Speaker 1: Hello, and welcome to another episode of the out Locks podcast.
Speaker 1: I'm Joe, Wasn'tal, And I'm Tracy Allowin. Uh, Tracy. You
Speaker 1: know what I'm really happy about? It could be any
Speaker 1: number of things great, that's true, but specifically I'm happy
Speaker 1: that the tent anniversary of the Lehman Brothers crisis happened
Speaker 1: on a weekend this year because I'm not really that
Speaker 1: I'm not really that crazy about all the anniversary coverage
Speaker 1: and I think, come on, we relive our glory days. No,
Speaker 1: I don't really like reliving it and everyone telling their
Speaker 1: stories over and over again. And I think the a
Speaker 1: lot of the lessons from that time are important and
Speaker 1: we should still talk about them. But I'm just kind
Speaker 1: of a little bit over, like, oh, this is what
Speaker 1: happened that day and all the details from them. Are
Speaker 1: you telling me that we are not going to do
Speaker 1: a Lehman Brothers anniversary podcast. We we are skipping over
Speaker 1: that one. Plus by the time it would even come out,
Speaker 1: because we're talking about this, it would be too late.
Speaker 1: So that I think there are interesting lessons and all
Speaker 1: that from the crisis and the collapse of banks and stuff,
Speaker 1: but I'm just sort of glad that the tenth anniversary
Speaker 1: is over. Do you know what people forget about? That
Speaker 1: was actually arguably scarier than Lehman Brothers collapsing at that time,
Speaker 1: and it happened like I think it was the day
Speaker 1: after Lehman Brothers, or maybe a couple of days after.
Speaker 1: Are you going to say the reserve fund, the money
Speaker 1: market Yes, yes, the money market fund that broke the buck.
Speaker 1: That was huge. People forgot about that right there, and
Speaker 1: that's also the thing that probably got um well every
Speaker 1: ball the mainstream remembers Lehman or Lehman the sort of
Speaker 1: to know people talk about the money market fund that
Speaker 1: broke the book. Anyway. I bring this up because one
Speaker 1: thing that I do think is very relevant, um in
Speaker 1: terms of ten years after, is this general frustration that
Speaker 1: after the financial system was rebuilt post crisis, it basically
Speaker 1: looks the same as it did pre crisis. Like there
Speaker 1: might be less risk and bank balance sheets might be healthier,
Speaker 1: and uh, households aren't. Um so is leveraged to their
Speaker 1: homes as they were in two thousand five, two thousand
Speaker 1: and six. But by and large, we rebuilt the same
Speaker 1: financial system we had before, right, I think you could say,
Speaker 1: there's been some tinkering around the edges, like, for instance,
Speaker 1: you did have money market reform, but certainly when it
Speaker 1: comes to the banks, a lot of the criticism that
Speaker 1: you hear nowadays is that not only did we not
Speaker 1: reform the banks, but the biggest banks have gotten even bigger. Right.
Speaker 1: We definitely didn't as a country, as a regulatory system,
Speaker 1: as a financial system, did not use the crisis of
Speaker 1: two thousand a, two thousand nine to think about whether
Speaker 1: there are different models that could be fundamentally safer. We
Speaker 1: essentially just put the you know, the sort of humpty
Speaker 1: dumpty and put it all back together again. Yeah, pretty much. Anyway.
Speaker 1: I bring that up because our guest today, I think
Speaker 1: is is someone who is trying to still push forward
Speaker 1: with a different model of banking. And we're going to
Speaker 1: be talking to Jamie mc andrews. He was a longtime
Speaker 1: veteran of the New York FED and he is the
Speaker 1: founder and CEO of what he hoped will be a
Speaker 1: new type of bank that is much safer for retail
Speaker 1: customers than any currently existing bank. Right. So I'm really
Speaker 1: excited about this conversation because this idea comes up every
Speaker 1: once in a while. As you say, it hasn't really
Speaker 1: gotten much traction just yet. But the notion of a
Speaker 1: narrow banking or full reserve banking, or it's sometimes called
Speaker 1: the Chicago Plan, I think it's a really interesting one,
Speaker 1: and this company is probably the one that's gotten furthest
Speaker 1: along with that idea, although as we're about to discuss,
Speaker 1: there have also been some roadblocks, right, so I don't
Speaker 1: want to get too into the business model of it
Speaker 1: before we bring Jamie on, because of course he'll describe
Speaker 1: it best himself. We should note at the outset of
Speaker 1: this that the bank, which is called the Narrow Bank,
Speaker 1: and we'll listeners will discover why, is not up and
Speaker 1: running yet it doesn't actually exist. It's still getting off
Speaker 1: the ground, and there's currently a lawsuit happening. Narrow Bank
Speaker 1: is suing essentially to have the right to exist currently
Speaker 1: it hasn't been approved to exist, and we can't really
Speaker 1: get into the details of the lawsuit too much because
Speaker 1: it's ongoing. But in our just in our conversation, listeners
Speaker 1: will discover what the goal of the Narrow Bank is
Speaker 1: and the sort of opportunities that it presents as a
Speaker 1: safer model of banking. Yeah, it's going to be good.
Speaker 1: All right, let's bring in Jamie. So Jamie mc andrews.
Speaker 1: Thank thank you very much for joining us. Thanks Joe
Speaker 1: and Tracy. It's it's great to be on odd Lots.
Speaker 1: Thank you. So, what do you describe what the Narrow
Speaker 1: Bank is? Okay, I'll be happy to and just to there.
Speaker 1: There are a couple of things you said in your
Speaker 1: intro that I'd like to clarify. The Narrow Bank does exist.
Speaker 1: It has received what's called it's temporary certificate of authority
Speaker 1: from the Department of Banking in Connecticut, so it's a
Speaker 1: chartered state bank. The dispute with the Federals or Bank
Speaker 1: New York is not about its UH regulatory status or anything.
Speaker 1: It's about whether the Federers or Bank of New York
Speaker 1: will provide TND with an account. So we're simply looking
Speaker 1: for account services from the Felt Reserve, not any regulatory
Speaker 1: approval of any sort. And the other thing is T
Speaker 1: and B is not ensured by the Federal Deposit Insurance Corporations,
Speaker 1: so it won't be dealing directly with retail customers. It's
Speaker 1: it's for institutional investors and so it's just those are
Speaker 1: just a couple, since I wanted to make sure your
Speaker 1: listeners understood. But yes, getting back to the basic question,
Speaker 1: what is t n B. T and B is designed
Speaker 1: to provide institutional investors with very high, are competitive, but
Speaker 1: safe deposit rates. It's specifically designed to perform this function
Speaker 1: because what we've seen since the crisis is that the
Speaker 1: interest on reserves that the FED pays to banks has
Speaker 1: not been passed through very well to bank customers, bank depositors.
Speaker 1: And we designed, my colleagues and I have founded TMB
Speaker 1: designed the bank two perform this specific service, and its
Speaker 1: design features are intended exactly to to get higher deposit
Speaker 1: rates safely two institutional investors. So Jamie, could you maybe
Speaker 1: in a nutshell describe how traditional banking actually works because
Speaker 1: I think that's going to help our listeners kind of
Speaker 1: understand what's different about your bank. So, you know, the
Speaker 1: commercial banks, they get a bunch of interests that's paid
Speaker 1: on the reserves they have at the FED. I think
Speaker 1: it's currently like one point nine something percent. Why did
Speaker 1: they get paid that interest and why are they unable
Speaker 1: to pass most of it onto their customers? Right? Let
Speaker 1: me let me answer that in two steps First, how
Speaker 1: to ordinary banks work. Ordinary banks raise money by issuing
Speaker 1: deposits to customers, and so customers come in, they put
Speaker 1: money into the bank and receive a claim on the bank,
Speaker 1: which is called a deposit, and it's they're able to
Speaker 1: withdraw cents on the dollar at any time. That's the
Speaker 1: unique feature of deposits. And banks have capital as well
Speaker 1: from their founders and perhaps external investors. There's capital on
Speaker 1: the balance sheet, so typically the money in the bank
Speaker 1: comes from depositors and the equity from investors. On the
Speaker 1: other side of the balance sheet, banks keep some funds
Speaker 1: in what are called reserve deposits, and those are usually
Speaker 1: at the central bank or they can take the form
Speaker 1: of currency and evolved and those allow the bank to
Speaker 1: honor their depositors withdrawal requests very quickly, and with other investments,
Speaker 1: the bank makes loans to households and businesses. So that's
Speaker 1: a typical bank. And so in the conventional bank there's
Speaker 1: only a fraction of their deposits that are held in
Speaker 1: these reserves. And consequently banks have a instability built into them,
Speaker 1: which is that if all depositors withdraw their funds at
Speaker 1: the same time, the bank may have difficulty sourcing enough
Speaker 1: reserves to honor all their depositors withdraw all requests. That
Speaker 1: would be a run on the bank. And if they
Speaker 1: can't borrow against the loans that they've made, they would
Speaker 1: be in difficulty. Now, historically, the Federal Reserve, throughout its
Speaker 1: history has not paid any interest on reserves. The deposits
Speaker 1: of the Federal Reserve were non interest sparing. But in
Speaker 1: two thousand six, the Congress of the United States authorized
Speaker 1: the Federal Reserve to pay interest on reserves. And the
Speaker 1: basic idea behind this was that the Federal Reserve was
Speaker 1: requiring banks to hold reserves and they weren't paying any
Speaker 1: interest on the reserves. So that can be considered the
Speaker 1: type of tax because it was required for the people
Speaker 1: to hold it and they didn't earn any money on it.
Speaker 1: Of course, the Federal Reserve could invest those funds in
Speaker 1: government securities and earn money on it. So the lost
Speaker 1: earnings that people suffered by holding required reserves is the
Speaker 1: type of tax. So Congress agreed with the Federal Reserve
Speaker 1: and the banking industry that there should be payment of
Speaker 1: interest on reserves, just like banks pay interest on deposits,
Speaker 1: and that authority was granted in two thousand six. It
Speaker 1: it was first used in two thousand eight in October
Speaker 1: two thousand eight, where the Federal Reserves paid interest on reserves.
Speaker 1: The other aspect of paying interest on reserves is it's
Speaker 1: a way to for the Federal Reserve to implement its
Speaker 1: monetary policy. It's interest rate target. Again, prior to the
Speaker 1: financial crisis and prior to two thousand and eight, the
Speaker 1: Federal Reserve affected the money market interest rates, the rates
Speaker 1: for example that banks lend to one another called the
Speaker 1: Federal funds rate, by affecting the supply of reserves in
Speaker 1: the market. So if they provide a lot of reserves
Speaker 1: to banks, many banks would have excess reserves and wish
Speaker 1: to lend in that market. That would drive the overnight
Speaker 1: rate down. And on the other hand, if they put
Speaker 1: only few reserves in the market and had a scarcity,
Speaker 1: there would be very few lenders of reserves and other
Speaker 1: banks would be short of reserves and that would drive
Speaker 1: the overnight interest rate up. But with the financial crisis,
Speaker 1: the Federal Reserve had many excess reserves in the market
Speaker 1: and so the interest rate would be zero on those
Speaker 1: except for the fact that the Federal reserve achieved the
Speaker 1: ability to pay interest on them. Once they were paying
Speaker 1: interest on reserves, then banks had a new source of
Speaker 1: demand for reserves because the reserves would earn this interest rate,
Speaker 1: and so banks, theoretically in a competitive market, would be
Speaker 1: happy to pay depositors to put funds into their bank
Speaker 1: and then earn the interest at the Federal Reserve. That
Speaker 1: would tend to drive deposit rates and overnight interest rates
Speaker 1: up towards the interest on access reserves. So it's become
Speaker 1: a monetary policy tool in the wake of the very
Speaker 1: large levels of reserves that the FIT has held, that
Speaker 1: the FED has created since the crisis. So I'm mentioned
Speaker 1: at the beginning that you, prior to having founded the
Speaker 1: Narrow Bank, you were at the New York Federal Reserve,
Speaker 1: and this idea of launching a new bank, if I've
Speaker 1: read properly, came out of research that you did while
Speaker 1: at the New York Fed about essentially this question, which
Speaker 1: is why aren't depositors at retail facing banks getting higher
Speaker 1: rates when the banks are able to collect higher rates
Speaker 1: from their reserves. That's that's about right, Joe. The there
Speaker 1: was a lot of concern um throughout the whole financial
Speaker 1: system that after two thousand eight, when banks were earning
Speaker 1: interest on reserves, the overnight rate was not very close
Speaker 1: to the interest on reserves. It was lying well below
Speaker 1: the interston reserves ten or fifteen basis points are a
Speaker 1: tenth more than a tenth of a percent, which is
Speaker 1: prisingly large amount. Things are little bit better today, but
Speaker 1: for several years the banks were paying rates on overnight
Speaker 1: funds that were very low compared to what they could
Speaker 1: earn on reserves, and it was a puzzle for economists
Speaker 1: to determine why isn't the competition for large deposits driving
Speaker 1: the interest rate up towards the interest on reserves, And
Speaker 1: there have been several economic explanations for that. Darryl Duffy
Speaker 1: and colleagues have explained that there's the market for UH
Speaker 1: federal funds and other overnight loans is the search um model.
Speaker 1: It's and over the counter market where people have to
Speaker 1: go out and find a counterparty, and that is less
Speaker 1: than perfect competition. With colleagues, I did research that pointed
Speaker 1: out that there's monitoring and credit exposure risks and for
Speaker 1: that reason, lenders one to expose themselves only to a
Speaker 1: few banks, and that grants those banks essentially a monopsony
Speaker 1: power over the lenders, and Morton Beck can bethically have
Speaker 1: another theory having to do with the bargaining. The nature
Speaker 1: of the bargaining between two parties over time leads to
Speaker 1: less than perfect competition. So it was recognized that there
Speaker 1: was less than perfect competition for these large deposits to banks,
Speaker 1: and so the Federal Reserve undertook a lot of work
Speaker 1: to improve the competition in the market. Ultimately, the Federal
Speaker 1: Reserve chose to create its own narrow bank, you might say,
Speaker 1: the overnight reverse from Purchase Agreement facility that serves about
Speaker 1: a hundred and sixty non banks. It's designed as a
Speaker 1: open market operation, and it legally fits that description, but
Speaker 1: it was designed to the economically element to an account.
Speaker 1: Essentially that these hundred and sixty money market mutual funds,
Speaker 1: broker dealers, federal home loan banks can deposit money at
Speaker 1: the Federal Reserve overnight and receive an interest rate the
Speaker 1: It's designed as a as a repo transaction, but the
Speaker 1: proffering of this collateral really doesn't improve the credit quality
Speaker 1: that the participants in that facility received because the Federal
Speaker 1: Reserve Bank is already extremely highly credit worthy, and the
Speaker 1: participants don't rehapomplicate the securities in the in the program.
Speaker 1: So it's essentially an account that those people, those those
Speaker 1: hundred and sixty institutions have at the Federal Reserve. And
Speaker 1: that was the way that the FED was able to
Speaker 1: narrow the range of interest rates overnight so that those
Speaker 1: large participants in the money market would surely be able
Speaker 1: to enjoy an interest rate at least as high as
Speaker 1: what the FED was paying, and they could go to
Speaker 1: their private counterparties and say, hey, I'm getting this interest
Speaker 1: rate at the Fed. You have to pay me more
Speaker 1: if you'd like my lending into into your institution. And
Speaker 1: that has um from the feeds point of view. There's
Speaker 1: a lot of work on that that has been uh
Speaker 1: successful in the sense that the overnight interest rate has
Speaker 1: remained above that level in the that they pay in
Speaker 1: the overnight reverse repurchase agreement facility. Right, So we're talking
Speaker 1: about a couple of things here. One of them is
Speaker 1: how commercial banks operate. One of them is how money
Speaker 1: market funds operate, and the other one is how they
Speaker 1: all sort of interconnect with the Federal Reserve and the
Speaker 1: FEDS monetary policy. Where would the narrow bank sit in
Speaker 1: that ecosystem and what would its relationship be like with
Speaker 1: the Fed? And UM, I guess large institutional depositors because
Speaker 1: you said you're not really targeting retail, that's right. So
Speaker 1: my colleagues and I at TNB have felt that there
Speaker 1: was a market opportunity to create a special purpose um
Speaker 1: ultra safe, low cost and focus competitor to inner that
Speaker 1: market for large deposits. And we asked ourselves what would
Speaker 1: be required to enter that market because we're hoping to
Speaker 1: attract very large deposits. And the first answer that we
Speaker 1: came to is the bank would have to be very
Speaker 1: very safe because we're competing with the largest banks in
Speaker 1: the world, many of whom are perceived to be too
Speaker 1: big to fail. So in other words, those banks are
Speaker 1: considered to have a government guaranteed by by many depositors.
Speaker 1: And so the only way to create a DiNovo bank
Speaker 1: that is very very safe is to designed the bank
Speaker 1: on a hundred reserve basis, and that is possible now
Speaker 1: in contrast to back in historical times, because reserves pay interest.
Speaker 1: And so it was the change by the Congress in
Speaker 1: two thousand and six that allow the fellow reserved to
Speaker 1: pay interest. That created this market opportunity. A bank could
Speaker 1: be designed on a hundred percent reserve basis and there
Speaker 1: therefore would be extremely safe and it would have the
Speaker 1: hope of attracting depositors. And then because it was a
Speaker 1: percent reserves, it would be a very low cost bank
Speaker 1: in terms of operating costs. The assets carry no financial risks,
Speaker 1: costly insurance from the fdi C is not needed, and
Speaker 1: so the bank would be a low cost competitor in
Speaker 1: that market. It's important to note that foreign banking organizations
Speaker 1: that take in wholesale deposits also do not carry the
Speaker 1: insurance of the fdi C, so in essence, the bank
Speaker 1: had to match that competition. But by designing the bank
Speaker 1: this way, then we would have a low cost operation
Speaker 1: that could pass on the interest on reserves earned from
Speaker 1: the federal reserve to large institutional depositors. And we thought
Speaker 1: that would be a market opportunity that would be able
Speaker 1: to compete with those very largest banks in the nation
Speaker 1: who enjoy the ability to attract deposits at very low
Speaker 1: rates because of their perceived safety. I think this is
Speaker 1: really the key thing here that we've got to which
Speaker 1: is your business model, And I just want to make
Speaker 1: sure people understand it. If right now I'm an institution,
Speaker 1: and let's say I have, uh, you know, a bunch
Speaker 1: of money, ten million dollars in cash I want to
Speaker 1: put somewhere right now, I would probably go to some big,
Speaker 1: two big to fail bank, and their assets would be
Speaker 1: a mix of things including, uh, some things that are
Speaker 1: very safe and other things which are riskier. And they
Speaker 1: wouldn't feel particularly compelled to pass on a competitive rate
Speaker 1: to me because they know I don't have any options,
Speaker 1: and I would just be choosing from other too big
Speaker 1: to fail banks. But your argument is you can create
Speaker 1: the safest possible bank in the world. Because I give
Speaker 1: you my ten million dollars I deposited with you. You
Speaker 1: will automatically that turns into ten million dollars worth of
Speaker 1: assets for you, because you put that ten million dollars
Speaker 1: in a FED account and that's the safest money in
Speaker 1: the world. And you don't have any other costs because
Speaker 1: you don't have a bunch of loan officers and credit
Speaker 1: people because that's not your business, and you don't have
Speaker 1: the fdi C fees, and you just pass that straight
Speaker 1: onto me. And even though you're not un too big
Speaker 1: to fail, I don't have to worry about any of
Speaker 1: your asset quality because it's the highest quality money in
Speaker 1: the world. Weld Joe. That's that's a good description. So, um,
Speaker 1: how does that differ from a money market fund, Because,
Speaker 1: of course, if I am a large institutional customer, one
Speaker 1: of the things that I would do if I have
Speaker 1: a bunch of extra money is maybe park it in
Speaker 1: a fund that invests in things that are usually considered
Speaker 1: quite safe, like US treasuries or commercial paper or something
Speaker 1: like that. So how is this difference. Well, for the
Speaker 1: government only funds, H. Tracy, I think you're. I think you're.
Speaker 1: There is a lot of similarity between the two types
Speaker 1: of institutions. Some of the differences are the TNB has capital,
Speaker 1: and it will have capital to help support the re
Speaker 1: payment of depositors claims. Money market mutual funds don't have
Speaker 1: any capital. The second thing is the nature of the
Speaker 1: assets that are being invested in by the two types
Speaker 1: of institutions. Government only money market funds invest in US
Speaker 1: obligations T and B will invest in Federal Reserve deposits.
Speaker 1: There's a difference in the liquidity of those two types
Speaker 1: of assets. There are bid ask spreads, and there's maturity
Speaker 1: transformation that's going on in money market mutual funds. Of course,
Speaker 1: that maturity transformation caused extraordinary problems, as you pointed out
Speaker 1: at the outset of your of this podcast, when the
Speaker 1: Reserve Primary Fund, which was was a prime fund not
Speaker 1: a government only fund, um broke the buck because they
Speaker 1: were engaging in both credit and maturity transformation. Uh, there
Speaker 1: was a huge run on money market funds, showing the
Speaker 1: the fragility of that particular financial model. The narrow bank
Speaker 1: does not have that fragility because you can always meet
Speaker 1: its depositors demands, and even government only money market funds
Speaker 1: engage in maturity transformation in order to boost the returns
Speaker 1: and that's a potential of fragility there. So T and
Speaker 1: B is simply a safer alternative. And because of the
Speaker 1: different assets, there are different interest rates that would be
Speaker 1: earned by, on the one hand, shareholders in the money
Speaker 1: market mutual fund and depositors at TNB, and it would
Speaker 1: depend on market conditions who had the higher interest rate.
Speaker 1: As we've seen recently, market conditions have changed in the
Speaker 1: money market. Many people believe it's the very large issuance
Speaker 1: of treasury bills by the U. S. Treasury. But in
Speaker 1: recent months, the treasury bill rate and the repo rate
Speaker 1: has moved up very close to the one that the
Speaker 1: subtle reserve is paying on uh it's on reserves. So
Speaker 1: UM market conditions have um, you know, moved somewhat against
Speaker 1: the narrowbank model. But we believe that there's a a
Speaker 1: business there. It may not be a huge business in
Speaker 1: present circumstances, but we believed could be an important component
Speaker 1: to the you know, to the financial system and I
Speaker 1: and a new and very safe alternative for institutional depositors.
Speaker 1: So I'm glad you said that about the business opportunity
Speaker 1: because that's exactly what I was going to ask you next. A.
Speaker 1: Have you estimated what how big of a business you
Speaker 1: think that it could be? And B. I don't want
Speaker 1: to phrase this in a way that might be sort
Speaker 1: of condescending or missing the points, but I am curious
Speaker 1: how much of this endeavor is about a business money
Speaker 1: making opportunity for you and your partners versus to some
Speaker 1: stent an implementation of an academic theory that's sort of
Speaker 1: a kind of a quasi academic project. Well, let me
Speaker 1: answer the the second question. First, this is a business opportunity.
Speaker 1: This is uh a very unique business opportunity and one
Speaker 1: that I think is inevitable given the payment of interest
Speaker 1: on reserves. I fully believe that narrow banks are something
Speaker 1: for the you know, for the future of our financial system,
Speaker 1: not not the past, not the sort of academic exercises
Speaker 1: that have been drawn on paper in the past. This
Speaker 1: is a living, breathing business opportunity that we believe is
Speaker 1: very important for depositors. And the reason again is the
Speaker 1: the see change that occurred in October two thousand eight
Speaker 1: when the subtle Reserve began paying interest on reserves. That's
Speaker 1: really a very important change in our financial system. But
Speaker 1: I don't believe even ten years later that it's been
Speaker 1: fully incorporated into the structure of the financial system. But
Speaker 1: let me um also distinguish T and B from the
Speaker 1: sort of historical plans and proposals for narrow banks. The
Speaker 1: famous example is the Chicago Plan, which was proposed in
Speaker 1: the wake of the banking crisis. Of the T and
Speaker 1: B proposal is very distinct from that plan, which was
Speaker 1: purely to make banking perfectly safe and it was also
Speaker 1: to outlaw conventional banks, very radical sort of proposal. T
Speaker 1: and B has no such interest in disrupting the business
Speaker 1: of conventional banks. We believe conventional banks are complementary to
Speaker 1: T and B, and the T and B would complement
Speaker 1: our financial system. And you know retail banking. Retail customers
Speaker 1: enjoy federal deposit insurance, they have safe deposits. This is
Speaker 1: for the large depositors. So let me talk a little
Speaker 1: bit about the social benefits of TNB. First of all,
Speaker 1: there is the benefit of to the customers directly of
Speaker 1: TMB that they would get higher deposit rates. But the
Speaker 1: first thing that would happen if TMB came into the business,
Speaker 1: and this is why it's hard to estimate how big
Speaker 1: TMB might be it might be very small, is other banks,
Speaker 1: the banks with whom TMB would compete, would raise their
Speaker 1: deposit rates. And that's because TNB represents a new competitive
Speaker 1: force in banking. So, as economists would tell you, increasing
Speaker 1: that competition would lead to lead to improve deficiency in banking.
Speaker 1: It also would lead to better implementation of monetary policy.
Speaker 1: The Federal Reserve, as I mentioned earlier, created this their
Speaker 1: own narrow bank but I consider to be equivalent to
Speaker 1: a narrow bank the overnight reverse Repurchase Agreement facility, and
Speaker 1: they did that to have better implementation of monetary policy,
Speaker 1: and in its documents, the Federal Open Market Committee repeatedly
Speaker 1: claims that the o E n r RP is necessary
Speaker 1: for the implementation of monetary policy. T and B would
Speaker 1: be accomplishing a similar goal of getting deposit rates higher
Speaker 1: and closer to IOE r um, something that the Federal
Speaker 1: Reserve leads is necessary to its implementation of monetary policy.
Speaker 1: It also would lead to better efficiency and government spending
Speaker 1: and better distributional effects, as this government expenditure of io
Speaker 1: we are is passed on two depositors and doesn't stay
Speaker 1: solely with banks. A second social benefit of TNB is
Speaker 1: the um effect it would have on the market for
Speaker 1: these large wholesale funds but are sometimes called large cash pools.
Speaker 1: There's a lot of research that has been done by
Speaker 1: economists pointing out that when the Treasury Department issues a
Speaker 1: lot of Treasury bills, that tends to crowd out the
Speaker 1: issuance of systemically risky short term liabilities by private firms,
Speaker 1: such as the issuance prior to the crisis of A B, C,
Speaker 1: P C, P, V R, D O S A R S,
Speaker 1: S repost and so on. All these panically of the
Speaker 1: seemingly safe but ultimately very risky UH short term liabilities.
Speaker 1: So when the again, when the Treasury issues a lot
Speaker 1: of Treasury bills, there's less issuance of those systemically risky
Speaker 1: short term liabilities. T and B could have that beneficial
Speaker 1: effect as well. If it were accepted in the market,
Speaker 1: then that would be an alternative to those investors who
Speaker 1: are looking for safe, safe haven and rather than go
Speaker 1: into some risky v R G O or something like that,
Speaker 1: they could go to T and B, and that would
Speaker 1: be beneficial to society, would reduce UH systemic risks. The
Speaker 1: third one is one that the great economist James Tobin
Speaker 1: pointed out in two papers. Paper was called the Case
Speaker 1: for Preserving Regulatory Distinctions and was presented at the Jackson
Speaker 1: the Whole Conference, and in those papers he recommended that
Speaker 1: there'd be narrow banks. His reason from narrow banks was
Speaker 1: again distinct from the Chicago Plan or anything. He again
Speaker 1: did not suggest that conventional banks be outlawed or anything
Speaker 1: like that. He thought the narrow banks would be complementary
Speaker 1: to the banking system, and what he saw at the
Speaker 1: benefit of neuro banks at that time was that there
Speaker 1: would be a less reliance placed on deposit insurance. As
Speaker 1: a society, we have placed essentially, we put all our
Speaker 1: eggs in the deposit insurance basket. And that's reflected in
Speaker 1: the fact that the f d i C in April
Speaker 1: two thou eleven changed its assessment formula on banks to
Speaker 1: charge its assessment on all the liabilities issued by bank
Speaker 1: holding companies. And that made sense because during the crisis,
Speaker 1: not to go back ten years ago, Joe that you're
Speaker 1: done with that, You're so done with that. But the
Speaker 1: the f d i C issued, you know, extraordinary guarantees
Speaker 1: on all transaction accounts and also um guaranteed and insured
Speaker 1: the debt issued by participating large bank holding companies. So
Speaker 1: it's clear that the f d i C has enormous
Speaker 1: exposure to the US banking system. And what James Tobin
Speaker 1: he foresaw that and he said, we're replacing so much
Speaker 1: emphasis on deposit insurance. It's so difficult to uh supervise
Speaker 1: these firms and actually uh control the amount of risks
Speaker 1: that they're taking. We could provide safety alternatively through technological means,
Speaker 1: not through government guarantees. And the technological means is to
Speaker 1: create safe UH deposits through narrow banks, and T and
Speaker 1: B has that flavor as well, So that would be
Speaker 1: another potential social benefit from TMB. But those are the
Speaker 1: social benefits. T and B is organized as a business,
Speaker 1: and it it's not created for some other reason. It's
Speaker 1: primarily a business opportunity that we see. So Jamie, you're
Speaker 1: obviously talking about a lot of the positives that come
Speaker 1: from narrow banking. And I have to say, as as
Speaker 1: a depositor who currently earns you know, zero points something
Speaker 1: on my deposit in the US, the idea of my
Speaker 1: bank being forced to offer me a higher rate is
Speaker 1: very attractive. However, there are some people who wonder about
Speaker 1: whether or not narrow banking could maybe have some negative
Speaker 1: consequences in the event that we have another Lehman like situation,
Speaker 1: so in other words, whether it might not end up
Speaker 1: increasing financial instability, because what might happen is if you
Speaker 1: have the hint of a run on UM, you know,
Speaker 1: certain money like assets like you mentioned commercial paper or
Speaker 1: ABCP asset backed commercial paper UM, which is what we
Speaker 1: saw in September two thousand eight, that the depositors will
Speaker 1: just flee all of those and move into narrow banking,
Speaker 1: and so you're effectively potentially worsening a run on the
Speaker 1: sort of interbank system. How would you respond to those
Speaker 1: sorts of concerns, Well, let me first say that in
Speaker 1: normal times. Some people have said in normal times, even
Speaker 1: narrow banks might think gain to gain a market share
Speaker 1: at the expense of conventional banks, and I'd like to
Speaker 1: say I don't believe that's that's really a concern, both
Speaker 1: because the vast majority of deposits in conventional banks are
Speaker 1: covered by deposit insurance, so they're perfectly safe, and those
Speaker 1: depositors would not have a reason to leave their banks,
Speaker 1: and their banks could, again in normal times, respond by
Speaker 1: raising their deposit interest rate and retaining their depositors. So
Speaker 1: there should be no UH large disruptions of banking in
Speaker 1: normal times as a result of UH a narrow bank
Speaker 1: or many narrow banks existing. Then the question is, as
Speaker 1: you described, Tracy, if there were a stressful situation UH
Speaker 1: in the marketplace, and if there were a run into
Speaker 1: narrow banks. Currently, if there's stress in the marketplace, people
Speaker 1: often find refuge in the government only money market mutual funds,
Speaker 1: as as was seen in the prime fund money market
Speaker 1: run in two thousand eight. So I think that people
Speaker 1: would still take advantage of going into money market mutual funds.
Speaker 1: Government only money market mutual funds, the narrow bank would
Speaker 1: require many days, if not a couple of weeks to
Speaker 1: acquire a new customers, so the one could not run
Speaker 1: into the narrow bank, uh, you know, immediately, And the
Speaker 1: narrow bank would have the ability to request current customers
Speaker 1: to slow down deposit inflows if if that were at
Speaker 1: all a concern, So there are natural breaks on the
Speaker 1: narrow bank. The narrow bank T and B would not
Speaker 1: want to be associated with any you know, distress in
Speaker 1: a market, and would not necessarily want to be the
Speaker 1: the recipient of flows that were causing some sort of
Speaker 1: problem for the US financial system. The other aspect is
Speaker 1: if there were a situation like this, the Federal Reserve
Speaker 1: would have many tools to address the situation. If there
Speaker 1: were a public necessity, Federal Reserve could choose to pay
Speaker 1: a lower interest rate to narrow banks relative to conventional banks,
Speaker 1: and that would thereby for the ability of people to
Speaker 1: run into narrow banks. So I again, that's sort of
Speaker 1: like a theoretical academic concern that in the real world
Speaker 1: would never occur. Jamie. In theory you mentioned worthy narrow
Speaker 1: bank to get off the ground and start collecting big deposits,
Speaker 1: it will likely or could certainly put pressure on the
Speaker 1: existing banks to offer higher interest rates. Would it be
Speaker 1: possible theoretically at some point for existing banks to offer
Speaker 1: segregated narrow bank like accounts where they basically tell people
Speaker 1: that if they want, they can have an account that
Speaker 1: backed up with reserves central bank reserves. I I think
Speaker 1: that that is a potential um direction that banks could go.
Speaker 1: They would probably need the Federal Reserve to to change
Speaker 1: their policies to allow banks to have a you know,
Speaker 1: a segregated account at the Federal Reserve. And I've I've
Speaker 1: recommended this and written a paper about the possibility of
Speaker 1: doing that. So I think that would be healthy again
Speaker 1: for a financial system, if if any bank could essentially
Speaker 1: form a narrow bank arm And that's again also something
Speaker 1: that James Tobin recommended in his but I think it
Speaker 1: would require a change in policy and operations by the
Speaker 1: Federal Reserve to to accommodate that that alternative for banks UH.
Speaker 1: And then another thing is, so let's say this became
Speaker 1: big and your narrow bank launched, and there were other
Speaker 1: narrow banks. The narrow bank or your bank isn't going
Speaker 1: to do things that get involved in loans and real
Speaker 1: estate and all that. What do you see is the
Speaker 1: future for that aspect of business banking, which is here,
Speaker 1: you know, the lending side. If more of the world's
Speaker 1: deposits were to opt for UH fully backed reserve deposits,
Speaker 1: I don't see any interruption in the business of conventional
Speaker 1: banks as a result of the creation of narrow banks. Again,
Speaker 1: the the point of narrow banks UH in the current world,
Speaker 1: and the reason T ANDB was created is to compete
Speaker 1: the interest on reserves more towards depositors, to provide competition
Speaker 1: so that the interest on reserves gets two depositors. That
Speaker 1: does not in any way affect the conventional banks ability
Speaker 1: to make real estate loans or anything else. All it
Speaker 1: does is it removes a little bit of rent that
Speaker 1: banks are currently earning between the amount that they earn
Speaker 1: on reserves and the amount the pay depositors. If you
Speaker 1: consider a bank today and as suppose a borrower comes
Speaker 1: up to the bank and proves to the bank that
Speaker 1: it is it's a perfectly risk free borrower, and they say,
Speaker 1: what will you lend at? What interest rate will you
Speaker 1: lend to me? The bank is not going to lend
Speaker 1: to that person at a rate below one point nine,
Speaker 1: even if they're perfectly risk free, because they can earn
Speaker 1: one point nine at the federal reserve. That's going to
Speaker 1: be the same before and after the narrow bank. The
Speaker 1: narrow bank does not restrict the bank's hurdle rate or
Speaker 1: change the bank's hurdle rate on lending at all, so
Speaker 1: the bank. All it does is the bank may have
Speaker 1: to pay a higher interest rate on their liabilities, and
Speaker 1: so they may be affected in that they have a
Speaker 1: lower level of rent. I would not even call this
Speaker 1: a lower level of profit, because I believe that the
Speaker 1: earnings that banks get between the interests that are paid
Speaker 1: to banks on reserves versus what they paid to depositors
Speaker 1: is really a rent. They get that for being there
Speaker 1: and for being perceived as safe. Um, they're not out
Speaker 1: competing for that, and so uh, that's really the effect.
Speaker 1: It would improve efficiency in banking if any banks are
Speaker 1: actually making a living on that part of their business.
Speaker 1: They would have their activity curtailed, but it's not going
Speaker 1: to interrupt in any way the profitable businesses lending to
Speaker 1: households and businesses. So, Jamie, you have the banking charter,
Speaker 1: you applied for an actual reserve account at the FED,
Speaker 1: which was rejected. Um, and hence the lawsuit. What next
Speaker 1: for you and what sort of argument are you going
Speaker 1: to be making about the Fed's decision. Well, we have
Speaker 1: not been just to clarify, Tracy, We've not been rejected
Speaker 1: on a reserve account. It's just that the Federal Reserve
Speaker 1: back in New York has not been willing to ye
Speaker 1: the reserve account. Uh, they've not said no. So we
Speaker 1: hope that the Felleral Reserve will provide us a reserve account.
Speaker 1: And we hope, um, they will do this quickly. And uh,
Speaker 1: we think it's in the interests of the Fettle Reserve
Speaker 1: and the interests of the U S taxpayers, as well
Speaker 1: as the interests of our financial system well as journalists
Speaker 1: who find this to be a fascinating story. We hope
Speaker 1: that it goes forward, if only because we'd really like
Speaker 1: to see how this evolves and how this plays out
Speaker 1: in the financial system and the banking system. So, Jamie McAndrews,
Speaker 1: thank you so much for joining us. That was a
Speaker 1: fascinating conversation. Great, thank you so much, Joe and Trying.
Speaker 1: I appreciate it. Tracy, I really loved that conversation. I
Speaker 1: feel like, um, just getting into the mechanics of banking
Speaker 1: is one of those things that it kind of makes
Speaker 1: your head hurt a lot, but it is really worth
Speaker 1: it to actually understand how our system really works. Oh yeah, totally.
Speaker 1: And the best way to understand, you know, the traditional
Speaker 1: banking model is probably to talk about a new banking model,
Speaker 1: which we just did in detail. You know, I sort
Speaker 1: of feel bad that I started that thing. The thing
Speaker 1: I didn't like, um the anniversary of Lehman, because oh yeah,
Speaker 1: you should feel like I do. Kind of feel bad now.
Speaker 1: But one point that I think Jamie made that I
Speaker 1: thought was extremely interesting, and something that people often forget
Speaker 1: about the crisis is how much of it was a
Speaker 1: result of the manufacture of safe assets for things that
Speaker 1: weren't from things that weren't safe. And so investors set
Speaker 1: out to take a bunch of crazy risks, but what
Speaker 1: they really wanted was extremely safe assets, and then the
Speaker 1: industry complied by essentially fabricating safe assets out of risky assets.
Speaker 1: And then he listed off, Jamie listed off this alphabet
Speaker 1: soup of things like, you know, the auction rate securities
Speaker 1: and asset back, commercial deposits and all that stuff, which
Speaker 1: were all examples of things that were more or less
Speaker 1: seen as triple A money like, but the underlying foundations
Speaker 1: of which were actually pretty risky. Yeah, and that's really
Speaker 1: the whole conversation that we just had was about how
Speaker 1: to manufacture more safe assets, but in a way where
Speaker 1: they are actually safe. And I realized the irony of
Speaker 1: me saying that, but that's always what we're trying to do. Um.
Speaker 1: But and in this case they actually would be. I mean,
Speaker 1: if they were in this case, I think it's safe
Speaker 1: to say that if the funds were in fact deposited
Speaker 1: right at the FED, they would literally be the safest
Speaker 1: kind of money imaginable. Yeah, it's sort of like the
Speaker 1: magic of banking intermediation in reverse, right, Like, normally banks
Speaker 1: take your money and invest it in a bunch of
Speaker 1: risky things, but your money is considered safe because it's
Speaker 1: a deposit. But in this case, your risky money would
Speaker 1: kind of be put at the FED and turned into
Speaker 1: something safe automatically, so financial engineering in reverse. You're going
Speaker 1: to say something else though before I interrupted you. Oh yeah, Well,
Speaker 1: the other thing I was thinking about is, you know,
Speaker 1: you mentioned banking reform at the beginning of the conversation,
Speaker 1: and um, I was just thinking, like, you know, here
Speaker 1: we have an idea to create basically the world's safest bank.
Speaker 1: And of course you know, the notion that the FED
Speaker 1: hasn't said yes just yet is very ironic. But I
Speaker 1: also wonder it's kind of hard to create something new
Speaker 1: once you have the existing infrastructure, right, and that might
Speaker 1: be the difficulty here. I think like the FEDS a
Speaker 1: little bit unwilling to try something new because they're worried
Speaker 1: about the knock on effect for existing financial institutions and
Speaker 1: you can't really start from scratch. Yeah, it is really difficult.
Speaker 1: And momentum and inertia, I always say, is like the
Speaker 1: most powerful, the most powerful force in the world. Right, Well,
Speaker 1: speaking of inertia, shall we wrap this up? At speaking
Speaker 1: of inertia, I don't really get that seg but yeah,
Speaker 1: let's wrap it up. Well I tried. Okay, this has
Speaker 1: been another episode of the Odd Lots podcast. I'm Tracy Alloway.
Speaker 1: You can follow me on Twitter at Tracy Alloway. And
Speaker 1: I'm Joe Wisenthal. You can follow me on Twitter at
Speaker 1: The Stalwart, and you should follow our producer on Twitter
Speaker 1: tofor Foreheads at Forehast, and you should follow the Bloomberg
Speaker 1: head of podcast, Francesco Levy on Twitter at Francesca Today.
Speaker 1: Thanks for listening to