Banks today have the power to extend their reach by multiplying the value of loans against deposits and shareholder capital held. Indeed, all the recent regulatory work has been to try and lift the capital ratios, to protect the financial system and to try to ensure in event of failure, tax payers are be protected. We have highlighted how highly leveraged the main Australian Banks are. And this morning we discussed the risks associated with a credit boom.
Last year the Bank of England suggested that banks have the capacity to create UNLIMITED amounts of credit, in fact creating money, unrelated to deposits.
In this light, a working paper from the IMF in 2012 (note this is a research document, not the views of the IMF), “The Chicago Plan Revisited“, is worth reading.
The decade following the onset of the Great Depression was a time of great intellectual ferment in economics, as the leading thinkers of the time tried to understand the apparent failures of the existing economic system. This intellectual struggle extended to many domains, but arguably the most important was the field of monetary economics, given the key roles of private bank behavior and of central bank policies in triggering and prolonging the crisis.
During this time a large number of leading U.S. macroeconomists supported a fundamental proposal for monetary reform that later became known as the Chicago Plan, after its strongest proponent, professor Henry Simons of the University of Chicago. It was also supported, and brilliantly summarized, by Irving Fisher of Yale University, in Fisher (1936). The key feature of this plan was that it called for the separation of the monetary and credit functions of the banking system, first by requiring 100% backing of deposits by government-issued money, and second by ensuring that the financing of new bank credit can only take place through earnings that have been retained in the form of government-issued money, or through the borrowing of existing government-issued money from non-banks, but not through the creation of new deposits, ex nihilo, by banks.
Fisher (1936) claimed four major advantages for this plan. First, preventing banks from creating their own funds during credit booms, and then destroying these funds during subsequent contractions, would allow for a much better control of credit cycles, which were perceived to be the major source of business cycle fluctuations. Second, 100% reserve backing would completely eliminate bank runs. Third, allowing the government to issue money directly at zero interest, rather than borrowing that same money from banks at interest, would lead to a reduction in the interest burden on government finances and to a dramatic reduction of (net) government debt, given that irredeemable government-issued money represents equity in the commonwealth rather than debt. Fourth, given that money creation would no longer require the simultaneous creation of mostly private debts on bank balance sheets, the economy could see a dramatic reduction not only of government debt but also of private debt levels.
We take it as self-evident that if these claims can be verified, the Chicago Plan would indeed represent a highly desirable policy. Profound thinkers like Fisher, and many of his most illustrious peers, based their insights on historical experience and common sense, and were hardly deterred by the fact that they might not have had complete economic models that could formally derive the welfare gains of avoiding credit-driven boom-bust cycles, bank runs, and high debt levels. We do in fact believe that this made them better, not worse, thinkers about issues of the greatest importance for the common good. But we can say more than this. The recent empirical evidence of Reinhart and Rogoff (2009) documents the high costs of boom-bust credit cycles and bank runs throughout history. And the recent empirical evidence of Schularick and Taylor (2012) is supportive of Fisher’s view that high debt levels are a very important predictor of major crises. The latter finding is also consistent with the theoretical work of Kumhof and Rancière (2010), who show how very high debt levels, such as those observed just prior to the Great Depression and the Great Recession, can lead to a higher probability of financial and real crises.
But this is more than a theoretical discussion, because Switzerland will hold a referendum to decide whether to ban commercial banks from creating money, after more than 110,000 people signed a petition calling for the central bank to be given sole power to create money in the financial system. Its been led by the Swiss Sovereign Money movement – known as the Vollgeld initiative – and is designed to limit financial speculation by requiring private banks to hold 100% reserves against their deposits.
“Banks won’t be able to create money for themselves any more, they’ll only be able to lend money that they have from savers or other banks,” said the campaign group.
If successful, the sovereign money bill would give the Swiss National Bank a monopoly on physical and electronic money creation, “while the decision concerning how new money is introduced into the economy would reside with the government,” says Vollgeld.
In the aftermath of the 2008 financial crisis, Iceland commissioned a report “Monetary Reform – A better monetary system for Iceland” which was published in 2015, and suggests that money creation is too important to be left to bankers alone.
Consider the impact if banks had to back loans with deposits. Credit would be expensive, and hard to get. Depositors would be better rewarded, and eventually households would deleverage, whilst property prices normalised. It might just reverse the “financialisation” of society. If it happened, banks would be very different beasts.
Financialisation is a term sometimes used in discussions of the financial capitalism that has developed over the decades between 1980 and 2010, in which financial leverage tended to override capital (equity), and financial markets tended to dominate over the traditional industrial economy and agricultural economics.
We note that by value, loans for construction rose 1.8% ($1.83 bn), whilst purchase of new dwellings lifted 1.6% ($1.24 bn) and purchase of existing dwellings rose 1.7% to $18.6 bn.
Refinanced loans rose 2.3% to $7.0 billion, and confirms the current focus of lenders trying to get existing borrowers to switch.
Looking at first time buyers, there was a 3.37% lift in the number of owner occupied borrowers (8,945) but there was a small fall in the relative proportion of borrowers, with first time buyers sitting at 14.9% (down 0.1%). Using data from our surveys, we overlay the first time buyers going direct to the investment sector, we see an additional 3,778 purchasers, down 1.3% from last month. Overall then, first time buyers are still active, despite high prices.
Finally, it is worth noting that we have seen momentum in the wholesale lending sector (up 3.8%), and non-bank sectors (up 0.9%), whilst the banks have seen growth slowing slightly at around 1.8%. Building Societies appears to be performing less well, although there is a small improvement, with a fall of 4.3%.
Standing back, momentum across the sector continues, and given that demand for property remains strong (especially in the light of recent stock market volatility) we expect lending to continue to move higher – indeed we have seen a number of lenders reduce their rates for new owner occupied and lending business, in an attempt to gain share. The property story is far from over, despite some falls in prices.
