In his new book, "Jimmy Stewart is Dead: Ending the World's Ongoing Financial Plague with Limited Purpose Banking," author Laurence Kotlikoff outlines his view of the drivers behind the financial mess and then offers up a solution with limited purpose banking.
  
 To be sure, the causes behind the ongoing financial crisis that Kotlikoff identifies are similar to what many other economists, journalists and regular Joes - especially on the web -  have identified: the largest financial institutions were able to take risks that went horribly wrong, and then get Uncle Sam to cover the cost - the classic "heads I win, tails you lose" scenario. Kotlikoff spares no words in his descriptions of the financial masterminds, (if they can be called that) behind the implosion. One example: "incredibly arrogant, irrationally overconfident and loaded to the gills with testosterone."
 
Turbo-charged banking and finance CEOs aren't the only ones that Kotlikoff rakes over the coals. He also points to the lack of effective regulation, calling the Office of Thrift Supervision, for instance, "comatose." In fact, its somnolence is the reason, he says, that AIG sought it as its regulatory body.
 
Similarly, the dismantling of Glass-Steagall allowed banks to move further afield from their original role as intermediaries who connect borrowers and savers. Instead, they could start gambling with others' money. Moreover, a lack of transparency when it came to banks' holdings meant no one (including the bankers) really knew what was on their balance sheets, nor were they able to grasp the risks involved.
 
Kotlikoff then compares the banking industry to mutual fund companies, which have weathered the meltdown pretty much intact. The reason for the difference? The mutual fund industry stuck to what it's been doing - connecting savers with others who can invest the money they're saving. It never started making bets with its own or others' money.
 
He also acknowledges that some of the financial reforms under consideration - such as allowing the Fed and FDIC greater authority to regulate non-bank financial institutions, and closer supervision of rating agencies - are a step in the right direction. In his view, however, they don't go far enough.
 
As a more effective solution, Kotlikoff advocates a move to limited purpose banking, which restricts financial institutions to acting only as intermediaries between borrowers and lenders, and savers and investors.
 
They would operate as pass-through mutual fund companies that would neither own assets nor borrow to invest, other than what might be necessary to obtain the equipment needed to run their businesses. Banks would sell a range of mutual funds - equity, private equity, REITs, etc - all of which would be held by third-party custodians and marked to market.
 
A single government agency would rate the funds, although investors could purchase additional private ratings, if they wished. In addition, demand deposits would be held in cash mutual funds, ensuring that banks would have reserves equal to 100 percent of deposits.
 
In another shift, investment bankers would be limited to a consulting role in transactions, while traders would be essentially electronic clearing systems, without the ability to acquire either assets or liabilities for themselves.  
 
The benefits of this approach? First, it eliminates the temptation for bankers and traders to risk such large sums of money that they threaten a country's financial system. It simplifies regulation. And, it can be implemented at little cost.  
 
In fact, this sort of shift already is underway. Mutual funds now hold 34 percent of all financial assets, up from 14 percent in 1980, Kotlikoff says. So, the market already is moving in this direction - albeit slowly.
 
Perhaps the biggest shortcoming of the idea is the political resources required to move in this direction. Many people, from those in the banking industry to government regulators seeking to protect their turf, have an incentive to maintain the status quo. It's hard to identify the elected officials who might be willing to take on either group in order to support ideas like those Kotlikoff describes in his book.  

We may all regret that inaction. In the book, Kotlikoff discusses Richard Fuld, former CEO of Lehman Brothers. Kotlikoff notes: "What I find interesting and alarming is his statement that, ‘What happened to Lehman Bros. could have happened to any firm on Wall Street.' If this is even half true, why would we consider maintaining the system as is?"

Better late than never, I suppose. But Big Bob Rubin has apparently had a change of heart as to the virtues of financial deregulation.

Appearing before the Financial Crisis Inquiry Commission today with former Citigroup CEO Charles Prince in his capacity as former vice chairman of the bailed out bank, Rubin expressed much different sentiments about the need to prevent banks from becoming too big to fail and derivatives from adding untold amounts of undetectable leverage to the financial system than he did when he was President Clinton's deregulator in chief.

The increasing scrutiny of the swaps that Goldman Sachs arranged to help Greece hide its debt shows once again why investment banking should not be subsidized by taxpayers.

Yes, the separation of commercial and investment banking imposed by Glass-Steagall with that in mind may seem antiquated, and it may not have prevented the financial crisis. Surely it would have had no bearing on what happened in Greece. And neither would the Volcker Rule, which doesn't even go far enough in terms of the U.S.

My apologies to all the technocrats out there who want us to stick to corporate finance, narrowly defined. But the Republican counter-proposal to Obama's budget is just too ridiculous to pass up in at least one major respect.

As James Kwak points out today, the party recommends that we reform health care the same way we did Wall Street after the Crash of 1929, with an emphasis on more disclosure so consumers can make better informed choices.

 

I'm finding it particularly difficult right now to sort through the controversies raging over the Bernanke nomination, the latest revelations regarding Tim Geithner's dealings with AIG, and the pros and cons of the so-called Volcker Rule for banks too big to fail.

The press has had a field day mocking President Obama's "fat cat" lecture, which some bankers heard only by phone. (Fogged in, they said.) And so have many bloggers.

Yves Smith's "all hat, no cattle" post on Monday summed it up best. Indeed, Obama's rhetoric has quite obviously exceeded his actions when it comes to bank reform. Why else would he listen to Tim Geithner and Larry Summers instead of Tall Paul Volcker?

One of the primary architects of what is now Citigroup has something to say about this whole $45 billion bailout thing: My bad.

"I'm sorry," former Citigroup CEO John S. Reed told Bloomberg in an interview Thursday. "These are people I love and care about. You could imagine emotionally it's not easy to see what's happened."

Reed ran Citicorp for 14 years before it merged with Travelers Group in 1998, creating Citigroup. He was co-chairman and co-CEO -- along with Sandy Weill -- until he retired in 2000.

Reed has been particularly remorseful lately, even saying it was wrong to repeal the Glass-Steagall Act in 1999. The end of that law, of course, allowed financial institutions that engaged in traditional banking activities to also participate in the capital markets. Reed had been a supporter of its repeal at the time, but has had a change of heart in the wake of the financial crisis.