The business of a bank is to understand and trade in risk. That's simple when the risks are simple, but complex as the risks get more complex; 40 years ago it would have seemed obviously ridiculous for programming to be the proportion of our economy that it is now, but programming has grown more complex in proportion to the businesses it's applied to. So it is with finance. (Water supply doesn't require understanding the business; supplying water to a simple business is the same as supplying water to a complex business, whereas making a loan to a simple business and making a loan to a complex business are very different).

What line would you even try to draw? It's very difficult to trade risk without a central clearinghouse. It's very difficult to run a central clearinghouse without being willing to guarantee at least some of the risk at least some of the time (you can limit how much, but we already regulate bank capital ratios etc.). Diversification is the banks' best defense against the risks they're taking, so if you require the separation of two more-or-less independent categories of risk (as Glass-Steagall does) that seems likely to make bank failures more likely, not less.

> day-to-day financing that we all need (home loans, etc.), according to Krugman, should move to the public utility model

I couldn't disagree more. Making home loans "too necessary to fail" pretty much guarantees a catastophic speculative bubble in residential property. Which, coincidentally, is what we're seeing in many places.

I quite like the idea of ringfenced utility banking, possibly even nationalized, but would set the "necessary" bar a lot higher.

Presumably doing this right would restrict these loans to "financing". Which is to say, to people with reasonable cash-flow who are seeking up-front capital for a purchase. A good public utility lender would offer low rates, but would have to reject more home-loan applications than the existing speculative players. By this measure, of course, Fannie and Freddie were the opposite of public utility lenders.

Done right, I'd like to think that utility lending would constrain bubble growth. Low-risk borrowing would get utility loans, producing actually-guaranteed-AAA investments. High-risk borrowing would remain with private lenders looking for risk, much like business loans do today.

The daylight between the two would (hopefully) prevent both housing price bubbles (by offering a stable rate floor) and credit bubbles (by clearly dividing safe, non-profit-seeking loans from speculation). It would likely price up risky loans, but we saw in 2008 that those were dangerously underpriced to begin with.

It's an interesting idea anyway, as is a utility model for 'safe' banking activities - non-interest-bearing deposits and financial services.

> Low-risk borrowing would get utility loans, producing actually-guaranteed-AAA investments.

I think this is where it falls over. Providing an actual guarantee for things that are low- but not zero-risk is just another way of saying "mispricing risk", and it creates the wrong incentives for pretty much everyone. Borrowers want to push the definition of "low-risk" so they can borrow at a subsidized rate. Lenders (in which I'm including the people buying your "actually-guaranteed-AAA investments") want to push it so that they can lend at zero risk but still make nonzero profit. Governments administering a public utility banking system want to push it because jam today gets votes today, and who cares about tomorrow?

IMO this is all happening already with the artificially-low interest rates being pushed by central banks almost everywhere; if they wanted to repeat 2008 I'm not sure they could do a better job.

My idea of "utility banking" would exclude any kind of loans. It would include only things which are genuinely risk-free, like transfers and deposits.

This is a reasonable point.

The distinction I was hoping to draw was between cash-flow loans and investment loans, where the former are (like interbank overnights) non-zero risk but immensely reliable. But it's probably impossible to set up that system without people manipulating it to get profitable rates (...like interbank loans).

Certainly, we don't have a great track record of the government properly evaluating what's actually for real safe. I was thinking that we could keep limit lending by preventing rate-based profits (like electric companies, which profit on coverage but not prices), but realistically that just moves the incentive from profit to popularity. Hand out good loans to bad risks, get reelected, blame the markets when they explode. Sounds painfully familiar, actually.

So yes: likely better to treat financial services as different from risk-bearing products altogether. You'd have utility "money storage" that does deposits, transfers, maybe offers financial advice, but doesn't extend any credit/investment of its own.

That's a good point. We would still want to separate the stuff like home loans from higher risk, more profitable finance.

What practical form would this separation entail? If they're really lower-risk then they'll naturally attract lower interest rates; what do you envisage beyond that?

> In the spirit of this comment, and I can't find the particular article I'm looking for right now, but Paul Krugman many years back was writing about how financial services should move more towards a public utility model.

Fanny Mae and Freddie Mac ... do exactly that. They are abused by politicians for achieving social ends (which should not be their function), first time the politicians know they won't be in office when it blows up (making loan decisions on any factor other than risk should not be done, unless you're prepared to bail out, but that of course means no positive discrimination without bailouts). The second and subsequent set of politicians know they're not really creating a risk, just modifying an existing one slightly. And that's when these companies don't just directly preferentially treat connected investors. Imho Fannie Mae is on track to need another bailout some 6-10 months after the election.

> The argument is, we would all be better off if we separate off all the risk-taking in finance to for-profit companies that can fail without posing greater risk to the economy.

Given that the government rescues "systemic risks", and CDS contracts are an easy way to transform local risk into systemic risk. Widely-held CDS for a large percentage of loans, like currently exists, means either loan defaults have no effect on the system or crashes the entire thing.

Now you could say. "Easy, let's just outlaw CDS contracts". But that's stupidly easy to circumvent, secondly it would disadvantage smaller players further. Or you could say you need more than 2% collateral, but that would immediately collapse pretty much all banks (and they're strongly incentivized to make damn sure that won't change) so can't be done.

> from an even more robust version of Glass-Steagall, but the finance industry ...

That's equivalent to demanding more collateral for loans. Yes if you can get to the end state the chances of getting your money back when things go south would go up by a lot, but how do you get there ? If you demanded that happens from day 1, all banks would collapse right then and there.

I think the more important lesson to be drawn from Glass-Steagall and the related changes of that era is the timing of those regulations : it was introduced just too late. Just barely too late ... to help anyone. It was a PR measure. The same is true for bank guarantees : always remember that the government will never pay those guarantees. If it ever comes to it, the government will withdraw the guarantee before they pay anything. Or do it like Greece and Brazil did : pay it out in worthless non-currency "dollars" that you can't actually buy anything with.

>Fanny Mae and Freddie Mac ... do exactly that.

Actually, that's not exactly correct. What FNMA and FHLMC do is buy mortgages on a secondary market and securitize them into MBS securities, and provide loan guarantees. I'm sure you know that. I'm sure you also know that the goal here of those two is to make home loans more accessible to all of us. They are also GSE's, so I see the comparison to utility companies. OK, but if we think about it, are these enterprises necessary? What I mean is and what you have to understand is that the goal here is not: "let's lend people money for homes through heavily-regulated entities (banks) which do not then go and gamble with that money (what Glass-Steagall wants to prevent," which is what Krugman was discussing, but rather, "let's create a government sponsored bureaucracy that writes some contracts down on pieces of paper to manipulate market equilibrium in an effort improve home loan lending."

>They are abused by politicians

It is certainly true that politicians are prone to be corrupt, I can't argue with you there. You know everyone knows the expression, "as crooked as a politician." I think what we have to concede here is that there's no perfect solution here. Economics is, at its very foundation, not a natural science--it is about people, and people are never, and will never be, perfect. Some people are inspiring, but in fact, some people are awful. It's my belief that we should learn from history and not repeat the same mistakes, again, after we repealed Glass-Steagall and paid the price for it in 2008.

How would Glass-Steagall have prevented, or even affected, the events of 2008?

Originally, Glass-Steagall placed a firewall between commercial and investment banking. That isolated deposit banking from high-risk securities and investment trading.

It wouldn't have prevented every part of the subprime crisis (Bear Stearns wasn't even a deposit bank), but it would potentially have lessened the scope of the crisis.

- Preventatively, it would have restricted the size of the CDO/CDS market. Without access to commercial banking deposits there would have been much less money to invest there.

- Reactively, it would have better protected deposits and saved the FDIC a small fortune. Indymac alone ran the FDIC $9 billion and depositors another $0.27 billion.

Its decline and repeal completely reshaped US investment banking, to the point where the entire industry would have looked completely different if the law had been applied 1933-2008. Of course, that's not entirely a good thing.

Some chunk of the pre-2008 growth has to be attributed to a flexible banking industry keeping us out of liquidity traps, and that was a genuine, non-special-interests reason to alter the law. Clinton didn't (exactly) repeal Glass-Steagall, he formalized a change that regulators had made far earlier by limiting enforcement of the firewall.

I can't say that long-term enforcement of Glass-Steagall would have been better, but I can certainly say that it would have altered the entire landscape that the subprime crisis happened in.

But surely RMBS would have ended up on the deposit-banking side? I mean fundamentally Indymac owned a lot of bad mortgages - with perhaps more intermediation than there would have been otherwise, but we expect retail deposit banks to own mortgages, that's a large part of their raison d'etre.

Please remember, in reading explanations of this, that the entire financial industry has a vested interest in complicating what they do to the average person.

The basic theory of Glass-Steagall is to separate risk-taking in finance with the "mundane," finance, as Krugman was saying.

On one side of the coin in finance, you have the boring finance: home loans, small business loans, that day-to-day stuff is not complicated and is necessary service to the economy. By the way, we can't let these banks "fail," or go out of business. That would cause economic destruction beyond what is reasonable. Fortunately, this type of banking is not very risky, either.

Now, you have the other side of banking, which involves risk-taking. Some of this is stuff such as investment banking and private equity which is actually very necessary for efficient allocation of resources. These types of businesses need to be allowed to fail, though, since not letting them fail would be a redistribution of wealth from the taxpayer to the rich, and it would also mean people who are not good at efficiently allocating resources get to keep their jobs while smart people who can do it better, get crowded out by the politics of government handouts.

Also on the risk-taking side of finance you have securitization and a lot of "financial alchemy," stuff. Fannie Mae and Freddie Mac arguably even fall in this category. This side of finance needs to also be allowed to fail for the same reasons.

I hope that makes sense. I recommend picking up an intro and intermediate-level macroecon textbooks for further reading.

But the crisis was a failure of home loans - which are as risky as anything that merchant banks do. There really was a collapse in house prices, there really were a lot of people who defaulted on their mortgages.

My oft-recommended book Doing Capitalism in the Innovation Economy [1] hammers on this idea of that financing of speculative vs. mundane ventures are fundamentally different games. The author argues that speculative finance is a good thing, as long as it's not just speculating on finance itself. In fact, it's so useful that the government should encourage it. He cites the long-term advancements produced by incredible amounts of public money injected into the defense industry, the space industry, the National Institutes of Health, the NSF, and so forth. But, he argues that such speculation needs to be cordoned off from the mundane economy, so that when bubbles burst, they don't take down the systems everyday people rely on.

[1] http://www.amazon.com/Doing-Capitalism-Innovation-Economy-Sp...

I've also seen the suggestion that regardless of where lending goes, "safe" financial services should be moved out into a utility format. That is, investments and loans shouldn't be conflated with non-interest-bearing deposits and money movement.

Right now, people are caught in a weird double-bind that mostly serves a small part of the finance industry.

- If you don't have a bank account with a balance, you pay through the nose to access money and paperwork (e.g. notary fees, high fees on welfare debit cards, wire transfer prices).

- If you do, you expose yourself to the risk-taking of the banking industry. That means losing your deposits with Washington Mutual or IndyMac, and if you stay below the FDIC cap it still means getting scammed when Wells Fargo opens you a fraudulent account.

There are some good reasons to combine these things, and some of the costs for non-account-holders reflect the actual price of moving money. But it's not obvious that access to non-investment services should be inescapably bound up with exposure to investment risks and pressures.

Would that be the same Paul Krugman who only a few months ago said the big banks are not a systemic threat anymore, in an effort to undermine Bernie Sanders' anti-big bank message?

http://www.huffingtonpost.com/entry/elizabeth-warren-big-ban...

As far as I can tell his point that shadow banking, Lehman et al, and not the regular banks were the main villains in the GFC is actually pretty accurate.

Yes I know... I stopped reading Krugman. I don't know, it seemed like he used to give a shit and write informatively. Now he just tows the party line and even seems disingenuous at times to be honest.

I think the saying is "toes the line", although I could be mistaken.

Or maybe he just has a good-faith disagreement about the importance of bank size?

I kinda wish they let those banks fail.

Those banks turned around and raised fees for everyone. Don't loan to most small business. Don't loan to most self-employed. Are just horrid institutions.

They have just seemingly given the wealthy credit?

They have given the wealthy so much money; somedays these 1 percenter's appear to be just gambling?

Literally just gambling, except in the realestate market. That market is still a sure thing for them, and very rich investor knows it. And they know so many of us will never qualify for loans; so jack up that rent Thurstan!

This recovery hasen't helped guys like me, or my mother who relied of safe cd rates to get ahead. (And no--I'm not blaming banks on low fed interest rates. I probally shouldn't have even wrote that last sentance.)

I probally should comment--I'm no expert.

I just wonder if we severely regulated credit default swaps, and the derivitave markets--the crash in 2008 would have been less dramatic?

The one thing I liked about Bush is he wanted the poor/middle class in homes. He believe little guys should be given a chance. I just wish he went about it with more regulations, on the big boys.

My brother in-law used to flip houses. He now is a yoga instructor. The banks won't talk to him. Houses are still being flipped, but only by the wealthy. They are making a killing in my county. They are buying up everything. Why not, at these interest rates, and banks that are literally bending over.

>Those banks turned around and raised fees for everyone. Don't loan to most small business. Don't loan to most self-employed. Are just horrid institutions. > >They have just seemingly given the wealthy credit?

Let me relate a short story about my experiences with my regional retail bank.

Since I don't have my paperwork in order with Vanguard after changing my address, I haven't been able to put my saving money into ETFs and bonds and such like I should. So it's been piling up for more than a year (yeah, irresponsible of me, I know!) in my retail bank accounts, checking and savings.

When it piled up to more than $25k, the bank "invited" me to join their "Platinum" accounts. These would impose a whole bunch of minimums on how much I have to keep in my accounts (minimum $10k in checking, minimum $15k in savings, something like that), in exchange for which they would... waive a few fees. And raise my interest rate on savings to the highest heights of 1% annually!

Whereas for the normal account, you get 0.02% interest annually, and for a credit card, you can get 1.5% cash back on your spending. They'll pay you more to spend than to save!

To the banks, us tech workers with our measly six-figure annual incomes are just more plebs, not even worth an interest rate above inflation.

I wonder if what good we see in capitalism is just the period of it when there's plenty of low hanging fruit for everbody.

What I mean is, we could praise a system where any guy can buy a cheap house, renovate it and call it his own. Now, take it to its logical conclusion and you'll soon have agents with access to credit leveraging all the capital to acquire every single flipable house out there and extracting maximum rent out of the people who would have got them renovated themselves in less "efficient" times.