Ronnie Phillips, professor of economics at Colorado State, wrote one of the most important books on the debt-free money bookshelf, The Chicago Plan and New Deal banking Reform (1995, M.E. Sharpe Inc.)
Ronnie had a recent op-ed in The American Banker (May 15, 2009) called Some Old Ideas for Oversight may Work Today in which he discusses narrow banking and 100% Reserve Banking, as well as the Chicago Plan. Copyright protection prevents us publishing the whole article here, and you need to subscribe to see it at the American Banker, but Professor Phillips has given us permission to print an excerpt here. This is how it starts:
“Since the 1930s, the nation has relied on Federal Deposit Insurance Corp. member banks to provide a safe and convenient payments system, while also channeling funds from savers to borrowers. As we have recently witnessed, this mixture of deposit and credit functions has created an unstable and risky banking structure supported by an extensive federal safety net.
The recent taxpayer bailouts of the financial system indicate some of the weaknesses in this safety net.
Would separating the deposit and lending functions give us a better financial system?
During the savings and loan debacle in the 1980s, Robert Litan of the Brookings Institution put forward a proposal that he labeled “narrow banking” as a solution to the “moral hazard” problem in banking. Litan proposed to create “monetary service companies” — institutions that would serve strictly a payments function and would hold only safe assets such as cash, government securities and high-grade commercial paper.”
From there he goes on to discuss The Chicago Plan. The following is a previously unpublished article in which Mr. Phillips covers much of the same territory:
The Chicago Plan for Banking Reform
Advocates of a return to New Deal-style banking regulation forget, or never knew, that there was a conceptually more elegant alternative proposal for reform put forward by prominent economists in the 1930s. Supporters of the proposal included Henry Simons, Lloyd Mints, and Frank Knight from the University of Chicago, Irving Fisher of Yale, and Lauchlin Currie, a Harvard-trained economist who was a special assistant to FDR. This proposal was variously known as 100% reserves or the Chicago Plan for banking reform. The National Banking Act backed national bank notes with federal government securities and the Chicago proposal advocated the extension of this principle to demand deposits. Alex Pollock of AEI, and a former banker, calls this principle “collateralized money.”
Had demand deposit banks been so restricted in the 1930s, it would have made federal deposit insurance redundant and too-big-to-fail would be a non-issue today. If the legislation of Senator Bronson Cutting of New Mexico had won out during the Congressional debates of 1934, there would have been no need for extensive financial regulation of banks. The enormous growth of regulation of the banking system in the years after the establishment of federal deposit insurance is evidence that the Chicago economists’ fears about the growth of government were warranted.
The supporters of this proposal believed that it would reconcile the divergence of private and public interests in a manner consistent with the problems of centralization of economic and political power. These proponents based their views on Article I, section 8 of the Constitution which granted to Congress the “power to coin money and protect the value thereof.” The Chicago view presumed that the existing institutional structure was neither efficient nor stable. Their overall vision was of a financial system with deposit banks serving essentially a warehouse function as trustees, small mutual savings associations for lending, and a centralized monetary authority subject to definitive rules to guide monetary policy.
During the savings and loan debacle in the 1980s, Robert Litan of the Brookings Institution put forward a kindred proposal which he labeled “narrow banking” as a solution to the “moral hazard” problem of banking. Litan proposed to create “monetary service companies” — institutions would serve strictly a payments function and would hold only safe assets such as cash, government securities, and high-grade commercial paper. Nobel prize winning economists Milton Friedman, James Tobin and Maurice Allais all supported a version of narrow banking. Tobin proposed the creation of “deposited currency,” which would combine the convenience of a checking account with the safety of currency. Also during the 1980s, L. William Seidman, then head of the Federal Deposit Insurance Corporation, proposed what he termed “two-window banking.” A two-window banking firm would allow savers to choose between “insured” and “uninsured” windows in which to deposit their funds. At a recent conference of the Levy Economics Institute, distinguished financial author Martin Mayer spoke in favor of a form of narrow banking. The 1930s proponents of the Chicago Plan concluded that Americans do not need banks to serve both depository and lending functions. As we have recently witnessed, this mixture of deposit and credit functions has provided an unstable and risky banking structure which is supported through deposit insurance and an extensive Federal safety net. The recent taxpayer bailouts of the financial system indicate some of the weaknesses in this safety net.
Shortly after the passage of the Banking Act of 1933, which created temporary deposit insurance and separated commercial and investment banking, Adolf Berle, an original member of Roosevelt’s “Brain Trust,” told the New York State Bankers Association that the Act was a “transitory phase.” What should be done, Berle argued, was to separate banking functions: savings banks for long-term securities, personal checking accounts that are convenience deposits for money, mercantile banking that receives deposits from merchants, Banques d’affaires that receive deposits but handle securities and lend on nonliquid collateral, and the trust business, both corporate and personal. Berle thought these functions should be kept separate and distinct at all times. Hy Minsky, whose life-long work on financial instability is now being rediscovered in light of the current financial crisis, and who was a student of Henry Simons, wrote in 1994 that an understanding of the ideas behind 100% reserve banking would provide “a guide to creating a reformed financial system that is consistent with a full utilization of resources and which provides for the broad based economic well-being that is a prerequisite for a strong and viable democracy.”
Ronnie J. Phillips
Colorado State University
rphillipcsu@aol.com