Using short-term borrowing — including zero-term borrowing, like ordinary bank deposits — to fund long-term illiquid assets is a strategy that can go catastrophically wrong.
Mencius Moldbug calls this problematic strategy maturity transformation, because short-term debt is transformed — imperfectly — into long-term debt. In case of panic, the disconnect becomes vivid.
A simple shift away from demand deposits could fix the problem:
If we replaced ordinary bank accounts with money-market mutual funds, then we would no longer have this issue of short-term borrowing going to fund long-term illiquid assets.Instead, the bank’s customers would be equity-holders, and there would be no rush in bad times to run on the bank to get yours before everyone else gets theirs.
The worst-case scenario would be that the fund had to break the buck — unpleasant but not catastrophic.
I’ve said as much before:
Most of these “maturity transformation” issues disappear when you move away from an old-fashioned bank, which makes explicit promises of r% interest and withdrawals on demand, and move to a bond fund, which makes no promises about what yields it can deliver — and which doesn’t have to unwind its investments just because shareholders want to sell their shares.Certainly bad debt can lead a money market fund to break the buck, and that can cause a liquidity crunch for investors who considered it cash-equivalent, but there’s no incentive for a run on the money market fund; shares just lose value, and no new shares are issued until the share price creeps back up to $1.00.
Further, any “maturity transformation” is pretty painless, as those who have cash now can buy shares, and those who want cash now can sell shares. There’s no angst about “fraud” from promising on-demand withdrawals while only holding fractional reserves.
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With no notion of first-come, first-served, a fund’s in no danger of a run; its shares simply drop in value when its assets drop in value. It’s comparatively stable, since no one has an incentive to make matters worse for other investors in order to save their own skin.
Isn’t a problem with that proposal that shares in a mutual is not what people with traditional deposits in a bank are looking for? What the latter want is to deposit $X and to be able to withdraw $X (possibly plus interest) at some future date. And that is a perfectly reasonable thing to want to do.
Strikes me that that desire or requirement can be met by trying to outlaw maturity transformation. It will never be possible to totally outlaw it. But murder and rape will never totally outlawed or prevented.
The problem is that a bank can’t promise to give everyone as much of their money as they want at any time along with interest from reinvesting those funds without creating the threat of a run on the bank. The problem goes away if either (a) the bank doesn’t reinvest the the funds and thus doesn’t offer interest, or (b) the bank doesn’t promise to give everyone as much of their money as they want at any time but instead allows them to sell their share of the reinvested funds. In reality, a bank would probably offer a bit of both: no-interest checking accounts with fees and money-market funds.
You are right: I think that having banks offer two types of account is the best solution. I can think of further arguments for this (which others have probably already thought of!).
1. I think everyone has a basic human right to an account where they can deposit $X and are guaranteed to get $X back. Sums so deposited cannot be invested because of the risks involved, thus such sums would effectively just be deposited at the central bank as reserves.
2. As soon as depositors want interest, they are trying to be commercial. The attitude of the state towards such people should be “OK, if you want to be commercial and try to earn interest, you’re on your own, just as you are on your own when trying to earn dividends from shares bought on the stock exchange. We, the state, make no guarantee you’ll get your money back.”
The latter “commercial” accounts COULD be similar to traditional deposit accounts: i.e. “we, the bank, are more or less promising you’ll get your money back with interest”. This might be OK if it is abundantly clear to depositors that there is no state guarantee. But the trouble is that banks would always try to hide the lack of state guarantee.
Thus the best solution is probably, 1, “no interest / state guaranteed accounts, and 2, mutuals. Nothing else allowed.