Sunday, May 20, 2012

The Monopoly Banks of the United States (Or Why the Volcker Rule is a Bad Idea)

Over at, Frank Shostak makes the very important point that, for all practical purposes, all banks are just branches of the Federal Reserve. He writes:

 By means of monetary policy, which is also termed the reserve management of the banking system, the central bank permits the existence of fractional-reserve banking and thus the creation of money out of thin air. 
The modern banking system can be seen as one huge monopoly bank that is guided and coordinated by the central bank. Banks in this framework can be regarded as "branches" of the central bank. 
For all intents and purposes the banking system can be seen as being comprised of one bank. (Note that a monopoly bank can practice fractional-reserve banking without running the risk of being "caught.") 
Through ongoing monetary management — i.e., monetary pumping — the central bank makes sure that all the banks engage jointly in the expansion of credit out of thin air. The joint expansion in turn guarantees that checks presented for redemption by banks to each other are netted out. By means of monetary injections the central bank makes sure that the banking system is "liquid enough" so banks will not bankrupt each other.

Shostak then argues in favor of the Volcker Rule and more regulations on banks:
 According to some commentators, the huge $2 billion loss by JPMorgan Chase, caused by the risky bets placed using the bank's money, raises the need to implement the Volcker rule — more controls on banks' activities. Critics of the Volcker rule are of the view that it will only make things much worse by stifling the efficient allocation of scarce real resources. Our analysis holds that as long as we have a central bank, in order to minimize the damage its policies inflict, it makes sense to impose tighter controls on banks. It is the central bank that enables banks to practice fractional-reserve banking, thereby polluting the economy with money out of thin air. A better alternative is of course to have genuine free banking without the central bank.
Shostak has a point in trying to smother the Fed controlled banking system. And, although, at first it appears that is what the Volcker Rule does, the Rule is in fact quite evil in that it drives bankers from dealing in the private sector and causes them to conduct more activity in the government Treasury market.

Here's the powerhouse Wall Street law firm  Skadden, Arps, Slate, Meagher & Flom on the Volcker Rule:

The “Volcker Rule” prohibits an insured depository institution and its affiliates from:
engaging in “proprietary trading”;
acquiring or retaining any equity, partnership, or other ownership interest in a hedge fund or private equity fund; and
sponsoring a hedge fund or a private equity fund...
The Volcker Rule would prohibit any insured depository institution and its affiliates from engaging in “proprietary trading” of debt and equity securities, commodities, derivatives, or other financial instruments. “Proprietary trading” is defined as engaging as a principal for the trading account of a banking organization or supervised nonbank financial company in any transaction to purchase or sell, or otherwise acquire or dispose of: 
any security;
any derivative;
any contract of sale of a commodity for future delivery;
any option on any such security, derivative, or contract; or 
any other security or financial instrument that the appropriate federal banking agencies, the SEC, and the CFTC (the “Regulators”) may determine by rule. 
But here's Skadden on what VR allows (my bold):

The Volcker Rule also specifically permits trading transactions: in government securities; in connection with underwriting or market-making, to the extent that either does not exceed near
term demands of clients, customers, or counterparties;
on behalf of customers; or
by an insurance business for the general account of the insurance company.
Bottom line, what the Volcker Rule does is drive banking from the private sector and toward the government sector. Thus, this rule, rather than limiting credit, simply pushes banks to use funds to invest in and provide more liquidity for the government sector.

If credit is to be created by the Fed, I would rather have those funds directed to the private sector, or see banks blow themselves up with synthetic instruments, than have the funds directed toward more investments in the government sector, which will do nothing but allow the state to grow. Thus, the Volcker Rule is a bad idea.

Of course, as Shostak concludes, " a better alternative is of course to have genuine free banking without the central bank."


  1. Speaking of Volcker:
    For all his faults and considering the fact that he was FED Chairman, Volcker to me is a bit of a hero.
    Yes, it's WRONG that one man can set the price of money, but old Paul set the price where it SHOULD have been (79-82 or so) and precipitated one of the worst (and purgative) recessions in U.S. history.
    Hated by many, but loved by at least one, he did what was necessary. He replicated reality.

    1. His status as "hero" is probably tied to the fact that he was willing to do what unpleasant, but necessary, in raising rates to reign in runaway inflation. Few people view Carter's Presidency in a positive light but it was Carter who appointed Volker. Albeit Presidential appointments come from a list prepared by The Fed, which supports the monopoly, one has to wonder who was to benefit from the “purgative recession.” It seems all Fed action ultimately benefits the Central Bank and its branches. The politicians and the media make a living putting a daily dose of lipstick on those actions.

  2. 1. I find it interesting that when arguing historical anecdotes with Keynesians and “progressives” that they seem congenitally unable to differentiate state action from laissez faire/private action. However, when those same people control the government and put their theories into action, their prior confusion seems to completely disappear and the beneficiaries of their policies are invariably the government and/or their personal cronies.

    2. When the “safe” investment in the government bond bubble collapses, will they blame that on the free market and unregulated speculators? Most likely.

    1. About 15 years ago, I watch a documentary where a STATE OWNED sugar cane field in the Dominican Republic was using Haitian slave labor.

      Guess what got the blame by the documentary creator? I quote, "capitalism and the profit motive."

    2. We all know that this is how "progressives" always behave. The emphasis should be on the term ALWAYS and we should be thinking about how we should proceed against people who ALWAYS employ these tactics against us.