I am helping organise BarCampBankLondon on July 5th. We've got a lot of precipitants who are interested in using technology to reach "poor people". Including a very interesting "stealth" non-profit start-up...

We've had a lot of interest from UK banks. I think the industry here is starting to refocus from shuffling loans in and out of structured vehicles to doing more practical things :-)

Anon:

Your wish is me command, but I didn't have anything original enough to add to make a post of this... it is almost all summary.

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Central bankers are bright people. But when they speak, I'm often left with the impression of wonderful minds trapped, by position, by the weight of their words in financial markets, by a very human impulse to rationalize their role and past actions. In view of this, Richmond Fed president Jeffrey Lacker's speech last week was an unexpected delight. This week has seen a lot of Fed Kremlinology about Lacker's speech, about what it means that (gasp!) a Fed president said some things that might be interpreted as not entirely laudatory of Fed policy. Whatever. Lacker's remarks stand on their own as honest and thoughtful.

I'm late to this party, see, for example, Yves Smith, Scurvon, David Merkel, Barry Ritholtz, Michael Shedlock, and Justin Fox. Lacker's speech is not long. You should read the whole thing. Some highlights:

1. Lacker distinguishes between "nonfundamental" crises, self-fulfilling panics on sound institutions, and "fundamental" crises, creditors seek to withdraw funds because they have reason to believe that a bank will be unable to make good on all of its obligations. He suggests that while liquidity support may be appropriate for panics, government support in a "fundamental" crisis may be actively harmful.

2. Lacker points out that in the long run, the fragility of the banking system isn't due to housing prices or securitization, but due to the fact that the financial system by design promises more than it can deliver: Financial institutions fund long-term risky investments with short-term obligations represented as risk-free. (When a fiat-money central banker starts channeling moldbug, you know we are living in interesting times.)

3. Lacker's core insight is that this state of affairs is not "natural" or "necessary", but a function of the institutional environment we've established, largely by virtue of government guarantees. He suggests that absent promises of intervention, financial intermediaries and their customers would come up with contractual arrangements under which banks would restrict the customers' ability to redeem deposits en masse (presumably in exchange for higher interest payments). Fighting conventional wisdom, Lacker seems to think the fragility of "modern" banking systems isn't actually necessary, that people's appetite for risk would be sufficient to fund large-scale investment without having banks pretend that those investments are perfectly safe and liquid.

4. Lacker makes a subtle and profound point that "moral hazard" is less about the "due diligence" creditors might or might not perform than the contractual protections they might or might not demand. Lenders to nonfinancial firms insist on "covenants", contractual triggers that give lenders the right to withdraw funds or renogotiate higher rates if borrowers fail to meet certain safety requirements. Those contractual arrangements institutionalize market discipline. Investors needn't be expensively active about supervising borrowers affairs, because the covenants themselves are a technology of surveillance, an automated alarm system. When alarms are tripped, six-figure analysts must be deployed. But much of the time, the mere existence of the alarms is enough to encourage good behavior. With government guarantees in place for financial firms, there has been no incentive to develop contractual surveillance appropriate to bank borrowing. In theory, regulators offer protection, but in practice, that hasn't worked so well. Small depositors will probably always require a mix of guarantees and regulation (try attaching a covenant to your deposit of last week's paycheck). But without government guarantees, larger creditors might be as capable of imposing contractual surveillance as banks are clever at avoiding regulation. If policemen were perfect, no one would invent alarm systems. So long as bank creditors can assume that an infinite well of dollars at the Fed will be deployed on their behalf, why pay lawyers and bean counters to install financial motion sensors?

5. Lacker points out that, for market discipline to work, central bank threats to not cover losses must be credible. "If actions speak louder than words in the case of central bank credit policy as well, then the only credible way to limit expectations of future lending is to 'incur the risk of short-run disruptions in financial markets by disappointing expectations and by not lending as freely as before.'" In other words, as mean or Victorian or Austrian as it sounds, some creditors have to actually get hurt, and the Fed has to be sufficiently blasé about the consequences that market participants believe the Fed would let that happen again.

6. Lacker does not discuss the problem of institutions so large or crucial that threats of nonintervention could never be credible. Given recent history, that's a pretty big omission. Lacker doesn't suggest that we eliminate the present system of guarantees and regulation, only that we contain it by delineating its scope and never extending guarantees beyond stated boundaries. But that doesn't strike me as practical. Unregulated institutions would find ways of making themselves indispensable, and creditors would prefer tacit guarantees to the costs of imposing surveillance. Lacker's logic requires that regulation and guarantee automatically attach to scale and interconnectedness, and that regulation be draconian so that unregulated firms could compete for funds without the government subsidy. In other words, we would need to move to a "narrow banking" sector that takes on very little risk, and an unregulated sector whose members are prevented from getting big. That's a direction I like, but Lacker doesn't go there. He seems to suggest that we could draw sharper lines and then hang tough without imposing major structural changes. I don't buy that.

Overall, this was an excellent speech. Do read the original. And thank you, Jeffrey Lacker.