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The Actuary The magazine of the Institute & Faculty of Actuaries

’Jimmy Stewart is dead’ by Laurence Kotlikoff

The title is a reference to the classic film It’s a Wonderful Life where the hero/manager of a small town bank, played by James Stewart, is faced with a run during the Great Depression. He persuades his depositors that although the bank cannot honour their deposits due to lending to other parties, these people are decent folk whom he knows personally and who he insists will pay them back as long as no-one panics and tries to withdraw their money at the same time.

Professor Kotlikoff argues that such bank managers are no more, yet banks are regulated as if Mr Stewart was still in charge. Instead, a huge amount of power is wielded by people such as Dick Fulds and Jimmy Cayne, who are not qualified to understand their banks’ operations, and are (according to Kotlikoff) sharks. His point is that these scoundrels have been gambling in a ‘heads they win, tails the taxpayer loses’ manner. His second point is that there are no firewalls — if one bank goes down, the whole lot go down.

His solution is limited purpose banking (LPB), where all financial institutions — banks, hedge funds, insurance companies — are turned into mutual funds, regulated by one super-regulator, the Federal Financial Authority (FFA), whose only Herculean task is to independently rate all assets. For example, if you want a mortgage, you go to an intermediary who arranges it for you. Your rating is then assessed by the FFA and your mortgage is auctioned off to a mutual fund. This fund is managed by an ex-bank but sold off to third parties. An investor has the choice of an almost infinite array of funds, but the point of the exercise is that it’s all transparent so you know exactly what you are investing, the bank assumes no risk at all, it acts purely as administrator and, while an individual fund can go bust, there is no contagion.

Kotlikoff argues that such a radical solution is needed. Will LPB work? Kotlikoff doesn’t give us enough to go on. While he goes through a lot of possible objections, for me he misses the big ones.

Banks borrow short and lend long. They don’t do this out of some perversity, but because people want instant access to their money and want to pay back their mortgages over a longer period of time. However, some people will want to borrow long but they will only be a small fraction of the monies lent out by banks, so LPB would effectively abolish banks and credit would dry up almost totally. With mutual funds, you get herd-like behaviour following indexes or fashion. LPB would turn the entire financial system into a mega-herd that would rush into and out of economies and sectors, acting as a giant wrecking ball.

Another problem would be the transition. Over recent years debt and money supply have increased exponentially, leading to most of our common troubles. Martin Wolf argues that the economy has become like a single commodity — the commodity being financial services. LPB would indeed rebalance our economy.

However, because our economy relies so heavily on the sector, the transition would be unimaginably painful. Unfortunately, Kotlikoff chose not to address this — instead detailing how Jimmy Cayne was playing bridge while his company Bear Stearns folded. Shocking and wryly amusing but a wasted opportunity.


Nick Silver is a director of Callund Consulting Limited


Jimmy Stewart is dead: Ending the world’s ongoing financial plague is published by John Wiley & Sons. RRP £18.99