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Ireland Must End ‘Trust Me’ Banking

We missed this when Lawrence Kotlikov Professor of Economics first published it in Bloomberg.  He proposed ‘Limited Purpose Banking’ as a way to end banking runs once and for all.  Ireland is held up as an example of ‘Trust Me’ banking gone very wrong.  His discourse has sparked many rebuttals – usually from within the financial sector but not always – see this from INET.  Here is an excerpt of Kotlikov’s main thesis…

Bank of England Governor Mervyn King provided a scathing indictment of the world’s banking system Oct. 25, suggesting that it too was unsafe at any speed. Speaking at the Buttonwood Gathering in New York, King cited Iceland and Ireland as exhibit A. His speech was arguably the most important statement by a Bank of England governor in the Bank’s 316-year history.

‘Worst’ Bank System

King didn’t offer up a profit-and-loss statement and crow, like U.S. officials, that his bank profited from the crisis. Instead, he discussed the horrendous loss-and-loss of workers and retirees and pulled no punches in decrying the status quo.

“Of all the ways we have of organizing banking, the worst is the one we have today,” he said.

King also made clear that neither the Dodd-Frank financial regulation law, nor Basel III, nor anything short of radical financial surgery will keep the world safe from a financial meltdown. The intensifying attacks on Ireland, Portugal, Italy, and Spain are indicative of this fact.

Yes, the Federal Reserve and the European Central Bank can print and distribute trillions of dollars and euros, but they can’t get people jobs, produce real goods and services, or make people use a financial system that has lost credibility and, thus, credit ability.

In discussing safe radical reforms to replace our radically dangerous “financial doomsday machine,” King cited my limited purpose banking proposal as eliminating “financial alchemy” (trust-me banking) and advocated its further study.

Like Mutual Funds

He is leaving the U.K.’s Independent Banking Commission to reach its own conclusion. But if you read King’s speech carefully, he finds the other radical solutions lacking in critical ways.

Limited purpose banking forces all financial corporations (those protected by limited liability) to operate strictly as mutual fund companies. Mutual funds are, effectively, small banks with 100 percent capital requirements. They would buy and hold stocks, bonds, mortgages and other securities with customer funds.

Limited purpose banking also establishes a single government regulator — the Federal Financial Authority — to oversee the independent and non-conflicted verification, rating, appraisal, custody, and full and real-time disclosure of all securities held by mutual fund companies. And it requires mutual funds to buy and sell securities in an auction market to ensure households and firms get the best price for their paper.

In short, limited purpose banking turns trust-me banking into show-me banking.

No Failures

Since mutual funds hold no debt, limited purpose banking eliminates the possibility of bank failures, with their terrible economic costs. And the FFA would put an end to most financial fraud. Rating companies would work for the agency, not security owners.

Regulators, performing the FFA’s limited tasks, would have no way to help future employers. Bribing politicians to do Wall Street’s bidding would be a thing of the past. And boards of directors and chief executives could no longer steal from shareholders; they would be compensated solely on the basis of their mutual fund’s FFA-documented performance.

In the words of George Shultz, former U.S. Treasury Secretary and Secretary of State, limited purpose banking delivers “what the country needs” — a new financial system that is “simple, clear, and most of all effective.” It would also remove the financial sword of Damocles hanging over Ireland and so many other countries.

The Irish should get up their Irish and end trust- me/mystery-asset banking once and for all. Limited purpose banking is Ireland’s and the world’s best hope for restoring prosperity.

(Laurence Kotlikoff is professor of economics at Boston University, president of Economic Security Planning, Inc. and author of “Jimmy Stewart Is Dead.” The opinions expressed are his own.)   (link to full article)

Posted in Money Systems, Resilient Investment.