Ashwin at Macroeconomic Resilience had a very interesting post last month arguing that the fundamental function of banks -- maturity transformation -- is no longer required. Historically, the reason banks existed was to bridge the gap between ultimate lenders' desire for liquid, money-like assets and borrowers' need to fund long-lived capital goods with similarly long-term liabilities. Banks intermediate by borrowing short and lending long; in some sense, that's what defines them. But as Ashwin argues, today, on the one hand, we have pools of longer-term savings for which liquidity is not so important, at least in principle, in the form of insurance and pension funds, which are large enough to meet all of businesses' and households' financing needs; while on the other hand the continued desire for liquid assets can be met by lending directly to the government which -- as long as it controls its own currency -- can't be illiquid and so doesn't have to worry about maturity mismatch. It's a very smart argument; my only quibble is that Ashwin interprets it as an argument for allowing banks to fail, while it looks to me like an argument for not having them in the first place.
Another way of reaching the same conclusion, in line with recent posts here, is that you can avoid much of the need for maturity transformation, and the other costs of intermediation, including the rentiers' vig, if business investment is financed by the business's own saving. In comments to the Macroeconomic Resilience post, Anders (I don't think the same Anders who comments here) points to some provocative comments by Izabella Kaminska in a Financial Times roundtable:
An FT view from the top conference, with Martin Wolf moderating. He said an interesting thing re. all the cash on the balance sheets of American corporates. That for many US corporates, banks have become completely redundant, they just don’t need them. ... The rise of the corporate treasury, investing wisely on its own behalf. Banks have failed at the one job they were supposed to do well, which was credit intermediation... No wonder banks have sought ever more exotic creative financing options .. their traditional business is dying. They’re not lending, can’t lend. So corporates are inadvertently acting by piling up cash reserves to solve that problem.... [You] see lots of examples of Corporates who don’t trust banks. … it’s amazing to think that we have come this far in the last two years… to a point where people like Larry Fink are suggesting banks are pointless.This is part of the story of Japan's Lost Decade that Krugman doesn't talk about much, but that Richard Koo puts right at the heart of the story: By the mid 1980s, Japanese corporations could finance almost all of their investment needs internally, but the now-redundant banking system didn't shrink, but found a reason for continued existence in financing real estate speculation. Banks may be pointless, but that doesn't mean they'll go away on their own.
2. Are Copyrights Necessary?
I'm surprised there hasn't been more discussion in the blogosphere of this new working paper by Joel Waldfogel on copyright and new music production. (Summary here.) Has Yglesias even mentioned it? It's totally his thing: an empirical study of whether file-sharing has reduced the amount of good music being produced, where "good" is measured by radio airplay, and various critics' best-of lists. Which, whatever, but you've got to measure it somehow, right? And, oh yeah, the answer is No:
We find no evidence that changes since Napster have affected the quantity of new recorded music or artists coming to market. ... While many producers of recorded music have been made worse off by changes in technology, there is no evidence that the volume of high-quality music, or consumers, have suffered.Information wants to be free.
3. It's an Honor Just to Be Nominated
Hey, look, someone at everyone's favorite site for d-bags with PhDs, econjobrumors.com, has started a thread on the worst economics blogs. And the first blog suggested is ... this one. "Krugnuts times 11," he says. I think that'll be the new tagline.
Congrats on your nomination Josh!
ReplyDeleteI am a little green.
Thanks - You're right in perceiving my argument as one for not having banks in the first place. My call for failure is really fuelled by my scepticism that any sort of ban on maturity transformation can work. But if we take away the liquidity backstop and preferential access to the Fed, then failure could very well mean extinction - an outcome that I am fine with.
ReplyDeletedoes this make Krugman The Slackwire divided by eleven? What's the exchange rate of Quiggins to Krugmans? Will Krugman's CB buy up Krugbills to in order to keep up with the export powerhouse of The Slackwire??
ReplyDeleteseriously, that site is noxious. went to the main page, saw this heading: 'Unfortunate reality of Chinese names in economics and fenance (63 posts)'
The accompanying post: 'Most Westerners cannot remember Chinese names. For example, when we look at the profs at CKGSB, we don't recognize any of them, but when we check out their CVs they are impressive. Given that "brand equity" is a prof's primary asset, it is too bad that most successful profs with Chinese names will never become well-known.'
Ughhhhh you have to be kidding...
'that site' = econjobrumors
ReplyDeleteYeah, it's a cesspit. You should have seen them hooting and hurling feces when Elinor Ostrom got the Nobel last year...
ReplyDelete"the fundamental function of banks -- maturity transformation -- is no longer required"
ReplyDeleteThe idea that banks are financial intermediators and their task is to do maturity transformation is wrong. Banks engage in maturity transformation only because we have intentionally built a financial system where payments system equals banking system. But if you strip payments from banks then what is left?
"for many US corporates, banks have become completely redundant, they just don’t need them"
Karl Marx: capitalism is M-C-M'
The fundamental function of banks is credit analysis and diversification. And the fact that M-C-M' equation is broken is not a banks' fault. Or at least it is not their direct fault. We have almost intentionally built such a financial system where corporates get all income while their customers need more and more debt. Today's capitalism is one of a weird upside down variety. Those who are supposed to take risk bear no losses. And those who are supposed to bear no losses take all risk. No wonder it is so politically and economically unstable.
Welcome to the club.
ReplyDeleteHuh, that link used to go to a thread denouncing me on the basis of this. I recall a particularly charming suggestion that my Cunning Plan was to bank-roll Communist agitation by selling macro-forecasting models to hedge funds.
ReplyDeleteI'd be a little sad if that thread had disappeared totally, but it doesn't seem worth searching out again.
JW - perhaps I can articulate my position a little better than I did on your last post on maturity transformation (MT).
ReplyDeleteThe observation I believe you're making is that business appears, at various times and places, to be comfortable running a financial surplus in aggregate as a sector (even if within the sector there may be businesses making a large surplus lending to those making a smaller surplus or a deficit).
But is it economically efficient for firms' fixed capital formation to be limited to retained earnings?It seems a little unambitious; or alternatively, I wonder whether this state of affairs indicates some structural deficiency (tax? Or longer term, education policy?) constraining the rate of fixed capital formation that business would otherwise aspire to.
If we ought to welcome, or at least accept, investment being limited to business' own retained earnings, then yes a key rationale for TM would fall away. But wouldn't there remain a distinct rationale for residential mortgages? I believe in the 1950s (UK at least) households used to save up for mortgages, but without a truly terrifying decline in house prices, this state of affairs appears unattainable.
About the copyrights issue, I'm not convinced that the study you point to really shows that copyright law is unneccesary. Maybe music creativity has continued to thrive despite "diminished appropriability" because the copyrights regime remains in force. Just because less copyright enforceability has not lead to less creativity doesn't mean that no copyright enforcement would also not mean less creativity. There seem to be other factors behind the continuing growth, like the move to digital music distribution (some of which has lower margins) and alternative sources of sales, overhead, and publicity that "diminished appropriability" has allowed.
ReplyDeleteThe fundamental function of banks is credit analysis and diversification.
ReplyDeleteI don't see this. Credit analysis and diversification are concerns for any lender. But not every lender is a bank.
Capitalism is M-C-M'.
Yup. The desire of capital-owners to make their assets as money-like as possible is an important dynamic. But there are offsetting factors -- most importantly for purposes of this post, the fact that a large part of savings in modern economies is not actually capital, at least formally, but deferred wages.
Today's capitalism is one of a weird upside down variety. Those who are supposed to take risk bear no losses. And those who are supposed to bear no losses take all risk. No wonder it is so politically and economically unstable.
No argument here. Altho I'm inclined to think this is even more true of the financial sector than the rest of the economy.
I don't see this. Credit analysis and diversification are concerns for any lender. But not every lender is a bank.
ReplyDeleteBanks are different *only* because they have access to the lender of last resort which is given them by law. In other words everybody else is denied this access by the same law. In return the lender of last resort imposes regulation and supervision and is supposed to ensure that liabilities of banks are convertable into money at par without any moral hazard. But there is nothing special about banks or about what they do. We have simply built it this way. Take away the payment system part (i.e. liquidity), and then you can take away the convertability part. But then you can also take away the lender of last resort part. And what you are left with is simple and pure credit risk.
Can the fundamental function of banks be maturity transformation if this is what we ask them to do with our institutional design? In fact, we almost "force" them to do maturity transformation. It is a subsidy that we give which does not come with too many strings attached. So instead of doing what they really have to do, i.e. credit analysis, they go full force and try to abuse the system to the extreme. And we just nod and say that this is their fundamental function and we should not bother.
"Altho I'm inclined to think this is even more true of the financial sector than the rest of the economy."
Incentives matter. Trading and structural contribution (steepness of the yield curve) is how today's banks make money. And both are taxes on the real economy. No wonder banks are such perfect destroyers of the economy.
Krugnuts times 11?
ReplyDeletePuff out your chest. That's an order of magnitude.
A simple incremental reform would be to allow Treasury Direct to offer interest bearing cash accounts and otherwise compete with banks and money market funds.
ReplyDeleteAnders,
ReplyDeleteI just belatedly replied to your earlier comment.
There are two issues here. One is the extent to which banks are still needed for maturity transformation, the other is how much businesses must/should rely on external finance. Separate questions, tho they overlap. Mortgage financing only goes to the first one.
On the second one, you might see a tradeoff between having the savings-investment link remain largely internal to the firm, vs. having it mediated by banks and various financial claims. In the first case, if you believe that there are strong reasons why firms can't or won't invest in projects that are big departures from their current business, the cost would be less innovation. (Incidentally, mainstream economics has no theory of how investment opportunities are distributed across firms. Not a bad theory, no theory at all.) The cost in the second case is a lower overall level of investment because of all the agency and information problems that come with external finance, plus the costs of intermediation itself, not least the bankers' vig. I don't think there's much question that aggregate investment is higher in the internal-finance case.
The other side of it, which doesn't bother most people in these discussions but bothers me a lot, is that external financing of investment is part of the larger process of converting all social relationships into financial claims. In a firm that funds investment internally, it's easier for people to judge projects according to their "professional conscience" rather than financial criteria.
ust because less copyright enforceability has not lead to less creativity doesn't mean that no copyright enforcement would also not mean less creativity.
ReplyDeleteSure. It's not so important whether the optimal level of copyright enforcement is zero (altho for music I think it probably is); what's important is wherever the optimum is, we're way above it right now.
JW Mason - your construction almost seems to contrast internally vs externally financed investment as alternatives. In reality of course you have three sequential levels of investment: simple replenishment of depreciation (ie capex = depreciation), then additional internally-financed capex in excess of depreciation, and finally debt- or equity-financed capex. So rather than alternatives, you have a general question of whether one should or shouldn't welcome firms investing in excess of their internal funds; the internal bit will happen anyway.
ReplyDeleteI certainly share your preference for financial claims (and indeed the 'cash nexus' more generally) being kept out of relationships and productive activities where feasible. And I agree that investment seems more efficient (and is certainly cheaper) if funded internally than mediated by a financial claim. But I struggle to follow your concerns over agency or information problems. If a company wishes to build a new warehouse and raises a mortgage loan or even unsecured debt to pay for it, I don't see how the fact of there being external financing in some way makes the investment less efficient.
Pension funds already (famously) supported the largest bank function--mortgages--through purchase of MBS. Of course someone still needs to vet borrowers so if not community bankers then I guess their very same functions would just transfer to the comparably few folks managing the huge balance sheet? That seems equivalent to worse.
ReplyDeleteAlso what are everyday savings (not for retirement) supposed to be doing? Might as well not be idle.
As for financing business expansion through own saving, how could that not slow down economic growth?