A knowledgeable correspondent sent in two proposals for financial reform:
- The ratio of loans to assets that a bank is allowed (that is, their leverage) could be inversely related to the size of the bank. That way, there would be a disincentive for banks to acquire other banks and become “too big to fail”.
- The interest rate banks pay the Fed could increase with the size of the bank or the amount they borrow, sort of like progressive income tax rates. This would also be a disincentive for banks to acquire other banks. Banks charge their customers higher interest rates for jumbo loans, so there is already a precedent for this.
These two proposals are hereby submitted for the Internet reading public to consider, deliberate, and, if so decided, endorse.
So… If I start a bank with $1,000 I should be allowed to loan out more money than a bank with $1 billion?
If I start with $5, can I loan out all the money?
😉
Based on the previous comment, it looks like I need to explain more clearly what I meant when I made these proposals. As an example of my first proposal, a bank with $100M of deposits would be allowed to make $1B of loans (10 to 1 leverage) while a bank with $1B of deposits would be allowed to make $8B of loans (8 to 1 leverage). In other words, big banks would be allowed less leverage than small banks. The rationale for this proposal and my second proposal is to give small banks a competitive advantage over big banks. This would hopefully cause big banks to split themselves up into multiple small banks. Small banks that take too much risk can be allowed to go out of business instead of having taxpayers bail them out. An excellent movie about the problem of having banks that are too big to fail is “Inside Job”.
A more direct solution to the problem of banks that are too big to fail is a proposed senate bill (S.2746), the Too Big to Fail, Too Big to Exist Act. This bill would simply breakup all banks and insurance companies whose failure could threaten the economy. This bill has been endorsed by former Fed Chair Paul Volcker and the current presidents of three regional Federal Reserve Banks (Richard Fisher, Tom Hoenig and James Bullard).