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Zero Reserve Banking?

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Last March, Ben Bernanke wrote:

The Federal Reserve believes it is possible that, ultimately, its operating framework will allow the elimination of minimum reserve requirements, which impose costs and distortions on the banking system.

So, the Fed is on record as saying we ought to move to a banking system toward a system in which there are no reserves at all, making all the discussion about reserve requirements, including that found on this site, moot.

Let's be careful not to fight the last war.

(Here is a more in-depth discussion of this pronouncement.)

Perhaps this is not as bizarre and alarming as it first appears, or at least, it is not such a radical change from what is actually being practiced right now. After all, the Federal Reserve essentially back-stopped the 19 biggest TBTF banks when their reserve ratios proved insufficient. Perhaps they (that is, Bernanke) are thinking, "Well, we managed to cover the worst banking bust in history. How much worse can it get?" Perhaps Bernanke is just acknowledging in fact what has already been practiced in the last crash.

Now, I am not saying this is a desirable, or even an efficient state of affairs. After all, we do not want booms and busts like the current one we are trying to claw our way out of (the results of that clawing, QE, etc, have still to be determined.) To solve that, we must look deeper to the root causes of financial instability, beyond regulations. We tried that post S&L and post Enron -- both of which had more "bite" than the current watered down set of regulations, and still failed.

I'm thinking we should eliminate securitization -- the practice of bundling up loans and selling them to outside investors - so that loans are not kept on the books of lending banks. Related to that is the practice of insuring, and allowing betting short on insuring, bundles of bank loans -- aka Collateralized Debt Obligations. We should also end the practice of back-stopping home loans via GSEs like the now-defunct Fannie Mae and Freddie Mac. We can eliminate sub-prime as a category, while we're at it, as this is the highest risk pool of borrowers for home loans. The banks will say some people, maybe many, will not be able to get loans if these policies are put in place. Well, if they are just going to fail to pay their mortgages down the road anyway, is that such a bad thing?

Is there a banking model that practices such policies? Yes, it's called State Banking, and its leading example is the Bank of North Dakota, one of the most successful banks since its founding in 1919, and a bank which has helped its home state -- where all its loans are made -- achieve the biggest surplus in its history in 2009, while most states were flopping on the beach under debt-bombs. It's not just the oil and gas in North Dakota either -- lots of states have that, and they have big debts too.

But, beyond banking reform, there is another way that will get people in homes they own (as opposed to the perfectly honorable, but somehow disparaged, practice of renting where you live): A Land Value Tax. According to the Federal Reserve, about half of the initial cost of buying a home is just for purchasing the land beneath it. That land gets its value almost entirely from location (unless it is a farm or some other kind of land that actually produces something of value, beyond serving as a base for a home, and even there, a Land Value Tax makes sense). If you tax the land, the price of the land will come down, making sites more affordable to more buyers; after all, if people are paying high rent, they will not pay high price too. If you tax it enough, you can eliminate every other tax, which falls on production. That means you will encourage production while discouraging land-hoarding, not a bad combination of win-wins! It's estimated, by Georgist Economists like Mason Gaffney, that up to 40% of GDP is actually some form of uncaptured "rent" on location and natural resources, including actual land (See: The Hidden Taxable Value of Land: Enough and to Spare).

This idea has actually been put in place in many cases -- most recently in Altoona, PA, which, after 10 years of transition, went completely tax-free on buildings this year, and is only taxing land. The result during the transition period already shows great leaps in Building Permits Issued, over comparable cities, like Johnstown, PA, which does not have LVT.

We also had zero tax on buildings during the great building boom in New York City in the 1920s, and a boom even somewhat beyond the policy's expiration in 1931, and into the Great Depression. Now you know why pre-war apartments are both so desirable and so plentiful in New York City.

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