How to Fix Banking: Start Over

Jimmy Stewart is dead. So is his bank, says Laurence Kotlikoff. Instead of the homespun, honest bankers like the one Stewart played in It’s a Wonderful Life, we have pinstriped pickpockets in a septic system that gave us the financial crisis, the William Fairfield Warren Distinguished Professor and College of Arts & Sciences professor of economics argues in his new book.

Challenging the policies of almost everyone from FDR to President Obama, Jimmy Stewart Is Dead: Ending the World’s Ongoing Financial Plague with Limited Purpose Banking calls for a new banking system called limited purpose banking (LPB). LPB would transform all financial institutions — traditional commercial banks, investment banks, hedge funds, insurance companies, credit unions, brokerage firms, you name it — into mutual fund companies. Checking accounts would be replaced with all-cash mutual funds, while savings accounts would be scrapped in favor of short-term mutual funds that invest their money conservatively. People seeking higher return but riskier investments (in, say, derivatives or mortgages) or who wanted to buy insurance could choose funds serving those purposes.

LPB would deny banks the ability to borrow, hold assets, and make financial bets; the banks would simply manage mutual funds. Kotlikoff also would replace our 115 government regulatory agencies with one — a Federal Financial Authority — that would verify, disclose, and supervise the ratings of all securities in these mutual funds.

Some people rock the boat; Kotlikoff shakes it to the breaking point. He previously has advocated a 10-percent-off sale at U.S. stores, bankrolled by the federal government; a national sales tax to replace income and payroll taxes; and disregarding financial planners’ saving-for-retirement suggestions as overblown. He was an advisor to former U.S. Senator Mike Gravel, the long-shot 2008 Democratic presidential candidate, who later switched to Libertarian. Still, the jacket for Jimmy Stewart Is Dead bears blurbs from five Nobel economists and former treasury secretary George Shultz.

BU Today talked with Kotlikoff about LPB.

BU Today: What do you think of President Obama’s and Congress’ regulatory reform?
Kotlikoff: I don’t think it’s addressing the core problem. We had financial malfeasance of many types, including the manufacture and sale of trillions of dollars of financial securities, liar loans, ninja (no-income-no-job-or-assets) mortgages. We had corporate executives clearly stealing from shareholders, in the form of compensation not connected to productivity. I don’t see these things being addressed.

The overarching policy has been to guarantee everything in sight, which goes beyond the ability of the government to deliver. If there were a run on the banks today, with all the obligations the government has committed to, we’d have the government having to literally print trillions of dollars.

Are you saying FDR goofed by creating deposit insurance?
I’m saying FDR was lucky. If the public had called his bluff and continued its run on banks, he wouldn’t have been able to back up his promise. Think about a run today. The FDIC has $18 billion in reserves, and they owe far more. It’s a fraudulent security.

If experience is the best teacher, shouldn’t we go with the kind of regulation that saved Canada’s banks from collapse?
It’s true Canadian banks are better run. But Canadian banks also have problems. If we had a run in the United States, would there be a run in Canada? Canada’s stock market fell by a bigger percentage than the U.S. stock market. We should not necessarily solve this crisis by restricting credit. In Italy, they require very high home down payments, 50 percent down. If you had those kinds of restrictions, there’d be less chance of the kind of problems we’ve had, but there’d be fewer people buying homes.

What about simply reenacting the Glass-Steagall Act, the Depression-era firewall between commercial and investment banking, which was repealed in 1999?
Lehman Brothers was an experiment in that policy. Lehman Brothers was not a commercial bank, they were not insured by the FDIC, they were allowed to fail, and because these companies are so interconnected, another bank can fail because Lehman Brothers failed. AIG failed because Lehman Brothers failed. It blew up in our faces.

Do you have a compulsion to be a contrarian?
No. I have a compulsion to save our kids and grandkids from poorly designed government policy.

Rich Barlow can be reached at barlowr@bu.edu.