Misreading the Great Recession and Applying the Wrong Fix

Most economists differ not on the causes of the Great Recession, but on their relative importance. They agree, however, that the core problem is human, not market failure. Their widely held assessment helps explain why the Dodd-Frank banking “reform” says so much and does so little. This study re-tries the usual suspects and finds none guilty. Instead, it points to multiple equilibria in banking and the overall economy. Whether it is Cooke and Company in 1873 or Lehman Brothers in 2008, leverage and opacity are the wicked brew that stokes bank runs. And bank runs prompt employer runs – laying off your employees (other firms’ customers) for fear that others are laying off their employees (your customers). The answer is fundamental, not cosmetic banking reform that fixes banking and the economy for good. The answer is replacing leveraged, trust-me banking with fully transparent, 100 percent equity-financed mutual fund banking. This reform, called Limited Purpose Banking, handles all aspects of finance, including lending, risk allocation and the payment system. It would permanently end the leveraging of taxpayers by banks and bring a permanent end to financial crises.