WI: Chicago Plan Implemented

[kernals12]

In 1933, America's banking system was crumbling. Many suggestions for reform came about. We chose to insure all deposits and slap on lots of regulations, most notably requiring banks to separate their deposit and investment activities. But there was a road not taken that I think would've been better.

It was written by 8 economists from the University of Chicago and therefore received the name Chicago Plan. The idea was to make all demand deposits fail-proof by having them be held in deposit at the Federal Reserve. This is known as Full Reserve banking or Narrow banking.

Any loans would've had to be financed by time deposits, which, by their very nature, are run proof.

The idea was elegant in its simplicity. And by taking away the ability of commercial banks to create money, it would've vastly expanded the government's seinorage revenue.

This would've certainly butterflied away the 2008 meltdown, and presuming that it would've been implemented in other countries, it would've done away with the devastating banking crises that IOTL hit Argentina in 2002, Venezuela in 1994, and Scandanavia in 1991.

 

[The Jovian]

Not really, chances are Ronald Reagan would've repealed the Chicago Plan along with the other banking de-regulations he did in the eight years he was President.

 

[James Ricker]

Not really, chances are Ronald Reagan would've repealed the Chicago Plan along with the other banking de-regulations he did in the eight years he was President.

Then the S&L scandal or something similar hits and anybody who voted to repeal the Chicago Plan is in a lot of trouble.
The Chicago plan will be re-implemented by the next Administration.

 

[The Jovian]

Then the S&L scandal or something similar hits and anybody who voted to repeal the Chicago Plan is in a lot of trouble.
The Chicago plan will be re-implemented by the next Administration.

I doubt either HW Bush or Clinton would do that, without being bludgeoned with the "socialism sucks" stick by the "keep your government out of my X" crowd that Reagan cultivated during the 80s. Also 40 years of the Chicago Plan may butterfly away the S&L Crisis altogether.

 

[Ian_W]

Also 40 years of the Chicago Plan may butterfly away the S&L Crisis altogether.

Nahh, the S+L's were specifically not-banks. If the Chicago Plan gets up, the ATL S+L's will be specifically written to fall outside that plan - we might have no S+L Crisis, but a Credit Union Crisis.

Capitalism finds a way. Even if that way is really, really stupid.

 

[kernals12]

Not really, chances are Ronald Reagan would've repealed the Chicago Plan along with the other banking de-regulations he did in the eight years he was President.

There would be public outrage over allowing peoples' uninsured bank deposits to be used for risky purposes. Plus, they'd be giving away a large amount of seignorage revenue.

 

[kernals12]

It should be noted that Milton Friedman was a lifelong supporter of narrow banking. He felt it was a preferable alternative to the FDIC.

 

[Laxault2020]

If this where implemented, would we still have the world bank and other regional development banks? How would those be effected?

 

[kernals12]

If this where implemented, would we still have the world bank and other regional development banks? How would those be effected?

Those aren't really banks. They wouldn't be affected.

 

[Laxault2020]

Those aren't really banks. They wouldn't be affected.

Thought so..but just wanted to check.

 

[Ian_W]

This would've certainly butterflied away the 2008 meltdown, and presuming that it would've been implemented in other countries, it would've done away with the devastating banking crises that IOTL hit Argentina in 2002, Venezuela in 1994, and Scandanavia in 1991.

The 2008 meltdown didn't happen in banks - it happened in exactly the sorts of institutions that are described as 'Lending Companies' in the Chicago Plan. Read the bottom of page 4 to page 5 - thats Bear Sterns.

 

[kernals12]

The 2008 meltdown didn't happen in banks - it happened in exactly the sorts of institutions that are described as 'Lending Companies' in the Chicago Plan. Read the bottom of page 4 to page 5 - thats Bear Sterns.

Bear Stearns funded its operations by rolling over short term debt (commercial paper). When they got into trouble, they found they could not get people to take their commercial paper. It was effectively a bank run.

 

[Ian_W]

Bear Stearns funded its operations by rolling over short term debt (commercial paper). When they got into trouble, they found they could not get people to take their commercial paper. It was effectively a bank run.

Commercial paper would be covered by the reference on page 4 to "(and, perhaps, bondholders)".

Expecting the Chicago Plan to save Bear Sterns (and Lehmann and so on) is like expecting a plan that moves the three point line out two feet to slow down the New England Patriots.

 

[kernals12]

Commercial paper would be covered by the reference on page 4 to "(and, perhaps, bondholders)".

Expecting the Chicago Plan to save Bear Sterns (and Lehmann and so on) is like expecting a plan that moves the three point line out two feet to slow down the New England Patriots.

Maybe it wouldn't have saved them, but it would've limited the contagion. Several money market funds failed because of the default on Lehman Brothers commercial paper. Such money market funds would be illegal under the plan, as it requires all demand deposits be backed by government bonds. If the only groups holding Lehman Brothers commercial paper were pension funds or insurance companies, their collapse would've been but a footnote in history.

 

[kernals12]

Nahh, the S+L's were specifically not-banks. If the Chicago Plan gets up, the ATL S+L's will be specifically written to fall outside that plan - we might have no S+L Crisis, but a Credit Union Crisis.

Capitalism finds a way. Even if that way is really, really stupid.

S&L's got the ability to offer checking accounts in the late 70s. That would not be legal under the Chicago Plan. Only banks that solely held government bonds could offer any demand deposits.

 

[Workable Goblin]

Maybe it wouldn't have saved them, but it would've limited the contagion. Several money market funds failed because of the default on Lehman Brothers commercial paper. Such money market funds would be illegal under the plan, as it requires all demand deposits be backed by government bonds. If the only groups holding Lehman Brothers commercial paper were pension funds or insurance companies, their collapse would've been but a footnote in history.

A money market fund is not a demand deposit, though. It's a kind of mutual fund where the fund operator tries to maintain the net present value of the fund shares at $1 each rather than letting them fluctuate, and to accomplish this only owns short-term bonds. You might be mistaking them for money market accounts, which are a type of demand deposit. Money market funds would not at all be affected by this regulation, as they were (and are) not by other bank-specific regulations (which was the whole reason they were set up in the first place--so people could have something like a bank account which was not a bank account, in a legal sense, and could therefore pay more interest).

Also, pension funds and insurance companies are also major financial institutions, so I'm quite certain it's not accurate to say "their collapse would've been but a footnote in history" if those institutions took a serious hit from Lehman. You're talking about some of the largest investors in the world!

 

[Ian_W]

Maybe it wouldn't have saved them, but it would've limited the contagion. Several money market funds failed because of the default on Lehman Brothers commercial paper. Such money market funds would be illegal under the plan, as it requires all demand deposits be backed by government bonds. If the only groups holding Lehman Brothers commercial paper were pension funds or insurance companies, their collapse would've been but a footnote in history.

Again, read the Chicago Plan. Lehmann Brothers are a "Lending Company" supported by stockholders and bondholders, not by depositors.

OTL Lehmann Brothers isn't a deposit-taking institution - its a jumped-up stockbroking firm that has started issuing commercial paper to bondholders, and using that for all sorts of stuff.

An ATL Lehmann Brothers, in a world ruled by the Chicago Plan, will also not be taking deposits (*) but will be convincing bondholders that their new fancy way of slicing and dicing the risk in mortgages will justify lending them lots of money at very little security ... and then their commercial paper will fail and then we get a run on the not-banks just like in 2007-8.


(*) A quick and easy end run on the Chicago Plan is keeping cash "on account to cover potential margin" at stockbrokers. Totally not a bank, right ?

 

[Johnrankins]

In 1933, America's banking system was crumbling. Many suggestions for reform came about. We chose to insure all deposits and slap on lots of regulations, most notably requiring banks to separate their deposit and investment activities. But there was a road not taken that I think would've been better.

It was written by 8 economists from the University of Chicago and therefore received the name Chicago Plan. The idea was to make all demand deposits fail-proof by having them be held in deposit at the Federal Reserve. This is known as Full Reserve banking or Narrow banking.

Any loans would've had to be financed by time deposits, which, by their very nature, are run proof.

The idea was elegant in its simplicity. And by taking away the ability of commercial banks to create money, it would've vastly expanded the government's seinorage revenue.

This would've certainly butterflied away the 2008 meltdown, and presuming that it would've been implemented in other countries, it would've done away with the devastating banking crises that IOTL hit Argentina in 2002, Venezuela in 1994, and Scandanavia in 1991.

The problem is that credit is going to be even tighter in the Great Depression plunging the economy even further. The last thing the economy needs in a depression is tight money.

 

[Ian_W]

The problem is that credit is going to be even tighter in the Great Depression plunging the economy even further. The last thing the economy needs in a depression is tight money.

The actual Chicago Plan recognises this, and explicitly calls for inflationary government policy aimed at adding 15% to wholesale prices, attached to making gold non-convertible and a bunch of other stuff.

Point 10 and point 11 are, however, pretty fuzzy on how that is supposed to happen.

 

[kernals12]

A money market fund is not a demand deposit, though. It's a kind of mutual fund where the fund operator tries to maintain the net present value of the fund shares at $1 each rather than letting them fluctuate, and to accomplish this only owns short-term bonds. You might be mistaking them for money market accounts, which are a type of demand deposit. Money market funds would not at all be affected by this regulation, as they were (and are) not by other bank-specific regulations (which was the whole reason they were set up in the first place--so people could have something like a bank account which was not a bank account, in a legal sense, and could therefore pay more interest).

Also, pension funds and insurance companies are also major financial institutions, so I'm quite certain it's not accurate to say "their collapse would've been but a footnote in history" if those institutions took a serious hit from Lehman. You're talking about some of the largest investors in the world!

Semantics aside, money market funds are vulnerable to runs, since, until 2016, they often advertised themselves as being redeemable at face value (in 2016, the SEC required floating share prices for funds not invested in treasuries). And thanks to the collapse of Lehman, several funds did not have the assets to pay back their investors, leading to runs.