Laurence Kotlikoff: Let’s limit the banks | Finance

Conventional banking has two ingredients that make financial collapse inevitable — leverage and opacity. Thanks to lobbying by the big banks, Dodd-Frank, the Vickers Report and other recent banking regulations do precious little to change this lethal brew. Instead, they’ve raised regulatory compliance costs, giving big banks a greater competitive edge and increasing their market share. The new regs also make bank runs more, not less, likely. Their restrictions on bailouts send a clear message to creditors — run even faster to reclaim your money at the first whiff of financial trouble.

Fortunately, conventional banking is not the only game in town. One-hundred-percent equity-financed mutual fund banking with full disclosure of the mutual fund’s assets provides an alternative model. I proposed this innovative idea in my book “Jimmy Stewart Is Dead.” The model is called Limited Purpose Banking (LPB), because it limits financial institutions to the role of middlemen — connecting borrowers and investors, facilitating savers, etc. — without owning any financial assets themselves. LPB is taking hold alongside conventional banking and may someday efface it.

LPB mutual funds are like mutual funds in which you hold your 401(k), IRA, Roth and other retirement account money. They are, effectively, small banks — except they sell shares to gather funds to invest. They borrow not a single penny. As a result, they can never go bankrupt. With the entire financial system consisting of LPB mutual funds, no financial institution will ever fail, and the banking system becomes riskless.

By the way, during the financial crisis of 2008, not a single equity-financed mutual fund, which, to repeat, is effectively a non-leveraged bank, failed or needed to be rescued. The only mutual funds that ran into trouble were money-market…

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