The case builds in U.S. for two-tier banking

Posted Jan 19th 2009 11:15AM by Joseph Lazzaro
Filed under: Forecasts, Politics, Financial Crisis

In the months, and perhaps quarters ahead, they'll be a great deal of talk about banking reform, in the context of financial services reform.

You'll hear much about the need 'to ban banks' or 'get control of commerce / economic activity out of banks hands' etc.

The fault, dear Brutus, is in ourselves

These well-intentioned arguments are missing the point. The problem is not banks per se, but the abuse of the FDIC provision and related insurance protections. In other words, what has to end is not banks, but 'heads the bank wins, tails the U.S. taxpayer loses (and pays).'

And as I wrote earlier, one viable solution, outlined by economist Richard Felson, is two-tier banking. An interpretive report by Gretchen Morgenson in Sunday's New York Times (NYSE: NYT) basically describes the themes discussed in the two-tier banking blog, and what appears to be the likely direction for banking.

Briefly, in the future, Felson argues that there should be two levels of banks. The first: private banks that invest in commercial operations, offer higher interest rates and have other exotic investment products, but offer no government insurance on deposits.

The second level: community-based banks that invest primarily in conventional mortgages, offer very low interest rates on deposits, have no high-risk / high interest rate investments, but offer government insurance for depositors.

The community banks would also feature below-private-market salaries for executives, perhaps supplemented with a portion of benefits paid by the federal government. "But there would be no $500,000 per year executives in these banks, only modest executive salaries," Felson said.

Back to '3-6-3'

And that's basically the trend Morgenson described in her article in The Times. A good portion of the banking sector will be transformed back into the low-growth, boring, but safe sector that it's supposed to be, with low executive salaries. It other words, it will return to '3-6-3' banking: 'Pay 3% interest, charge 6% interest, golf at 3 p.m.'

The advantages of the two-tier system? There will be fewer, costly federal government bailouts, Felson said. The private banks could continue to invest in speculative, vacation condo complexes in suburban Las Vegas, it's just that when those projects fail, it will be on the stockholder's dime, not the taxpayer's, he said.

Banking Sector Analysis: Two-tier banking approaches. There's nothing wrong with a bank paying 9% on deposits so that it can loan the money out for a speculative mortgage for luxury condos in Las Vegas. It's just that in the future, you as a depositor will know that you could lose every dime in that bank.

Meanwhile, the insured banks will pay a much lower interest rate on deposits, but those depositors will know their money will always be there.

We want banks to take deposits, lend, process transactions, create wealth, and perform a myriad of other functions that have helped economies grow for hundreds of years. What we don't want is bank losses and recklessness paid for by the U.S. taxpayer.

Tags: bank stocks, banking, banking sector, BankStocks, FDIC, gretchen morgenson, GretchenMorgenson, inthenews, TARP

Print this

Reader Comments (Page 1 of 1)

1-19-2009 @ 11:45AM

avwrobel said...

Baloney Joe! You guys and your 'exotic investment products'! If you want to gamble, go to Vegas or buy stocks. Krugman's article in the NYTimes had it right. Its time for the great nationalization. All banks need to back to 3-6-3. Get the gambling out of it (and the risk off of taxpayers' backs).