Something you underestimate is that some of us are not fully convinced that MMT or MMR is actually more correct on the operational details. Just because you are convinced you are right, and the MMT leaders are convinced they are right, doesn’t mean there aren’t people still trying to determine who’s more correct on the operational details? Hence why I appreciate it when you write up a more nuanced explanation of your understanding of things.

    For example, the context of this piece… there is a fundamental disagreement about the role/relationship of banks in the economy. So what I’m saying is at times in the disagreements, it’s not obvious what the “point” of disagreement is for someone like me. But when you write up a piece like this, I get more of a “aha!” moment when I come to more fully understand what you were saying, or trying to say, in a previous disagreement in a comments section.

  7. I did n’t see the bit about banks selling on the debt to unsuspecting third parties, after having attained worthless rating disguising bad debt as good, and selling insurance on those supposedly good (AA rated) debts or betting , themselves on same said debt going bad. Banks gaming the debtors for fees, or illegally foreclosing on mortgages.
    No mention that banks once owned by those who ran, and hence took less risk, them became banks owned by stock holders, and how managers of banks took to making money for themselves ( income and bonus) at the risk to the stock holder loosing.
    You sure DID NOT explain a whole load of stuff and, in my opinion, misguided the reader by your omissions.

  8. Thanks for this article–I thought it was a good elucidation of what banks are supposed to do and what went wrong. But maybe sometime you can write something on the two primary functions of the classic banking system–servicing the smooth facilitation of a complex payments system (as you put it) and creating money through lending. Before notational money, these two functions were necessarily related, i.e., the bank needed some deposits of bullion to back up its lending, but now they need not be.

    To paraphrase Clemenceau, Money is too important to be left to the bankers.

  9. I didn’t think it was tortured at all. Money is a slippery thing…………excellent encapsulation of the seemingly insidious nature of the banking sector. As a former member of that sector, I truly wish more people understood both its nature and necessity for a well-functioning economy!

  10. They should be regulated like the public utilities they are, but with a corrupt congress even that would have little effect. Free market capitalism tends toward survival of the fittest, biggest and most politically connected. Engraving regulation in stone after the 1929 crash did no good. Congress will sell the country down the river just to keep their job.
    Impose term limits vote out all incumbents!

  11. To a banker, the job is to make money. To the rest of us, the bank must make a positive contribution to the economic life of the country. Once they fail that test, their ability to do business should be taken away.
    Make this comparison: to an auto executive, the job is to make money selling cars. But to the society as a whole, the point of the auto industry is to make safe cars and provide employment. If it fails to do that, it loses the privilege of being in business.

  12. When ever I hear someone espouse the view that loans should be backed by gold, my first thought is why? I am a chemist and while gold holds some properties that are interesting, its properties are not that outstanding relative to other elements. At least platinum and silver have uses other than paper-weights. Copper is more useful than gold.

    By the way, who pre-tell would you leave in charge of the monetary system? States?

  13. The American Dream Is Now a Myth: Joseph Stiglitz (Nobel prize-winning economist)

    According to Stiglitz, regulations, particularly those governing the financial sector are contributing to the disparities.

    “Financial regulations allow predatory lending and abusive credit-card practices that transfer money from the bottom to the top. So do bankruptcy laws that provide priority for derivatives,” he said.

    Stiglitz argues that Americans were increasingly being made to think that higher income inequality was a byproduct of faster growth, but he says that’s a false choice. The U.S. economy grew faster in the decades after the Second World War, when inequalities were lower, than it did after 1980, he said.

    “Textbooks teach us that we can have a more egalitarian society only if we give up growth or efficiency,” he said. “However, closer analysis shows that we are paying a high price for inequality: it contributes to social, economic and political instability, and to lower growth.”

    Western countries with the healthiest economies, such as those in Scandinavia, have the highest degree of equality, Stiglitz noted.

  14. Hey, I’m all for the right of banks to pursue profit and the greed-feeding of consumer/speculators. I was not shocked one bit when this all tumbled down. What I’m shocked by is the bailouts and the refusal to let justice be served. The propping up of outright fraud and failure by all regulators and governments. All these entities should be impoverished and shining my shoes. They are not. Why not???? No one has an honest answer to this.

  15. The banking’s system has failed to operate properly in the lending business because they learned to shift liability for their poorly underwritten loans to investors they deceived with the help of the credit agencies as to the quality of these loans. Frequently, these poor quality loans were mixed in with good quality loans into a “slurry” that was then given the rating of the best quality loans in the “slurry.” This system of making bad loans just to get fees then selling them off immediately is what is killing the system. It fosters fraud. The banks must be required to keep a portion of the loans they create to prevent this type of activity. To date, I am unaware of any rules that prevent this type of fraudulent activity from continuing.

  16. Cullen, I think it goes back to the MMR imperative of making productive investments with loans. The question is who is responsible for that. I think the bank is (lender), rather than the borrower, for the following reasons:
    (i) banks have an expertise and informational advantage (look at the VC model)
    (ii) when loans are not securitized, (i) is maintained, but also, they will make the best profit-maximizing decision for the long run. It is after all an investment. The long run for individual borrowers is indeterminate.
    (iii) risk management: they can optimize productivity vs. risk because of diversification. (The borrower, by definition, to maximize future productivity, is highly risk concentrated.)
    (iV) last 100 years of evolution in bankruptcy/restructuring law puts the onus on the lender. (The days of debtors prisons and seizure of insolvent assets disappeared long ago.)

    Therefore, we should continue to blame Jamie Dimon.

  17. Cullen, you missed the most important part about banking.

    When you make stupid decisions as Wall St did during the boom years, like loaning money to anyone regardless of their ability to pay, then you must face the consequences. However; this is NOT what happened, Wall St got bailed out by the taxpayers – their losses were socialized, while they kept the profits. This is NOT Capitalism in any way, shape or form.

    The USA is no longer a Democratic country with Capitalistic ideals, but has morphed into a Plutocratic Corporatocracy and this is what is bankrupting our society.

  18. I agree, though I add our Government to the list of people who are at fault since they agreed to bailout Jamie Dimon and the other psychopathic bankers.

  19. There it is. Wealth does not disapear, it only changes hands. In this case it went from the American people to the criminals on Wall St. and the banking community. They all deserve to be in jail.

  20. If banks are for profit then they should lose the govt. gaurantees!

    Invetor and shareholders must either learn to read a balance sheet or lose every cent they chose to trust with a for profit bank.

    There is nothing regulators should do more than simply allow the banks to fail on cue. That will solve every issue they think they can control. EVERY ISSUE!

    1. it will take care of a naive public- they will either learn or lose their money. they can choose.

    2. the shareholders will become more informed or lose their money. They can choose

    3. Owners and CEOs- will be known for making you money or losing you money. If an investor chooses to give money to someone who has been known to be a poor steward of capital…then let them lose everything. That should weed out the prudent from the foolish. The quicker we take away a fools capital the better the system will be.

    4. ALLOW- any capitalist instituion to feel the full benefit of profits. The inverse must be true as well.

    5. any and all regulator/policy maker/elected official must disclose any relationship with said financial institution. ANY relationship is very broad and there should be strict limits on what can and can not be spent to influence or contribute to any official. And all contributions should be attached to that offical like a NASCAR sponsership. They should have to wear a Polo shirt with the Banks logo on it so everyone can see who he works for.

    Absent that….no issue with the banks. Just free them from regulation and guarantees. Let them feel the full force of the crisis they create. stop protecting them and let the investors feel the full force of being a shareholder for these black boxes. Regulating them more will only make things worse. Until the public is allowed to lose money for giving money to poor stewards why would they stop.

  21. MMT is a policy agenda. It’s just boring far left wing progressives thinking about excuses to get us all to believe in their big government agenda. As more and more people realize this about MMT it will slowly die off back into the shadows from where it came.

  22. The more important point is that things like this shouldn’t happen in the first place. I think that’s cullen’s bigger point. Pointing fingers after the fact is pointless if you don’t stop this from happening again.

  23. I like Mosler’s view also – in a perfect world. But back here on planet earth the banks don’t serve public purpose. They serve private purpose. They’re profit generators who serve their shareholders. Warren knows banks are not a branch of the govt serving the public interest. But MMT does this to create a relationship where there is none (or little) and rationalize their policy views that are based on the myth of a money monopolist. There’s a reason why they spend countless hours ripping into the bankers. Because they know this is a contradiction in their work and they know that without banks that serve public purpose their ideas fall flat. It’s also why many MMTers support nationalized banking. They need one vertical component to rationalize the money monopolist argument.

    But let’s not kid ourselves. Banks aren’t in the business of serving public purpose….I’m interested in describing and understanding our REALITY. If people want to use these understandings to steer policy then fine. But don’t describe reality as one thing in an attempt to rationalize a policy agenda. That’s just wrong. MMT wants to change the world by altering the structure of these institutions and the policies the govt serves. That’s fine. But what’s the point of trying to rationalize a policy agenda by claiming that the world we live in is the one they want? That just confuses people and serves to undermine their work. I keep saying they should just say that MMT is not an accurate description of the world we live in, but rather a possibility. And they ignore me. Fine.

  24. Ayn Rand would agree with almost everything Cullen said. But I don’t.

    “Obtaining money is a privilege, not a right.” Oh really ? So you are saying that banks have no RIGHT to obtain money from the Fed’s discount window ? That banks have no RIGHT to create money from thin air when they make a loan ? That’s not square with the facts, Cullen.

    Cullen’s discussion of banks only talks about old fashioned commercial banks that make money by loaning to private citizens, and managing the risk on those loans so that the private citizen will be able to make his loan payments. The reality is that most banking activity on Wall Street is largely investment banking, a legalized casino, yet the bank deposits must be backed up by the Federal government and/or bailed out by low interest loans from Bernanke. The reality is that banks do not manage the risks of home loans, since they sell the loans to someone else. The reality is that there has been ongoing fraud in the way home loans have been originated and sold, and that the Federal government will ultimately be on the hook for many of those bad loans.

    Cullen’s claim that banks are purely private would be true only if banks loaned private bank notes, not US dollars. Or if banks only loaned their private cash from their bank vault. It would only be true if bank deposits were not insured by the FDIC. It would only be true if the government let banks fail during crashes. It would only be true if banks had no access to the Fed’s discount window. It would only be true if there were no TARP and no $30 trillion in low-interest loans from the Fed. And so on.

    “a government managed loan system would almost certainly be a disaster waiting to happen” What is disastrous about the state-owned Bank of North
    Dakota ? What is disastrous about the state-owned banks in Germany ?

    “this is a component of the economy that requires great oversight and better regulation.” That’s the only thing Cullen said that Ayn Rand would disagree with, and that I can agree with.

  25. If a bank is insolvent it should not have access to the discount window and in fact gets shut down. FACT.

    I didn’t say there has been no fraud or that banks have never done anything wrong so there’s no need to lecture anyone about all that. I’ve been plenty critical of the banking industry in recent years.

    The fact that banks are regulated (like all corporations), receive subsidies (like many corporations) or have access to govt aid (like many corporations) does not make them part of the govt or even an extension of the govt. It’s a contradiction for you to criticize the private profit seeking motives of the banks in one paragraph and then, in the very next paragraph claim they aren’t private profit motivated institutions.

    I have one word on state owned banking – China. It’s a total disaster. Yet MMT doesn’t support the Chinese ways. Hmmmm. Why not, Dan? Why more contradictions there?

    And I like how you’ve tried to politicize this all by using Rand’s name. That’s a weak tactic used by someone with a weak argument.

  26. This post, I think, touches on a great discussion that everyone ought to engage throughout the country. MMR’s ever crystallizing view of money is extremely helpful in furthering the conversation, and I am proud that the readers of PragCap and MMR have interest, as I do, in understanding more deeply the monetary world in which we live.

    And yet, I have questions concerning some of what was said above (hopefully supportive questions, as that is how I intend then to be).

    Cullen says, “Like most other private profit seeking entities the goal of a bank is not just to service the smooth facilitation of this payments system, but to to make money for its owners.”.

    We’ve heard this over and over, in our MBA classes, on shareholder calls, books about business, that he purpose of a publicly traded company is to make money for share holders. In other words, the end of a business it to make a profit. I ask this question to people at random, and almost always get the same response – “Q: What is the purpose of a business? A: To make a profit”. I think this notion should be challenged and is a subtle perversion of S = I + (S – I). To me, the profundity of S=I+(S-I) was the emphasis it puts on productivity and by extension the enhancement of the human experience. Cullen has often eluded to as much, so thus I wonder if there is an inconsistency in the assertion that a business’ end is to make a profit. Would it not be more accurate to say that the end of a business is to provide a product and service and that the means to that end is profit? Is it not the case that when profit usurps production as the end that we cease to be the inherently high quality, innovative producers for which we have come to be known. In other words, profit is a metric to the management of the efficient and effective production.

    If “the essence of money [is] a tool and a social construct” as Cullen says, then it begs the question, to what end is money a tool and social construct? Furthermore, if money is a tool, why is it that we talk about making money as the end of our enterprises?

    To be sure, the convention of the modern world is to speak of organizations as “for-profit” and “not-for-profit”. Or we bifurcate “public purpose” against “profit-seeking”. It seems to me that such dichotomies are difficult to escape, but are nonetheless categories arising from a view of money that is incomplete and unthoughtful.

    If MMR is a perspective that challenges the mainstream convention of economics and money, it seems it can go a step further to challenge the conventions of neo-liberal thinking whom manage our largest and most important institutions, banking and non-banking alike.

    More could be said and discussed, but just a few of my thoughts on the matter.

  27. Thanks Kyle. Good thoughts. I agree with this 100%:

    Would it not be more accurate to say that the end of a business is to provide a product and service and that the means to that end is profit? Is it not the case that when profit usurps production as the end that we cease to be the inherently high quality, innovative producers for which we have come to be known. In other words, profit is a metric to the management of the efficient and effective production.

    The best businesses and the best capitalists are the ones who provide a service that gives much to society. In exchange, they will be rewarded. Banks are a bit different though in that they’re not really in the business of offering goods and services that will change the world on their own, but rather, making the institution of money a more useful tool (helping lead to the increased efficiency of money’s various uses).

    MMR is young in its development and I think we’ve made some real strides already. The concepts of the MMR law, S=I+(S-I), JKH’ institutional approach, etc are all really powerful concepts that will need to be further developed as the MMR concepts become more well-rounded. Criticism and comments like yours are important in helping push that all forward. So thanks.

  28. Cullen,

    Great post! Very clear and right on the mark.

    The issue that I have with banks is the privatization of profits and socialization of losses – and the expectation that this should continue (i.e., resistance to regulation). When a bank invests in complicated investments (i.e., derivatives) that it doesn’t understand and when things go wrong it expects the public to come to the rescue, that’s wrong. Secondly, when a bank issues a large number of risky mortgages which then go into default and the bank expects the public to come to the rescue, that’s also wrong.

    What other industry is backed by the public in this way? Certainly not my for-profit business. If we screw up and end up with losses, we pay the price which ultimately could be the loss of our business. Because of the continued presence of risk, we have become better managers.

    Now I understand that banks are the oil and therefore some protections are in order for the greater good. However, risk doesn’t exist if there’s nothing to lose (another bailout please!). The only way banks are going to become better at risk management is if there is pain and/or loss when they do it poorly. Further, I don’t think the public should have any role in underwriting the investment side of a bank. If banks want to operate a casino, they should be required to establish a separate legal entity for those operations and know that there will be no rescue if they end up holding a bad hand.

    Other than that, I’m in favor of private banks. :-)

  29. The government should provide banks that are not for profit.
    Just places that keep your money safe, pay a reasonable return, and make prudent loans that make financial sence.
    Is that too much to ask?

  30. I think you’re overly confident in the ability of govt loan originators to price risk. Not that private banks are great at it, but public banks will have almost zero motive to price risk accurately. Unless they’re regulated like crazy (the govt regulating itself – that will no doubt work out, right!?!). But I don’t see why we can’t have both? Better bank regulation and competitive pricing of loans?

  31. Cullen,

    Good post and definitely a topic that requires more objective discussion. One topic that seems noticeably absent in this discussion was the government’s current role/actions. Deposit guarantees, creditor bailouts and tax laws are just a few of the ways in which government alters the price of credit. These actions, which impact the decisions of both banks and consumers, may unintentionally exacerbate the normal boom/bust cycle. When considering the enormous privilege already afforded to private banks, its important (IMO) not to forget the institutional structure derived to encourage greater risk taking by both consumers and banks.

  32. No apologies please

    This was another great piece on the true nature of money (a perspective I still feel MMR and MMT largely share – along with other basic truths such as the nature of our government as a ‘currency issuer’ – even if MMR has developed a more thorough and accurate account of how the process works).

    While the driving force for the provider of capital may be profit, I would argue that any society whose value system boils down to that is doomed. (Moreover, I would argue that this provider is not the critical actor in a viable free market economy, but rather, the entrepreneur, who needs capital to build a business, and would further argue that the real deals don’t do this to make money, but rather the reverse – and would do this even if all it earned was a modest living for them and their family.)

    I agree that blaming a narrow sector of society is pointless; flaws in the system enabled various sectors to operate in dysfunctional ways. But society as a whole is responsible for the ‘system’ and the problem goes beyond technical flaws in it. Rather our society has embraced values that supported the development of those flaws, and one key to those flawed values has been an overestimation and misunderstanding of money and its reliability as a moeasure of absolute worth.

    People sense that the current system is lacking in integrity (one of the core societal values that does not reduce to the profit motive), but they need more understanding in key areas – such as the nature of money and how our monetary system operates – to figure out how to restore that. Otherwise, their frustration and dismay may lead (and be led) to counterproductive responses.

    Keep on educating.

  33. If former New York Fed Chairman and Goldman Sach’s alumni Stephen Friedman knew about secret loans to Goldman in 2008 and 2009, how did he not buy GS with unknown information?


    FINRA, SEC, DOL, CFPB, FTC, FRB, and PCAOB Wells Fargo Whistleblower Filing


    Did Warren Buffet know about Bank of America’s Secret Liquidity Lifelines when Berkshire Hathaway Invested $5 Billion in BAC?


    Updated with some Warren Buffett and Goldman Sachs: “The Fed’s Secret Liquidity Lifelines”: Wachovia Corporation and Wells Fargo & Company


  34. Kyle.

    I should have read your comment before posting mine below. The point you make about the inadequacy of profit as an absolute value in human terms, is much the same as my take on it.

  35. Corporations aren’t people (contrary to Mitt Romney’s beliefs!). They don’t desire happiness or have feelings. Corporations, like money, are merely one tool we use to achieve happiness and other things that result in superior living standards. I don’t think there’s any conflict in using tools like this to achieve higher living standards. But don’t mistake the corporation for the end. Like money, a corporation is a tool. Something that helps you get somewhere. And certainly, there’s no guarantee that a successful corporation or piles of money will actually help you get there in the end anyhow.

  36. Thanks for a very good description. I would only add that many RE agents and Banks were dishonest. When we sold our house in 2006, I was very surprised at the inflated price the agent set, over double what we paid 20 tears ago. But it sold to a young married pair with kids. The RE agent got the high commission his estimate made. The bank sold the mortgage, so they felt no responsibility for the risk created by the deal. Who is responibile for the inflation of prices, and where was the banks’ Assessor of true value? I understand (from newspaper articles) many were fired for not going along with the inflated prices. I confess to not minding the profit.

  37. Agreed – and I think your point is important for avoiding any fuzzy liberal illusions about the nature of institutions.

    But ultimately, people – as employees, managers, shareholders, citizens, members of society – are responsible for seeing that they are run with a degree of integrity (and faith in any system entails the conviction that this is the only path to long-term viability).

  38. the way I put to younger guys in the firm it is that banks assume risk — liquidity, credit, duration mismatch — in exchange for interest margin.

  39. Sorry, I didn’t mean to suggest that money should be backed with gold, only that it was. My point was that when banks were required to have reserves in something other than money itself, the lending function was limited to their ability to keep the balls in the air, i.e., have enough gold (or equivalents) around to withstand a run. Now, however, reserves are simply other Federal Reserve Notes, which can be (not necessarily will be) created at will. Therefore, there is no particular reason to tie lending to deposits.

  40. Can’t banks be a little of both public and private–like a utility or an industrial authority? We have plenty of institutiona which straddle the line between public and private–especially when those entities receive government backing–implicitly or explicitly.

  41. They could be. But at present, if you walked into the boardroom of a bank and listened to their meeting they wouldn’t be talking about how to serve public purpose better (not that they’re planning to destroy the world or anything). They’re talking about how to generate higher profits for their shareholders so they can pay themselves bonuses and reap the benefits of delivering profit maximization and keeping their shareholders from firing them. Creating banks that serve public purpose would require a very different institutional structure than the one we currently have. So yeah, it’s possible, but major overhauls and changes would be required.

  42. Cullen,

    Very good post. You were clearly in a “deep thinking”, philosophical sort of mood.

    By the way, did you read Warren Mosler’s recent post on demand leakage? Being a relatively new “student” of MMR and MMT, I found it helpful.

    Keep up the good work.

  43. ” There is plenty of blame to go around for the current debacle that is the US economy. Home owners were greedy in the run-up and the profit seeking banks were quick to turn that extra demand into higher earnings per share.”

    Sorry if someone else made the same point but there is personal responsibility and greed on both side of this equation but there is also a major difference in my view. Banks are composed of people who are allegedly professional by trade and education in measuring risk. I like your use of “homeowners” as individuals but disagree with the use “banks” which seems to personify an institution. Banks are run by executives who exemplified the same greed on a larger scale than individuals. Somewhere in this financial debacle they could no longer see the forest for the trees. Too many of these individuals in the bank have never had to accept the responsibility either civilly or criminally for their greed and violations of regulations.

  44. How can we simply say that banks are profit seeking entities that are not public servants.

    As a citizen, I have no power to create money I don’t have. Banks do. This seems to me that they are performing a government-like function. They are special entities to whom our society has given quite a remarkable power. They make money by employing this power to create money.

    If money is such an important glue to our society, it’s quite obvious that banks are serving the public in a very special way, a way that is unavailable to a common man or woman, not just making a profit.

    Does any one else see this as a bit of a contradiction in the basic premise of the article?

  45. JH

    Sorry I was referring to govt. guarantees when their beta don’t work out.

    When u remove the net the acrobats become more conservative. The fools die and the good ones may break a leg or two.

    I don’t want to do a long post but Im consistent with my views on this stuff.

    Separate the banks from investments and allow the investments to feel the full force of their investments. We should encourage risk and reward it . If risk pays off often then were not doing it right. Risk, should not reward that often.

    By its nature it should discourage taking it.

    But it’s part of evolution. Traditional banks should be sent to Canada or Austria to learn what to do. And they shouldnt come v
    Back until John carney or someone names Minsky stamps their passport

  46. Let’s be very specific here. The legal definition of public purpose is:

    “A governmental action or direction that purports to benefit the populace as a whole.”

    Nothing, or very little about banking involves directed government action. And while the issuance of loans might grease the engine of capitalism it is not done so in a manner that “benefit the populace as a whole”. In fact, lending and the extension of credit is generally a very unfair and biased exercise done in accordance with the banks profit maximization goal. These are not charitable institutions seeking to hand out money for free for the betterment of world peace and mankind. If you want money issuance that is truly for public purpose look to the US govt, not the private banks.

  47. Well, there are big problems with banks simply because they need special rules in order to operate. We allow private banks to create money out of nothing through a special public dispensation. This is what allows them to make loans in excess of the amount of money they have on deposit.

    So they are already semi-public institutions. It’s just a matter of how much public and how much private.

    My personal take is there should be more public banking a al Ellen Brown’s proposals. How much? About 20% of the economy – which is a number many people like to have as the government percentage of the overall economy.

    Yes, there will be problems, but banks are inherently problematic creatures. We should not abrogate the entire credit creation process to the private sector.


    I fully agree with the full wipe-out provisions you outline here. It’s just that banks can easily lose more money than they have, even after shareholders and bondholders are taken into account.

    So we need to find a way to keep banks from risking too much, but then allowing them to make money too. This backstop of the feds probably isn’t affordable at any price for the real value of the insurance, and 100% reserve banking doesn’t make sense to me. It would require far more government deficits to fund the growth of the economy, and cut out much of the interesting lending which needs to be done by the private sector.

    Banks are hard, because I like so much of what they do so much of the time. But the bad times are very, very bad – so how can we keep from throwing the good times out when we regulate the bad times?

  48. And there’s the beauty of MMR. Two of its founders can totally agree on the actual workings of modern banking and disagree about how it should look in the future. We explain how it works, you decide how to use it. :-)

  49. actually Perc, he has come out many times against the bail outs, just not in this particular piece. nor did he point out, as FTR did, the William Black points of “control fraud”. But this piece was trying to be more objective about what banks are, not specifically about what went totally bonkers with the system.



  50. The MMT attacks begin:

    “Cullen Roche put up a post at Pragmatic Capitalism today that argues the neoliberal position that the primary purpose of private firms is to increase shareholder value, that is, to maximize owner utility. The neoliberal idea behind this is that by doing so, the invisible hand of the market will guide the economic toward utility maximization for all participants.”


    I don’t see neoliberal or invisible hand in your post at all.

  51. This isn’t about MMT. This is just about what is. If MMT wants to criticize banks every day while also claiming they are public servants then they should do that on their websites where their audience is more prone to fall for this doublespeak. But please don’t try to bring that fight here. Thanks.

  52. I think some of the contradiction is covered by the acknowledgement that banks, like other utilities, require a special category of regulation (see also Mike S.’s comment above).

    Because of the power of money, and the nature of human institutions, banks would require a special kind of regulation and oversight, regardless of whether they were public or private (corruption is remarkably free of discrimination between the public or private nature of the institution inviting it. I personally am pretty agnostic between which would work better – not being familiar with any set of real evidence on which to base a preference.)

  53. Right Colin. Banks, being issuers of money (the social construct that binds our society) must be regulated. But don’t confuse this loose relationship with the govt to mean that they are directed by govt action or intend to benefit the populace as a whole. That’s a very naive way to view the way modern banks work. Especially when so much criticism has been thrown their way….

  54. Sorry. I know MMT is a bad word around here. I thought your post was excellent and misrepresented at their site so I thought you should know. Thanks again.

  55. No worries. I just don’t want threads here becoming MMT flame wars every time some MMTer thinks I said something that even remotely relates to them (which this post absolutely did not). I stopped using the MMT framework a long time ago. Big deal. Let’s move on.

  56. “The best businesses and the best capitalists are the ones who provide a service that gives much to society. In exchange, they will be rewarded.”

    There is so much nobility in that concept, that the best provide much. It is the reward with which so many have a problem. Reward without contribution is stealing and contribution without reward is inequitable and corrupt. And you can’t have one without the other.

    Incidentally, for those of us who are work in the financial industry, it is perhaps more important for us to ask the question “how can I enhance my contribution” than any other industry today.

  57. A description of money be true, but human self-interest can undermine it. Banks influence on Congress, for example (and Jamie Dimons’gentle questioning before a congressional committee) corrupts the use of the description in reality. So MMR can be true, but the real world (dishonesty and politics) weaken the value of MMR when used in participating in our financial industry.
    Cullen is careful to distinguish MMR as not having a political role, but real life must be taken into account.

  58. A description of money be true, but human self-interest can undermine it. Banks influence on Congress, for example (and Jamie Dimons’gentle questioning before a congressional committee) corrupts the use of the description in reality. So MMR can be true, but the real world (dishonesty and politics) weaken the value of MMR when used in participating in our financial industry.
    Cullen is careful to distinguish MMR as not having a political role, but real life must be taken into account. Comments about Bernanke and neoliberals are besides the point.

  59. Cullen, give me a break. Only 6 months or so ago you were a diehard MMTer. Now you are a diehard MMRer, who apparently desires an MMR echo chamber, hence the invective anti MMT comments liberally tossed here at those awful MMT people who dare to challenge your new found dogma. Sorry, friend, but I think the neoliberal label put on you is mostly spot on. If the shoe fits….

  60. There’s really no need for the offensive tone in your comments. MMT was taught to me as something that is apolitical and “descriptive”. And then all of the sudden the founders decided that the policy agenda was “central” to the theory and that the prescriptive and descriptive were intertwined. So when the facts changed my opinion of the theory changed. What’s so unreasonable about that? I have zero interest in pushing someone’s policy agenda and when they made this clear it became clear to a whole bunch of us that there were bigger problems in MMT. So when the facts change, I change my mind. What do you do? Tow the party line like a good little Keynesian?

    If you don’t like MMR and insist on pushing MMT then be my guest. I have no problem with that. Just don’t come here spreading your policy beliefs and calling people whose work is based largely on Wynne Godley’s “neoliberals”. I am not asking or demanding that a single person follow my work. The writings I post here are purely my own opinions. No one has to follow them or believe them. But when you leave comments like this you undermine yourself and prove that you’re just interested in more political mud slinging.

  61. Banks really should serve public purpose, but don’t. Maybe what this country needs is one big credit union based banking system or something similar?

  62. This gets us back to Adam Smith’s notion that individual actors pursuing self-interest can work to the common good.

    If the rules are set up properly, banks, in the pursuit of profit, can fulfill the need society requires of them: providing credit to the credit-worthy (not to those with inside influence, denied on the basis of other discriminatory criteria, or to a poor risk for short-term gain but long-term loss, or one that can be passed off to another party).

    I believe that, far from ‘Laissez Faire’, Smith fully endorsed the need for active management to establish such conditions.

    If society also needs credit to be available in some higher risk situations, such as to support innovation, or to those who have suffered a past history of discrimination and exclusion. then separate investment, nonprofit or public entities for these purposes may also be desirable.

  63. The entire point of this article is to highlight the need to regulate the banks. Neoliberalism directly favors deregulation. You don’t have any idea what you’re talking about.

  64. MMR or MMT don’t really interest me here. What does interest me is your about face regarding MMT. What I think is at play here is YOUR ideological proclivity–you are a conservative at heart (which is okay) and don’t want to be associated with liberals of any stripe (MMT is comprised of mostly liberals, no?). Fine. But lets move on and cut to the chase already.

  65. That’s not really accurate at all. I vote almost entirely along liberal social lines. So again, you’re just jumping to an unfair conclusion about someone you don’t know and only passively follow on the internet. It’s true that I don’t want to be associated with anyone’s policy agenda, but that’s only because I am not interested in economics to promote policies. I am interested in economics because I want to understand the monetary system better.

  66. Very nice piece Cullen, my only exception appears to be the Private Sector personal bias of yours, specifically that:

    “But we must also understand that, while private profit seeking banks are a superior alternative to a government managed loan system”

    Firstly, Canada has a fairly tightly government and private regulated banking/loan system, so do many countries, if I’m not too mistaken, the good ole USofA is there too in some forms. I think that one could see this as ‘government managed’ for the most part but not ‘state-run’. I’m not trying to be abstruse here.

    I suggest that perhaps instead we must understand that several decent effective models exist for banking and credit, some more efficient and better run than others. A fully state-run nationalized system being one alternative, perhaps the best when all others fail for reasons we appear to be witnessing in real time in much of the western world right now.

    I furthermore suggest that we should all try to promote banking system controls aimed at rooting out greedy psychopaths before they do too much damage to the economy and society in general. The Market, or private sector, as you will, often does this poorly, in fact, it often encourages and rewards ugly behaviour.

    I continue to maintain that domestic banking and credit works well as a tightly regulated utility. Investment banking can and should be outside of that, with a system where the firm partners shoulder the risk and have the most skin in the game. A smart watchdog with teeth should be always present and clearly able to identify and put a stop to criminal and unfair behaviour.

    Keep up the good work !!

  67. What’s the difference between investment bank(Bear Stearns, Lehman Brothers, GS, JP, …) and hedge fund?

  68. Okay. I can appreciate that. I’ve always liked your style and thoughtful approach to matters economic. You make it hard for me to not like you in spite of my reservations with your latest ideological manifestation.. Damn.

  69. I 100% understand your position on what looks like a pretty significant switch from MMT to MMR. But I hope readers will take the time to judge for themselves whether this switch is a positive or a negative development. I don’t intend to force it on people so if you have issues with it then let’s hash them out. I don’t pretend to know everything about everything and I really do appreciate the feedback and opportunity to explain myself when necessary.

  70. Cullen,

    I definitely agree with most of your posts. I completely support private profit-seeking capitalist institutions. Unfortunately, I’ve just come to the conclusion that banks aren’t private and they aren’t capitalists. Banks are backed by the government because they use leverage and disrupt the money supply if they fail. Real capitalist enterprises don’t alter the money supply – they just build capital. Once you get that banks are given the government-granted privilege of money creation, it’s hard to view them as capitalists. Banks create credit money. You say banks provide money to people who haven’t earned it yet, but banks aren’t lending money from their vault of stored cash, they are creating new money thanks to their government-granted privilege. The beauty of the banking business model is that you can create new unearned credit money, and then demand that credit be repaid with real money derived from productive achievement. If the borrower can’t repay the debt, the bank claims the collateral as it’s own property, even though the bank just started with credit money it created out of thin air.

    I think capitalism is an amazing economic system. I love rewarding productive achievement. I just don’t like banks because they are really just con-men masquerading as capitalists. I don’t fault you for your devotion to capitalism. I fault you because you are too quick to turn your back on the interests of the people who build capital.

  71. Thanks for the comment Luke. I don’t think I turn my back on the people who build capital. After all, a big part of MMR’s work on S=I+(S-I) is focused on this point. The MMR Law further hammers this point home. Production is the key to any economy and capital formation is essential here. I am not taking that for granted. And I agree with much of what you wrote. I just think banks need to be regulated better and perhaps the compromise you and I agree on is that banks should have their profit generating potential reduced via tighter regulations so that they can play a more stabilizing role in the capital formation process???

  72. Cullen,

    Great topic. Since the banks are in effect peddling a product that they themselves are allowed to create at will, e.g. debt dollars, fully exchangeable with U.S. fiat currency, a product totally owned and operated by the Federal Government, backed only by law, then it’s only logical that the banks must be “owned” by the Government as well. Uncle Sam needs to be the only shareholder.

    I appreciate your comment above: “I think you’re overly confident in the ability of govt. loan originators to price risk. Not that private banks are great at it, but public banks will have almost zero motive to price risk accurately. Unless they’re regulated like crazy (the govt. regulating itself – that will no doubt work out, right!?!).” Cullen, it’s the same issue with the private banks because they can pass off the risk to someone else. Today, the private banks have absolutely zero motive to price the risk at all! Just shut up about it and sell the loans off and keep the origination fees.

    As to your idea “I wish we could have both” [private and public banks]; actually we kind of do with Fanny and Freddy being owned and run by the US. The banks can make little or no profit these days because the interest rates are so low, therefore they cannot take any chances with borrowers that might not pay the principle back. Today the only way to get a loan from private banks is if the loan’s principle can be at least partially guaranteed or actually backed up by Fanny and/or Freddy, or the bank must sell the loan off to suckers. The same is true with student loans most of which are now owned and operated by Uncle Sam/Sally Mae. You see — the bank’s managers and shareholders are taking all the profit (if any), and Uncle Sam is taking all the risk (which is now enormous).

    The problem is that the private banks screwed up completely in 2005-2008. It’s their fault that the made a total mess. They took lessons from the Savings and Loans, eventually the loans were covered Uncle Sam and the quasi banks were combined into the too big to fail “zombie banks” that the world has today. Now the world’s folks and public countries can no longer pay the interest to the private bank’s shareholders. It doesn’t work anymore! If you add up the numbers, we’re all insolvent. Further, there is no way out for the world. Each country needs to nationalize its banks (just like China), and pay off at least the un-payable publicly owed debt+interest with newly printed currency and significantly reduce the privately held debt dollars overtime. The banking industry of the world will survive as “publicly owned” and the people of the world can get going on all the work there is to do in the world that currently needs to be done. Will time and money be wasted? YES But the wasted dollars will not go to the bankers in the form of forclosures etc., the situation we have now. At least it will be fiat currency created by the various governments that is wasted and not people’s lives.

  73. Agreed. But now that you’ve described the banking system as it is, maybe you could offer a few thoughts on how it should be (or could be)–I, for one, would love to hear your ideas on this subject.

  74. Cullen,

    I agree with you for the most part, and wholly in regards to the notion that a collective misunderstanding of money’s purpose in our society is responsible for its abuse. But I think the reason so many people blame the banks is that the financialization of the global economy over the past 15 years (and potentially back to the early 80’s) has lent the banking system far too much leverage politically… Bottom line, all risk managers at the major players have to change the way in which they manage risks when there is an implicit floor underneath them; if they’re purpose is to generate a the greatest profit for their owners, even attempting prudent and self-sustainable risk management would to some extent attenuate their only true purpose. Moreover, to the extent that they do decide to renege from this nash equilibrium in sight of prudent and self-sustaining risk management, it’s become very difficult to do so because the rest of the herd is busy piling into bubbles and self-reinforcing feedback loops of group think that in some regards resemble the nature of ponzi schemes. At such point in time, the question begs, is not the most prudent risk model to participate through positions that can be easily unwound as to catch the middle to the upside as a bubble builds momentum and then find a way to unwind that position and short it, paying a premium to grab some huge theta? If such is the case, does not the most prudent risk model actually amplify market swings because contradicting them in full is not prudent at all either.

    What I think I’m getting at in this rant is that you’re story here is describing banks for what they should be – the grease in the engine. But they can only be thought of in this analogy as exclusively the grease in an engine if all they do is borrow and lend money. But when these banks trade for their own accounts, or for their sponsored hedge funds, et al., they reflexively manipulate credit supply and demand by altering Investment Grade credit indices (cough JP Madoff cough) or bidding up input prices, etc. Sometimes they even do it with the intention of manipulating credit markets to move their own positions in actual lending or make their books look pretty. I agree with your description of banks as to what they should do in our society, but they cannot and will not be able to do so while their primary purpose – making a profit – will by inherent interests, contradict their societal purpose. Banking isn’t evil, but the callousness and defensive nature surrounding its virtue, whereby it bends the arguments for itself towards ‘enviably suiting’ a societal need, are ultimately catastrophically destructive. That said, restore the right inherent interests (remember the beauty of the checks and balances of the constitution?) to the banking system – which, prima facie, predicates a collective awakening in regards to the true nature of money itself – and we can begin to restructure. I believe you’ve called this cannibalistic capitalism yourself…

  75. We all will just have to accept some kind of a compromize. More regulated banks will be less efficient but less error prone and vice versa. And there will always be some jerk (MF Global) that finds a loophole, no matter what. All we can do is pick a policy from the center of the bell curve and hope for the best. Perfection ain’t in the cards.

  76. Cullen,

    Thanks for this post. But isn’t it a bit of a contradiction to say you’re not promoting a policy agenda and then say things like banks shouldn’t be publicly owned?

  77. If the banks were “owned” by the government the government would have equity or an income stream from their earned income. The only “owners” of most banks are private shareholders. This is most certainly not government ownership. That seems pretty cut and dry. What’s to debate?

  78. Cullen:
    I agree with virtually everything you wrote in this article.
    I think the primary reason is that you speak about values, and the value of money, and how money should be “properly” utilized.
    It’s like most things in our society which are inherently neutral: sex, religion, politics.
    It is how these neutral items and entities are used or abused by people that make all the difference.
    The bankruptcy you seem to be referring to is a bankruptcy of properly using the privilege of money – it should be an honor, which is honorably used, as a win-win for all parties.
    Without that perspective, any monetary or political system will eventually become bankrupt, for the people themselves, at least the movers and shakers, have grinded our progress to a halt.
    Don Levit

  79. I’ve been pretty clear about this. The conversation you’re referencing above has to do with MMT vs MMR. We intentionally did not embed policy in MMR. Yes, we all have differing policy perspectives and at times interject with policy views, but don’t confuse this for the core understandings of MMR. Just a few comments above Mike is disagreeing on the view that banks shouldn’t be publicly owned. But we all agree on the basic underlying operational realities like the fact that banks are privately owned for benefit of shareholders and serve self interests and not public purpose. They are not publicly owned and do not align their interests with that of the society as a whole (if you want to argue that SOME of the things banks do are in the name of public purpose then fine, but I am generalizing and I think most people would agree that most bank activities are done in the interest of shareholders and not public purpose). I don’t think those are controversial statements. But when I talk about policy I am not making a statement about MMR’s views. I should have been clear about this above. I am stating a personal preference. I personally don’t think banks should be publicly owned, but that’s a personal preference and has nothing to do with the current reality of the way banks operate in today’s environment. Mike disagrees. We’re both MMR co-founders so there you have it. Hope that helps clarify.

  80. Just to throw in a historical note, a century or so ago, the banking houses of JP Morgan, Jay Cooke, and the worst, Jay Gould, had their fingers in every pie (notably RR’s) and manipulated in all the ways ‘Witt’ lists above.

    A few years ago, the New Yorker ran a piece on the writer Louis Auchincloss, whose novels document the NYC banking class of a later era, as well as the school where many sent their sons (Groton, created in a marriage of New York money and Boston pedigree and bankrolled by JP. Graduates: FDR – a somewhat anomalous relationship; Acheson and Harriman: one, the architect of policies that may have forced Japan into war, and then ‘containment’ of the USSR, the other, the wealthiest man of his era, and one or both present at Yalta, Bretton Woods, the founding of Nato, etc; McGeorge Bundy, one of the authors of Vietnam War policy; Cy Vance Jr, representing the next generation).

    According to the article. early on Auchinclosss basically defended this class, believing that it could help get a business off the ground, as well as giving ‘a good man, down on his luck, a break’ (my attendance at Groton while it was still ca 200 all male students, a result of efforts to diversify; nevertheless, the paucity of Catholics and especially Jews, led me to want to ask “would the ‘good man’ get the same chance if he’d gone to City College and summered in the Catskills, rather than Harvard and Fire Island?”) However, by the end of his life, he was pretty thoroughly disillusioned with the role this class played.

    (The article also included notions on the connection of Groton to the Vietnam debacle. My own, somewhat different conclusion, was that it was more a matter of parochialism, and narrow loyalties to classmates/colleagues than more contemptible influences.)

    US recovery from the ‘Robber Baron’ era suggests it can be done, However, ‘corruption’ or even ‘cronyism’ are perhaps too harsh as terms for the more subtle aspects of what must be dealt with: the current Harvard/Princeton-Goldman Sachs-Treasury/Fed nexus is an example.

  81. It’s refreshing to see you guys disagree on policy actually. Eliminates the “cult” feel.

  82. A corporations prime directive is to make money for its shareholders. You wouldn’t want it any other way. Imagine some idiot saying he just wants people to be happy so never mind about profit? How long wiill he be in business and what happens to your investment? If someone,does not like what the banks are doing, they need to change the regulations and put some teeth in those regs. Otherwise expect Jamie and his buds to keep on doing what they do.

  83. MMT’s deception on this is so obnoxious. They want to convince us all that there’s a money monopolist so they have to say the banks serve public purpose. Then they publish articles left and right complaining about the role of banks in serving public purpose. They hypocrisy in this is unbearable. I don’t know why you continue to give them the time of day or even mention the letters MMT to your audience. They’re political ideologues with an axe to grind and they hate that you’ve abandoned them to wallow in their socialist misery. Stop talking about MMT. Even associating yourself with them at this point is bad mojo, Cullen.

  84. This was never about MMT and I have no idea why anyone made it about MMT. Let’s just all agree to move on. This political bantering is exactly what I want to eliminate from the site. It’s pointless and usually devolves into childish nonsense that is totally counterproductive.

  85. So long as we have a system where loans are packaged and sold instead of being kept and serviced by the originator, we have an incentive to write bad loans.
    Banks should not be huge profit machines. Allowing them to be such is not in the best interest of the country or the people.

  86. I don’t disagree really. We should regulate banks to ensure that the risks that they take are not excessive. But that doesn’t mean we should snuff out of the profit motive entirely.

  87. Gambling is fine for Wall St. but it has no place in banking.
    There needs to be a clear dividing line between the two.
    To allow the kind of gambling by the banking community that has ended in the implosion of the economy and the underwriting of losses by the taxpayer in order to allow huge profits for a privileged few is the very definition of being irresponsible.

  88. That is precisely why we need to go back to the kind of regulations that strictly limit what banks are able to do.
    It has been made painfully clear by both the great depression and the current economic calamity that banks left to their own devices are dangerous and destructive to the good of the people and of the country at large.

  89. You’re correct SS. There is nothing to debate. As Cullen has pointed out MMR explains how things are in the world today and it’s beyond MMR to suggest what should be changed. The idea of nationalizing all the banks in the world is well beyond any current reality. All I’m saying is that the world’s bankers knew they were pushing the boundaries of the economic system of the world for it’s own profit (as Cullen points above), and it appears to me that we could be headed for a catastrophe. You can use MMR to help predict the future if you understand how the system works (as Cullen points above), but those in control either don’t understand or they do understand and they are only in it for themselves. BUT they have screwed up big time and so now we are all in danger. With this reality one could easily suggest that there was some sort of conspiracy that backfired. I don’t go for that. This likely happened with individual banker VPs trying to make a buck for their bank and getting a promotion or two. Even the bank shareholders had nothing to do with it. Looking at the current vs 2007 value of their shares, they paid the price if they didn’t dump or short their own shares. Question-what would MMR predict would happen if all the banks in the world were suddenly nationalized and the bank shareholders were only individual nations rather than individuals? I think this is worth considering since the reality is “Misunderstanding Banking is Helping Bankrupt an Entire Society”

  90. Cullen,

    Excellent piece, thanks. I would like you to broaden your stable of potential improvements to the system when your write articles like this. You have been consistent in suggesting that more regulation would, if not prevent repeats of the recent meltdown, at least make repeats less likely. I agree it would help, but I also feel strongly that too many people think bad behavior, bad risk management, can be regulated away…..it won’t and can’t.

    I’ve written before that people have the misplaced perception that regulations are like walls as barriers to bad behavior….they aren’t. A better analogy is a maze. The regulated employ the brightest minds to conceive ways to achieve their desired goals while staying compliant with current “regulations”…..and the regulated private banks will always have more wealth to employ brighter minds to navigate the maze of regulations than the regulators. So you end up with additional regulations on top of the prior ones, creating only more confusion, which to the regulated is opportunity.

    The better alternative, in my view and experience, is simply letting failure fail. Bailouts must end, and claw-backs of pay and bonuses from failed performance must be allowed. You will find that risk management will miraculously improve overnight. More thorough evaluation of counter parties and other due diligence will improve overnight. The fundamentals of good decision making have disappeared in our era of bailouts and default insurance.

    Ironically, in my view, more regulation only insures that bailouts will continue. Complying with every new regulation, providing the convenient “We did everything you asked us to do”, will be a persuasive argument when failure happens again and the failed management comes to govt once again with their hand out…….and be assured, failure will continue to happen even with more and more regulation. Thanks, krb

  91. Financial wealth changes hands. Real wealth, say the “value” of a house, can in fact be destroyed and we saw quite a bit of that during 2008.

  92. Corrupt and criminal behavior happen all the time. If the Glass Steagall bill was not abolished, the damage in 2008 crisis will be much smaller.

  93. The above debates about whether banks should be privately or publicly owned seem misguided and based upon a poor starting assumption. That false unstated assumption is that we must allow the privilege of credit money creation. In my opinion, productive capitalists and laborers would carry on living their lives, and would be significantly better off, if nobody could expand the money supply with fractional credit. I’m not against making loans – I’m just against loans that aren’t made from savings, but rather, are made by making new money. Once you get that credit money is time-delayed theft, debates about who should do the stealing seem like a waste of time.

  94. Credit Money when borrowed comes into being as a tax on the future. It transits from the future to the present day. When that happens there is a rate of increase in the money supply. This increased rate of credit entering the supply causes it to chase after asset inflation. It gets more complicated as credit is confounded with money. Real money lent out of the vault at a bank has both velocity and its base amount. When credit money enters the supply, it fakes out the market with false velocity, and base numbers. In other words real markets for goods are faked out. Also, the market for money is distorted.

    Looking at banks, originally they were trusted partners that shifted money from one account to another. Mary would transfer to Joe, and the bank would be the trusted transference agent. But, banks got into the credit game, actually creating a lower form of money called credit.

    This credit is based on what the market will allow. The market is not omniscent,b ut is a creature of the law and signaling by money information. Markets use money to allocate goods, information and services. Looking closely at it, credit and banks create circular illogic. A banker attaches your house to his double entry ledger, creating a loan. The credit money, from the loan, enters the supply, often causing asset inflation, driving up the apparent value on the ledger and allowing more loans/credit to enter the supply. The circular illogic of credit works on the downside too. When the market collapses, it signals to the asset side of the ledger, and the bankers stop making loans.

    Money cannot be a social good if Credit money is the dominant form in the supply.

  95. Since money systems can only be observed through the lens of history, then government money systems have shown themselves superior to private formation of credit. It follows that private credit masters will host governments, and force the law to benefit themselves, thus forming a controlling unelected oligarchy.

    In the absence of law, markets will be directed by money, and the private profit motive. This is often antithetical to the good of civilization. For example, privatizing the public commons so that the commons can be tolled (through usury) benefits only a select few – the credit masters usually. Imagine all the ports, bridges, railways and public spaces privatized, as the credit masters are trying to do in Greece.

    Recent history such as that of the Greenbacks refute the notion that government money is a disaster. Greenbacks had parity with Gold at the end of the Civil war. The state bank of North Dakota did not get in trouble recently like private banks did. In fact, ND is doing just peachy, with its economy leading other states, the oil find nothwithstanding. The historical examples of Australia and Canada’s state banks are impossible to ignore.

    It is true though that Statist powers will try and seize control of the money power. That is why private credit formation is dangerous. It is also dangerous when the state becomes fascist or communist and controls the population similarly. In my studied opinion, the rightful place for money is as a legally safeguarded public issuance, but with private banks e.g. 100% reserve. This makes money money, and adds a layer of protection, keeping humanities predators at bay.

  96. State banking, while it has a better history than private banking, still does not fix the money problem. Why? Here’s an excerpt from the AMI:

    The problem is almost all of our money is created with a debt attached; it is ‘borrowed into existence’ from banks, who create it when we have to borrow it.

    As our economy grows, we need new money, but almost all of the new money is presently created with interest-bearing debt, so almost every new dollar has more than a dollar owing on it – so it has to ‘earn’ more than a dollar and pay it all back to banks (who never had it in the first place). Who owns and runs any particular bank makes little or no difference because the debt-based money-creating banking system will still own and run us, on a treadmill.

    Money doesn’t have to be created like this; coins aren’t, they’re just created as money, with no debt attached; when they’re issued, it’s revenue for the U.S. government, saving taxpayers $$$. All money can be created this way. And; if we don’t start with any debt, then we don’t start with any interest either.

  97. 1. Banks have been lobbying Congress for decades to get legislation passed that benfited consumers to take on more debt. Like taxdeductions.
    2. One Alan Greenspan reduced minimum bank reserve requirements in the early 1990s.

    There’s a reason why e.g. germans are more prosperous. German tax legislation is actually much less favourable for folks who take on debt.

  98. I don’t understand how banks could make loans with a 100% reserve requirement.

    If I deposit $1100 in a bank, it can loan that amount minus the reserve percentage – say 10%, and thus $90 to Mary. Now, assuming she deposits the loan in the banking system, it is true that this system now can loan $81 to John and so on.

    But if the reserve requirement is 100%, the bank would have to keep the entire $100 on deposit, and could only earn profit by charging me fees for holding my deposit, and processing transactions on it.

    I’m not sure how any credit would be available in this system. Would this requirement apply only to ‘demand deposits’ and not ‘time deposits’ like CD’s? Would the banks make loans from equity capital; or be able to borrow (based on some % of assets or deposits) from a CB at one rate and make loans at a higher rate – and how would this differ from fractional reserve?

  99. Colin,

    You’re right. If we had 100% reserve requirements, then banking as we know it simply would not exist. Lending would exist, but lenders would have to surrender their purchasing power until the loan is repaid, the way grandma does now when she buys bonds. In other words, credit money would cease to exist and lending would not alter the money supply. Just as you suggested, credit would be much harder to come by, but the positive consequence you ignore is that assets such as land would be significantly more affordable due to the lower demand.

    More credit access to buy land causes land prices to rise – a negative consequence for all. Less credit access for land causes land prices to fall, making land more affordable for working people.

  100. I am not ‘ignoring’ positive aspects – I’m pretty open to any workable alternative to the current dysfunctional system, which, I concur with Stieglitz, has led to unsustainable wealth and income concentration at the expense of working people and real democracy. I just want to know how the system ‘REN’ envisions would work.

    It sounds like the answer might be that credit would be based on ‘time deposits’ like CD’s – one of the possibilities I raised in my question.

  101. The Germans also have a mittlestand (sp?)banking system, which is state type banking. Small business in Germany has the same access to Capital at the same rates as do big business.

    With regards to 100% reserve, there is a weakness not discussed. It is the drain. In a credit system when you pay off your loan, it drains the money supply toward the bank, decrementing the ledger. However, in a 100% reserve system, the drain drains back toward the original creditor (us savers), and the money does not disappear.

    This means that a 100% reserve system will not be able to tune the economy easily during an inflationary period. Also, during crises people will freak and not make loans. IMO a 100% reserve system should have some component of State Credit. State credit can drain back to the state, offsetting taxes, and as well be a drain on the supply. To tune the money supply with interest rates, there has to be a drain.

    It would work like this: A bank is 100 percent reserve, and loans our our savings. At the same time, the Treasury has an account at all the private banks as well. Some state money is there on hand, so the private banker can loan it out as well. In this way, the central Treasury creates all money, but inteferes only minimally in the economy. Most money in existence is then money which had its origin in the past, and a portion of the economy isState derived Credit (future tense). Both forms of money in this system have high power so we can trade our output. State credit is much higher in power than the private credit we have now.

  102. With regards to Luke’s comment about land prices. The FIRE sector likes to attach land as an asset to the bank ledger. In this way, credit money has a counter in land. That means that land prices automatically go higher as credit money chases it. The FIRE sector will ALWAYS try to alter taxes such that land and financial assets are untaxed, while labor is taxed.

    Money systems have two main components, the fiscal side (taxes) and the monetary side (banking). Both are a function of the law and system design. However, in our credit banking system we live under today, the fiscal side is responsible and in league with the monetary side to drive land prices high.

    A good example: The total land costs of New York State exceed the value of all American business. Consider, if real money chased after real gains in a real economy, there will be a much greater output of wealth generation than what we have today. The distortions that private credit brings to a money supply and an economy make it hard for capitalism to work.

  103. Sorry Colin – didn’t mean to put words in your mouth. I think you have it right that time deposits are consistent with 100% reserve and demand deposits are most certainly not. The critical issue is that purchasing power must be surrendered by the lender during the duration of the loan such that the loan does not create new money. In other words, savings are the source of credit in 100% reserve, whereas the government-granted privilege of credit money creation is the source of credit in fractional reserve.

  104. REN,
    I think we pretty much see eye-to-eye here, I just have a few minor quibbles. I think the term FIRE can be counter-productive because it avoids specifically defining where the thefts are occurring. In my opinion, fractional-reserve (credit money) and private land ownership are the two specific thefts within FIRE. However, there are many components of FIRE that are productive services. Housing is the productice capital component of real estate. Life/auto/health insurance, ATM/checking services, and financial planning are all productice services in the financial sector – it is really only the financial companies that create credit money that hurt others. Lumping the good and the bad into “FIRE” will allow the defenders of the status quo to correctly point of that you are antagonizing productive achievements.

    Further, your left-wing bias appears to be creeping through, which can be harmful if your intent is to build consensus. I think you’re right noting how the wealthy will always try to prevent land taxation, but I think you are incorrectly implying all of the tax burden shifts to labor. In my opinion, you are forgetting the large tax burden that low land taxes place onto capitalists as well. I think we need to crush the idea that labor and capital somehow antagonize each other. It’s the rentier class (landowners and credit money creators) that mooch off of productive labor and capital.

  105. Luke, thanks for the comments. It’s always good to see how others perceive. But, for the record, I’m a conservative. The reason I’m pro labor on taxes and money, is that I believe financial freedom is required in order for a citizenry to be vigilant against Statist powers. If the population are wage slaves, and everybody is working long hours, there is not enough energy left over to be a watchdog. Consider, we have just put the industrial revolution into hyperdrive with the advent of technology and high speed telecommunications. If you could go back in time and describe today to somebody in 1944 , they would be amazed and think we have a leisure society…but we don’t. The theft of wealth in a credit economy is astronomical.

    With regards to the FIRE sector, their products are useful in the right context. But, we are not well served when the FIRE sector owns the credit money power. AIG is a good example, where they helped lobby for the Graham Leach Bliley act, in order to break Glass Steagall. Then they proceded to counter party credit at banks making AAA loans. Dial in a little shadow banking. Let’s party and borrow from the future, and who cares if the world economy crashes. In a 100% reserve world, the FIRE sector would be constrained to its rightful place and peform useful services for fees. Sober individuals would be attracted to FIRE instead of the psychopathic behavior we see in Wall Street.

    There is this idea in textbooks that credit is borrowed and it goes to the factory for improving productivity. That is a nice view, where credit improves productivity. But, the reality is that most credit chases after land, especially in these times. More than 70% of the loans on the books are related to land. I don’t believe that labor and capital antagonize each other. I want capital to benefit labor; it can do this when it is real money. Labor can best save their output with real money, and not pseudo money such as credit. With a real money system, the need for safety nets is diminished and two income families become less of a need. These are very conservative notions, it is just that most conservatives are out to lunch when it comes to the money system.

    Consider, that by 1974, in Canada…who had a State Bank at that time; the population became self financing and had very low debt levels. Companies used their own profits to fund other companies and startups.

  106. “I’m a conservative”. I wondered, but these conventional labels may have become completely outdated.

    “…perform useful services for fees”. Does this mean you don’t think banks should be in the business of making loans (and charging interest) at all – eg to small businesses? It also seems as though you believe RE princes could be low enough, and working incomes high enough that residential mortgage lending would also be unnecessary.

    This would mark a significant (should I say ‘radical’) difference, with even Luke’s position.

  107. Variation on a joke:

    “A liberal, moderate, and conservative walked into a bar. The bartender said, ‘You know Mitt – those labels just don’t mean what they used to anymore.'”

  108. Colin, aren’t you implying a false choice? Your question about small business loans seems to imply that our two choices are either 1) No loans for small business, or 2) Allow banks to create new money to lend to small business. The third (and rather reasonable) alternative is to allow small business loans from savings such that loans don’t expand the money supply. That is 100% reserve lending.

    Our money supply is composed of currency (created by government, with no associated debt) and credit money (mostly created by banks, which transfers resources from productive citizens to credit money creators as debts are extinguished). If the money supply expands through the issuance of credit money, then private sector debt levels will expand. As private sector debt levels rise, economic potential declines, as more resources must be dedicated to debt service, rather than expansion of the capital stock.

    I have no idea how far land prices would fall without fractional reserve banking, but I believe it would be significant. I would hope that people would have learned by now that increased credit access for land purchases makes land less affordable, not more affordable, but I’m afraid too few people have gotten that message.

  109. I think maybe a label would be “freedom lovin.” We probably need new labels. Both Republican and Democratic parties house Statists. In the case of Repubicans, it would be Rockefeller types who would make the population into wage slaves. This is done by creating unbalanced economies and using the credit mechanism. From the democratic side, they want political statism, which leads to communism and fascism, and then mass death. Statists of both persuasions are the real enemies, and the core driving force is the pride defect in man. We look in the mirror and it is us. But, I’m much more conservative than liberal. I would like to see single income families and power returned to sovereign individuals. A whole host of social ills would disappear. With money power returned to people and their individual states, our Federal structure would start working again.

    The founders had the right idea, in that powers should be balanced to keep man’s excesses from causing self destruction. They left it up to us to figure out the money power, but we seem to be failing at that. Too many special interest oxes will be gored.

    The most equitable form of taxation is land rent value taxes. Economists call it the free lunch; and for many reasons…mostly because land does not follow supply and demand curves. The reality is that money can fly out of your wallet to pay usury on loans, or it can go to pay taxes. Think of usury as just another tax, but going to pay the new oligarchs. Californian’s are a good example, they pay both high personal income taxes AND pay high debt levels on their homes. If you tax the rent value of land, then the scenario of growing debt for land never occurs. With 100% reserves, and rent value taxation, land prices would drop, but the tax stream would take up the difference. Income taxes would drop to zero and money would become stable. Much of the unproductive financial theft would return to productive labor.

  110. Luke,

    Once again, I am not trying to imply anything – only to understand REN’s position (I think I understand yours, and it is quite compelling).

    I realized after reviewing REN’s various comments that he probably did not mean to imply banks would only ‘earn fees for services’ and not from charging interest. I suppose they could charge ‘loan origination fees’, but it is hard to see how they could be the risk assessing and taking agent without setting and earning the interest differential between deposits and loans (subject to appropriate regulation).

  111. REN,
    If you favor 100% reserve lending and land value taxation, then we are pretty much on the same page. But I think saying you are anti-statist is false. Land value taxation is a form of socialism just like income, sales and payroll taxes are. Land taxes just socialize community-created value rather than socializing productive individual achievements as taxes on labor and capital do. Land value taxes are the best path I can fathom toward free markets for capital and labor. The refusal to tax land ensures labor and capital will pay the prices through higher taxes and higher land values.

  112. I look at it like I do gravity. It is a force and it can make me fall down and bump my head. The same goes with an economy. There are certain rules that history teaches us, and if we don’t learn them, we fall down. It usually leads to war.

    One rule is that there are four modes of production: Land, Capital, Labor, and the Public Commons. With regards to the public commons, we all use roads and infrastructure to make our society more productive. People here argue over the nature of capital, so I won’t go into it. Labor puts capital to work creating wealth. Land is required to convert energy from the sun, and to give up stored energy in the form of minerals.

    If you tax income, then that reduces spending on the productive side of the economy. If people are in debt, they cannot spend on the productive side of the economy. If you tax Labor, that reduces the ability to create and be productive.

    Capital can accrue unnaturally, as in rentier income, and as in financial transactions. Land can be monopolized, and thus stored energy can be brought into the now, creating capital advantage. Witness land cattle barons, oil cartels, etc. Land also does not follow supply and demand. More money does not equal more land, but instead asset inflation.

    So, of all the taxes, tax on land and finance is the most equitable. Taxes on income and labor cause negative outputs in my estimation.

    Since the magna carta, we in the West have given up a measure of our sovereign power. Sheriff’s for example, derive their power from the people to make arrests. This power actually resides as a natural right of the individual. Our Federal structure codifies that idea that we give up some of our power to the “social” structure. But, I wouldn’t call is socialism, but instead Federalism. Socialism implies that the power is owned by the state and is handed down from the top. That is the opposite of what I imply. Some power is handed to the State by us to do our bidding.

    The same goes for the money power. We the people own the money power and we give a measure of it over to the State to govern on our behalf, much the same as our police powers are voluntarily given over to Sheriffs. Private unelected credit masters do not deserve credit money power. Likewise, we should demand our elected officials tax appropriately according to economic law.

  113. Luke, sorry that was me above. I’ve enjoyed it. Thanks for the insights, I think this subject could take a lifetime to completely understand, especially how history and economics are so interwoven. I see the money power as the hinge of all history.

  114. Collinstoe, In a 100 percent reserve world (I advocate also for some percentage of State Credit), banks earn fees for financial transactions. These fees could be considered interest if you want. They represent a transfer of wealth to pay for their services. Bankers should be trusted partners who intermediate between creditors and debtors. Creditors are savers who have extra money to loan out to people who want to borrow.

    Bankers should not make money and engage in a market for money. The credit money scheme, connected to markets, guarantees inflation and depression by its very nature. In the upper middle ages of England, bankers would go to the big fairs and settle debts between creditors and debtors. The population used debt free Talley sticks to pay taxes, and the banker would earn fees for their services.

    For long term mortgages, a 100 percent system could be easily handled with a mutual fund type arrangement, where savers park their money long term under a legal framework.

    Money is a creature of the law, and has a force component. Also, any system design predicates its output.

    MMR is interesting in that they are attempting to describe our system. I wish they would look at the fundamental nature of money though. I see some movement with MMR averting their transfixed gaze from government and toward private credit.

  115. Amen. And that’s why banks would prefer that a debtor doesn’t repay the loan (e.g. mortgage) at all. Then the bank continues to receive the maximum amount of interest “”from here ’till the kingdom comes”” on the loan.

    And mr. Michael Hudson (www.michael-hudson.com) agrees.