Fractured Banking

"As Europe's Crisis Grows," The New York Times frets, "suddenly, over there is over here." 

They are right. We live in an interconnected world. It used to be said that when the US sneezed, Europe (or Japan or South America) caught a cold. Now, it goes both ways, since we have so much money invested around the world, and the stewards of all this money are batwinged dastards who have suborned sovereign nations into their dark schemes.

A crucial mechanism linking financial players in the United States to the problems in Europe involves credit default swaps, those insurance-like products that did so much damage during the 2008 financial crisis. (Think American International Group.)

Billions of dollars in swaps have been written on sovereign debt, guaranteeing that those who bought the insurance will be paid if Greece or other countries default. But since these instruments trade in secret, investors don’t know who would be on the hook — as A.I.G. was in its ill-fated mortgage insurance — should a government default or a bank fail. (NY Times)

What the international financial insurers need to be told is that they’d better make good on it or they’re going to jail. Same for the bankers who loaned irresponsibly knowing that governments would bail them out or print them more money once they blew through their allotted portion.

Fractional Banking is Fractured

The first problem is that banks are loaning out money they don’t have, essentially creating money out of thin air. The second part of the problem is the exotic financial instruments that allow companies to gamble with money they don’t have and to write insurance policies full of promises they can’t keep.

If this were just financial giants screwing one another, who would care? Unfortunately, it’s not. Central banks of sovereign nations fund all of this high-flying chicanery, which really means you and I are the ones who pay when a bankster shoots craps at the casino.

Paul Volker warned us. He was the Fed Chairman who cleaned up Carter's mess. Obama hired him on to much high hope and fanfare when he first took office, and then promptly ignored him because he was crapping in the punchbowl.

Is Limited Purpose Banking the Answer?

Christophe Chamley and Lawrence Kotlikoff wrote a great little paper entitled, Limited Purpose Banking - Putting an End to Financial Crises.  Muchas gracias to Conservatives on Fire for turning me on to this little Gem.  Chamley and Kolitkoff's solution?

They propose restricting banks to traditional banking, and putting similar restrictions on brokerage houses and insurance companies.  Presumably, this would let the high fliers continue flying, they just would have to do it outside of our financial system and without the taxpayer-funded safety net.
 

Please go read the article.  It is very short, and his entertaining analogy explains those exotic instruments known as credit default swaps.