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Open Letter to Lord Turner

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An open letter from Laurence Kotlikoff of Boston University to Lord Turner, chairman of Britain's Financial Services Authority

Dear Adair,

I listened to your terrific talk at the Soros conference, which is posted at

I could focus on the eloquence, fantastic delivery and numerous deep insights, but let me make a couple of comments that may be of actual value at the margin. Take them from where they emanate - real friendship and respect.

It seems that you are questioning yourself. On the one hand, you are saying it's critical to consider radical solutions. On the other hand, you are saying, "Too radical, too fast, is too dangerous. If we move to real safely, we may need to take decades."

And you seem to be saying, "If we get the regulators to do their jobs, we can fix this thing." But, you're also saying, "Regulators just failed us miserably and are working for their next bosses on Wall and Lombard streets."

I take your public self-questioning to be an extremely healthy sign. No one can honestly contemplate the continuation of the current financial system without having deep and terrifying concerns. Yet, it also seems scary to imagine moving to a very different type of system, which has never been test-driven.

But the British public should be extremely thankful for your candour. I can't imagine a head of the SEC providing such an open and honest appraisal of our financial ship of state, let alone admitting his uncertainty (which we all share) about knowing precisely how to fix it.

What I didn't hear in your talk was an emphasis on the snake oil. To me, it's the single most important factor in what happened, and the full and immediate disclosure and FDA-type verification of the securities being marketed is the only way to prevent it. It's not prop trading, but prop information that's the problem because the prop information is a front to sell the snake oil.

You referenced Limited Purpose Banking twice in your talk. It seemed like you got close to saying it was the way to go, at least over time, but then you said you were worried about sudden swings in the willingness of the public to extend credit to itself without traditional bankers "managing" their risks.

Let me respond.

Limited Purpose Banking (discussed in Jimmy Stewart Is Dead) has two legs - one is strict mutual fund intermediation and the other is the Federal Financial Authority that represents an FDA for the securities industry insofar as it would verify, fully and immediately disclose, and independently appraise and rate all securities bought, sold, or held by the mutual funds. When I reference disclosure, I mean, for example, displaying, in real time, on the web all of the details about each of the individual mortgages in a collateralised mortgate obligation. And yes, this would eliminate prop info about investment strategies. I think that's a price worth paying.

Re the mutual fund leg, your talk suggested that Limited Purpose Banking might be subject to major credit swings because of changes in market perceptions. I differ for several reasons.

First, when there is disclosure, the potential for major and sudden swings in perceptions is greatly reduced. Recall the Tylenol scare back in 1984. A couple of bottles of cyanide-tainted Tylenol led, overnight, to no market for 30m bottles worldwide. The perception flipped from the pills being safe to being toxic. Once the contents of the bottles were replaced with new Tylenol and were disclosed, via safely sealed containers, to be Tylenol, as opposed to rat poison, the potential for such wild swings in the market value of Tylenol ended. I think the FFA's disclosure, verification, rating, and appraisals will keep wild swings, which we now see, in the perception of the credit-worthiness of borrowers from occurring.

Second, you seem to be suggesting that if perceptions changed, there would be massive and sudden sale of mortgages and other loans under LPB. But the mutual funds intermediating mortgage and commercial lending would be closed-end, so there would be no fire sale of the loans themselves.

Third, you seem to be saying that the bankers are more level-headed than the public, so the public will panic, while the bankers won't. I think the public panics when they suddenly suspect the bankers are stealing their money. Moreover, in the current setting, we have bankers fully panicked with respect to lending. Why else would they sit on more than $1 trillion in excess reserves here in the US? (Yes, the Fed is paying interest on those reserves. But what it's paying is paltry.) I don't see any evidence that bankers kept their cool in this crisis and kept lending. Absent Uncle Sam's take over of Fannie and Freddie, we'd have had very few mortgages issued in the past 18 months here in the States.

Fourth, under LPB, the government is always free to intervene directly in mortgage or commercial paper mutual funds and ensure the supply of credit.

Fifth, if you are pushing for very high capital requirements (as you seem, at a minimum, to be doing), you are, in effect, pushing for each bank to become one very big mutual fund. But one big mutual fund is much less efficient than one, potentially, very big mutual fund company that markets many different mutual funds. It allows the public to buy the individual securities they want to hold.

Sixth, one can't be a little bit pregnant. Even permitting small degrees of risk-taking by the intermediary will leave the intermediary enough rope to hang itself as well as the economy. Citigroup could have a 99 per cent capital requirement. But what if it has one trader who buys one security that has one obscure clause that commits it to a $1 trillion payout in some extreme state of nature? Well, that security may be viewed by regulators as acceptable for Citigroup to hold, but it's not acceptable for the public who will get hit with the bill and the economic fallout. With a $600 trillion gross derivates market, losses of this magnitude aren't out of the question.

What we need is 100 per cent capital requirements in all potential states of nature, not just the current state of nature.

All best and let's keep debating how to move forward.


Laurence Kotlikoff is a professor of economics at Boston University, President of Economic Security Planning, Inc. (see, and the author of Jimmy Stewart is Dead: Ending the World's Ongoing Financial Plague with Limited Purpose Banking.

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