Federal (Reserve) Express

Perhaps one of my less orthodox beliefs is that we should have let Wall Street fail in 2007. Of course, the Bush-Obama administrations would be loth to let this happen, but I think there’s good reason to believe the just policy (as this self-evidently is) would not also create mass unemployment. And in an age where commenters inevitably spew hot air about “structural reform”, bank failure would set the stage for the most important adjustments in over a century.

James Tobin, Nobel Laureate and a little bit of an economic hero to me, once said “the linking of deposit money and commercial banking is an accident of history”. This has deep implications for our (broken) monetary transmission mechanism which is predicated on our weak financial system.

Weak, you say? America has the the world’s deepest credit market, but it thrives off well-documented subsidies encouraging debt and moral hazard through:

• The implicit TBTF guarantee.
• Deposit insurance.
• Interest rate tax deductions.

By a free marketer’s own definition, Wall Street can not be efficient. And 2007 showed us that which can not, is not. Now, before you accuse me of sounding like an Austrian, note that what I’m suggesting would only work under strong state intervention, done right. Here’s all we need:

• A federal employment guarantee program (a special form of the rare creature known as “fiscal stimulus”).
• FedEx – or the Federal Reserve credit card!
• FedEx Business

Now, let’s be clear about a few things. The government is a bad choice for an employer or a bank. (Aside from bureaucrats, local services, etc). But while the financial system stabilizes, aggregate demand will crash, employment will plummet, and credit will crunch. Then government ought to double up as the lender and borrower of last resort.

As spending crashes, employment guarantee programs (which can be coordinated with private enterprise via an “employee auction” market – which I will outline in a later post) should stimulate demand. Here comes your national credit card, with limits and interest rates set by the Fed. This will allow the Fed to increase limits and reduce rates during a credit crunch, thereby sidestepping the private banking system. During normal times the limit would either be absurdly low, or rates obscenely high allowing private banks to compete fairly for market share.

This is a piggyback on Miles Kimball’s Federal Line of Credit. My amendment would be a special loan for small businesses and startups that can’t easily sell corporate debt. This requires an unfortunate level of government bureaucracy, and in most times private banks would be much more efficient. But we’re trying to stabilize demand, here, without handing out money to bankers.

There’s a non-zero chance we won’t ever have to do something so nutty again. Once the government reneges it’s “implicit promise” to bailout “systematically important” banks, executives and shareholders will no longer expect relief, and will raise equity and deleverage appropriately. Matthew Klein and John Aziz have argued along these lines, but I’d add this wouldn’t just reform a risky practices on Wall Street, but challenge the very way we approach monetary policy, which is today tethered to the credit system.

Establishment of a central consumer banking network will allow the Fed to increase demand in a fair and just manner. And to the extent future recessions don’t threaten a credit crunch, open market operations will suffice. But our “exotic” quantitative easing policy has certainly benefitted the rich, asset-owning class than the still intolerably high number of unemployed.

In the near-term this would be more expensive. Government employment guarantee programs won’t be cheap (though wait for my post on the employment auction market which should substantially lower costs and increase efficiency), and will require sustained deficits. But if we credibly commit to irresponsibility – as they say – and let a government finance program take us through the lows of bank failure, the emergent credit system will be more efficient, effective, and morally just.