Tyler Cowen Argues Against his Own Previously Held Views on Banking Regulation

by robekulick

Since my previous post on financial reform (https://robekulick.wordpress.com/2011/12/28/free-market-financial-reform/), I’ve been reading a lot about it and I wanted to provide some interesting additional information:

First, Tyler Cowen has apparently repudiated his views on mutual fund banking: http://marginalrevolution.com/marginalrevolution/2010/07/jimmy-stewart-is-dead.html

Cowen is concerned that:

(1)  There aren’t enough liquid assets to cover the entire quantity of bank deposits;

(2) the dependence of the proposal on banks having to hold immense amount large amounts of government debt;

(3) non-bank lenders, (think GE Capital) will circumvent the system possibly leading to the exact same sort of “too big to fail problems.”

He is in favor of increased capital requirements for banks, but is skeptical of imposing them before the current financial crisis is done like Gary Becker: http://marginalrevolution.com/marginalrevolution/2011/07/does-boosting-bank-capital-requirements-limit-output-or-growth.html

However, Larry Kotlikoff, of BU, has taken up the mantle of mutual fund banking (limited purpose banking) in a recent book and argues that it is still the key to ending the too big to fail problem: http://www.amazon.com/Jimmy-Stewart-Dead-Ongoing-Financial/dp/0470581557/ref=sr_1_1?ie=UTF8&s=books&qid=1279363780&sr=8-1/marginalrevol-20

In response to Cowen’s non-bank lender problem, Kotlikoff argues that any “non-bank” organization offering credit will have to be organized as a partnership rather than a limited-liability corporation.

Cowen replies:

“I am not inclined to see unlimited liability as a practical alternative.  How many businesses supply commercial credit?  Trade credit?  Credit by any other name? — namely contracts involving derivatives, annuities, insurance, repurchase agreements, etc., with intertemporal payments and embedded interest rates in the prices.  Would they all have to give up limited liability?  Or would we end up channeling more financial intermediation through indirect credit transactions, while maintaining limited liability?  A version of this dilemma is experienced regularly by systems of equity-based Islamic banking..

Second, unlimited liability creates a pecuniary externality across shareholders.  Who wants to be the remaining “fat cat” shareholder?  Why should Bill Gates ever invest?  Non-mutual fund banks will end up owned by thinly capitalized individuals or entities, thereby defeating the purpose of unlimited liability while at the same time raising transactions costs.  Walter Bagehot made this point, see also Joseph Grundfest, here is Hansmann and Kraakman with a reply.  Alex very ably surveys the main arguments in an MR post.

Unlimited liability is fine for small-scale, private banking, especially in the international sector where tax evasion is a motive and the banks aren’t fully part of any standard regulatory network.  It doesn’t work to force it on such a large sector of the economy as most commercial credit and non-bank lending.”

I have more on banking I want to post, but this is probably enough to digest for now.