It is called The End of Alchemy. I can give it faint praise, but not much more than that.
1. It is long-winded.
2. I share his view that risk-based capital regulations inject a false sense of precision into bank regulation.
3. His main idea is this:
The aim of the PFAS [Pawnbroker for all seasons] is threefold. First to ensure that all deposits are backed by either actual cash or a guaranteed contingent claim on reserves at the central bank. Second, to ensure that the provision of liquidity insurance is mandatory and paid for upfront. Third, to design a system which in effect imposes a tax on the degree of alchemy in our financial system.
Here is how I understand the idea would work. A bank would make a risky loan of, say, $100. The bank and the central bank would agree that in an emergency the loan could be sold to the central bank for, say, $90. In that case, the bank could finance up to $90 of the loan with deposits. This would replace deposit insurance, risk-based capital regulations, and other attempts to reconcile the desire to prevent the bank from failing with the need to address moral hazard.
I do not see how this can handle modern financial instruments. Take AIG, for example. Their problem was that liquid liabilities appeared seemingly out of nowhere, as “collateral calls” on the credit default swaps that they had written on mortgage securities. There is no way that this contingency would have been built into King’s system. King writes,
No doubt there would be other practical issues to resolve, but the reason we employ high-quality public servants is to solve such problems.
That was the exact sort of hand-waving that came with the original TARP proposal to buy up the “toxic assets” in order to fix the financial system. Those of us who understood the financial instruments involved knew that it was impossible to work that way, and TARP as implemented did not work that way at all.
4. Perhaps of all the high-level officials involved in central banking over the past twenty years, King’s thinking is the most nuanced, realistic, and humble. And yet his ideas did not impress me. This is going to sound really arrogant, but I do not believe that the central bankers know enough about finance to be able to fulfill their promise to stabilize financial markets.
“No doubt there would be other practical issues to resolve, but the reason we employ high-quality public servants is to solve such problems.”
Are you sure this isn’t high-quality humor?
So, let’s say you back (formal and shadow) deposits. First imagine the PSST “transition” (aka depression) between here and there. Set that aside. Let’s say you get there. You are through the depression you voluntarily caused. Then comes another crisis you didn’t cause or predict. Does that stop the fire sale and deflationary pressures? Probably makes that even worse, right? And that’s if he’s right about everything else.
I guess I don’t understand. If they are selling loans, does the bank have less incentive in making sure the loans are good? If the deposits are backed by hard money doesn’t that make them more risky in the sense that you can’t make up losses by having a larger portfolio? And in the event of a systemic fire sale, harder backing is like the (alleged) problem gold had that it is difficult to increase the money supply, or at least one mechanism has been reduced. How do his ideas break this identity that making things easier makes the boom more treacherous and making things harder makes the deflationary depression more intractable?
Didn’t Merton Miller say “Banking is a 19th century technology. Finance is a 20th century technology” ? I suspect bankers do know enough about finance, but don’t want to give up their sweet arrangement. Miller insisted there’s no reason the M&M propositions don’t apply to banks–except that the implicit bailout guarantee is like a free put option which they don’t want to give up (I’m mixing in Ed Kane here a little).
“This is going to sound really arrogant . . . .” Not really. You do not *say* that *you* “know enough about finance to be able to fulfill [a] promise to stabilize financial markets”; and, after all, the central bankers’ record in this regard over, say, the last ten years is pretty dismal.