Unanimously Agreeable Safe Central Banking

Sankarshan Acharya
Founder, Pro-Prosperity.Com and Citizens for Development

February 2, 2016

This is built on a memo on "Unanimous Agreeability of Safe Central Banking Policy" sent to President Barack Obama and presidential candidate Donald J. Trump on February 2, 2016.

Problem of Moral Hazard due to Privileged Information and Access to Cheap Funds 

The crux of moral hazard problem that bedevils the US economy is private custody of publicly insured deposits at too-big-to-fail (TBTF) banks run by too-big-to-be-jailed (TBTJ) bankers, as found in a research paper on efficient resolution of moral hazard mimeographed at the Board of Governors of the Federal Reserve System, Washington, D.C. 

The TBTF-TBTJ mega banks are structured as bank holding companies with banking, market making and trading subsidiaries. They have government-granted authority for market making and clearing.  They are protected against insolvency by the Federal Reserve Act of 1913 which stipulates that the Federal Reserve is bound to create money only for them, preemptively, before they ever turn bankrupt.  The mega banks are thus privileged with no risk for their closure and tacit protection of their executives against lawsuits.

The Federal Reserve Act, FDIC and SEC Acts (created as part of the Glass-Steagall Act), and similar recently enacted laws like the Housing Economic Recovery Act of 2008 and Dodd-Frank Act of 2010 are fundamentally unfair (unconstitutional). They are primary source of (a) economic instability leading to depression and social unrest and (b) economic inefficiency resulting in decay in national competitiveness. This has been proved in a paper published in the Journal of Financial Transformation which claims to have 18 Nobel Laureates as authors and in an unpublished paper on coalitions of borrowers and lenders which the elite journals do not want to even review (returning my journal submission fee). That these papers are based on general equilibrium models with no implicit or explicit bias or unfairness or dogma or philosophy - as opposed to dogma-ridden unfair models in the elite literature on economics and finance that support/rationalize the unconstitutional acts (which define the established system of governance of the economy) is presented in a compendium entitled constitutional capitalism

The unanimously agreeable rules of goverance - that have stemmed in general equilibrium within an unbiased, fair and dogmaless mathematical microeconomic model of the economy - comprise a unique alternative system of governance which is fundamentally fair (constitutional), efficient and stable. This unique alternative is antithetic to the established system. It can be construed to shape an antithetic philosophy. But it is a philosophy that attains in general equilibrium of the economy, not an apriori philosophy imposed on the economy.

Under the currently established system, the mega banks have access to valuable real-time information at their MM subsidiaries from orders flowing from all unprivileged buyers and sellers of securities that are required by law to be executed and cleared by the clearing house which is under the purview of these banks. The mega banks also have access to cheap bank deposits under their custody and to cheap Fed funds.  Mega banks effectively sway the Fed to decide the price of money. The mega banks can thus use valuable order flow information garnered from their MM subsidiaries and cheap funds at their disposal from their banking subsidiaries to bet against the unprivileged public.  This system ensures that the unprivileged public is guaranteed to lose to the privileged few mega banks, all the time. 

The problem is due to the established laws foisted on the unprivileged public by their own elected representatives.  The elected representatives and their kith, kin and cronies get richer due to political contributions and swelling private hedge funds managed by the mega banks.  This is a system of moral hazard which is fundamentally unfair (unconstitutional), unstable and inefficient. 

Efficient Resolution of Moral Hazard with Safe Central Banking Policy

A comprehensive mathematical model of the economy based on microeconomic behavior of net-worth maximizing leveraged households and firms and with a cost minimizing not-for-profit government and with a market fairly valuing securities shows in general equilibrium that the moral problem is efficiently resolved:

  • With safe central banking-which gives an option to every firm or household to keep a part of their savings that they want to be held absolutely safely in a central bank account.
  • Without federal guarantee of bank deposits; there is no panic due to sunspot because individuals and firms can choose to hold as much of their savings as they want absolutely safely in their central bank account. The extant literature rationalizes federal guarantee of bank deposits with a dogmatic presumption that some sunspot (if not god) driven illiquidity causes panic. There is no chance for illiquidity in a free market system. For example, the insolvent mega banks could have been auctioned in 2008 and unprivileged investors could have bought pieces of these mega banks at clearing prices determined by supply and demand for risky assets. Instead, the privileged bankrupt banks used their agents running the government to loot the assets from the unprivileged and also print unseemly sums of money on the back of the unprivileged for the mega banks. This caused the great recession (financial catastrophe of 2008), which was worse than the Great Depression according to the Fed. The same experts that caused the 2008 catastrophe advised the next administration to borrow $10 trillion of new money in addition to the Fed printing $4.5 trillion out of thin air. Where has this 'new wealth' gone? It has gone to government 'I owe you's, backed by declining tax revenues and trade deficits, oil pits, foreclosed home inventories and subsidies to the impoverished. About 94 millions people still looking for jobs, whereas just 62 persons have more wealth than the bottom half and the top 1% have more wealth than the rest.
  • Without government-imposed or government-monitored minimum capital standards for banks. 

The safe central banking policy is proved as economically stable and efficient and as fundamentally fair.  This equilibrium model was mimeographed in 1991 at the Board of Governors of the Federal Reserve System, Washington, D.C. 

Unanimous Agreeability of Safe Central Banking Policy

  • Everyone (rich and poor) prefers to have a part of their savings absolutely safely and invest the rest in risky assets. The exact ratio depends on an individual's risk preference. But the idea of allocation of savings between absolutely safe assets and risky assets is unanimously agreeable.
  • The issue is who can keep the absolutely safe portion of individuals' or enterprises' savings? Currently, banks keep a part of their savings at the Central Bank (Fed) in capital reserve accounts. But non-banks (individuals and non-banking enterprises) are not permitted to do so. This was the cause of the Great Recession of 2008 which became worse than the Great Depression according to Federal Reserve.  Since 1991 I saw this serious problem in a comprehensive mathematical model of the economy mimeographed at the Fed. This paper was blocked without satisfactory explanations by referees or editors of elite jouenals where it was submitted for publication. After I knew for sure that the blockage of a profoundly important seminal research paper was deliberate and designed to serve the vested interests, I translated my math into plain English and sent a memo with a paper published elsewhere to all members of the US Senate on March 31, 2003 with a proposal for safe central banking facility for all (banks and non-banks) to preempt a looming crisis that I saw coming. The US Congress held testimonies of top Fed officials and urged for a conference of experts to which I was invited in November 2003. I did not go to the Fed conference but requested the conference organizers to circulate my safe central banking paper.
  • The 2008 financial catastrophe was primarily because of lack of safe central banking facility for non-banks: The Fed had to guarantee $3.5 trillion of previously uninsured money market funds and $7.8 trillion of previously uninsured bank debt to prevent a run on these funds and to avert the domino of crashing market in 2008. The Fed did in 2008 what I had proposed since 1991. Now, large investors and firms do not trust banks for absolute safety of their savings. They have been buying Treasury securities.  The economy has almost gravitated towards safe central banking without any formal (law-based) government structural support.  There is still no formal government guarantee of bank debt and deposits above $250000.
  • If what is happening after the 2008 crisis (the equilibrium/stable solution that I had proposed since 1991) is formalized as safe central banking available to every household and banking and non-banking enterprises, mega banks will no longer be able to blackmail the Congress for the custody of absolutely safe deposits and for having used and lost the deposits on bets against everyone with a view to privatizing profits and socializing losses.  For example, mega banks bet against stock holdings of the unprivileged investors in 1990-2000.  Many investors salvaged their financial investments to buy real estates.  Mega banks then bet against mortgage industry, foreclosed on homes and made home owners renters.  Mega banks lost heavily as a result.  They had to be rescued in 2008.  The mega banks have then used cheap deposits and Fed funds to bet on oil (which is a bet against the unprivileged that has been financially eviscerated).
  • Once safe central banking facility is extended to everyone, banks will compete for deposits from non-banks and the latter will trust only those banks that have sufficient capital (money of bankers) to hold their deposits without federal insurance by paying higher interest as a result. This will make the banks highly capitalized to compete for uninsured deposits. This will also let the banks that cannot muster sufficient capital perish.
  • The safe central banking policy is unanimously agreeable. By this I mean no one can publicly argue against it. The TBTF-TBTJ banks, currently enjoying enormous benefits by blackmailing non-banks and Congress, may privately grumble about safe central banking, but they have to realize publicly that their established current system of moral-hazard robbery has decimated the enterprising individuals comprising the economy. The economy is at the cusp of a socialist takeover, which would take away not only everything the TBTF-TBTJ bankers (robber barons) do not want to lose, but also of the assets of enterprising individuals to feed the inefficient through subsidies and doles - making the economy perpetually non-competitive. This prospect should make the TBTF-TBTJ bankers and everyone (rich and poor) agree to my safe central banking policy proposal.
  • Notwithstanding Iowa results, someone like Mr. Donald Trump with a volition to make the country great again, can articulate the issue of moral hazard to people directly to win the general election. Due to my research, the Republican party has its platform/manifesto amended after 2008 by explicitly stating for elimination of moral hazard in banking and finance.