REVIEWS
“The Money Problem is a fresh and insightful analysis of how money and shadow banking are implicated in financial crises and what to do about it. Ricks is intellectually fearless and takes nothing for granted."
— Darrell Duffie, Stanford University
“Ricks offers an original and important contribution to the ongoing policy debate about how ‘shadow banks’ should be regulated so as to improve financial stability and reduce the risk of another catastrophic breakdown. He proposes a highly original solution that is breathtakingly simple—but also comprehensive and far-reaching. Writing with a lively and engaging style, Ricks presents its points so clearly that anyone, even readers not trained in finance, can understand the arguments. The Money Problem is one of those rare works that combines serious scholarship with a genuinely interesting proposal for fundamental reform, dealing with questions central to the welfare of all.”
— Geoffrey Miller, New York University School of Law
“Ricks has written a fascinating and challenging book that is broadly accessible yet anchored in a deep conceptual understanding of the economics of financial markets, money, and banking. He makes clear that the fundamental fragilities that drive financial crises are similar across episodes, even as the institutional specifics can vary widely. Whether or not you agree with his policy prescriptions, you will come away with a better understanding of the essence of the problem that financial regulation seeks to address.”
— Jeremy C. Stein, Harvard University
“The Money Problem is a terrific book packed with extremely interesting ideas about the foundation of banking and monetary institutions and how their regulation might be reconceptualized. Writing with a clear, direct, and accessible style, Ricks deftly navigates through the often complex terrain and offers an intriguing alternative to current approaches. The Money Problem is due significant attention from legal scholars, economists, and financial experts; it will reshape key discussions on financial regulation for years to come.”
— David A. Skeel, Jr., University of Pennsylvania Law School
"In his superb new book, The Money Problem, Ricks meticulously and persuasively argues that financial stability and money creation are two sides of the same coin. Understanding this relationship yields an immensely important policy payoff. By controlling and guaranteeing what counts as money, the government can solve the problem of financial panics, with all their untoward consequences. Ricks proposes several simple reforms to achieve this result. His proposal may seem radical, but he makes a compelling case that it is both feasible and desirable."
— Vanderbilt Law Review
"The Money Problem, by Morgan Ricks, of Vanderbilt Law School, contains another set of proposals that deserve attention. By emphasizing the ways in which legislative charter value can rein in on bankers’ appetite for risk, it takes the opposite tack from the emphasis on higher capital requirements that has occupied most of regulators’ and legislators’ attention until recently."
— Economic Principals
"The best book on finance in decades....clearly and sensibly written. It challenges a great deal of orthodoxy very straightforwardly. If you are not a financial regulation junkie, you may not want to tackle The Money Problem, but if you do, you will be rewarded by excellent analysis and clear writing."
— Martin Lowy, author of Debt Spiral: How Credit Failed Capitalism
"The essence of Ricks's intriguing plan is twofold. First, the government would guarantee all deposits, charging risk-based insurance premia. Second, only regulated banks would be allowed to offer liquid liabilities, defined as debt liabilities with maturity of less than a year. In this way, argues Ricks, government would regain control over money."
— Financial Times
"The Money Problem is in my opinion indispensable in understanding the current debates around financial reform, and is a must-read for anyone seriously interested in money and banking. This book is especially timely given the long-running argument this past year between Bernie Sanders and Hillary Clinton over how to move beyond Dodd-Frank in regulating the financial system. Ricks provides the concepts needed to resolve that and a number other live debates surrounding financial regulation and monetary policy."
— Joseph Lawler, economics reporter for the Washington Examiner
"Highly recommended."
— Choice
"The problem of runnable debt has solutions. One idea comes from Ricks, a former official in the Obama administration’s Treasury Department. In his new book, The Money Problem, Ricks argues that the government should drop the pretense that its insurance extends only to $250,000 worth of deposits. Ricks has an even more controversial solution for the risks that shadow banks pose. He proposes banning any financial institution that isn’t a bank from issuing runnable liabilities—in other words, he calls for the end of shadow banking....To put it mildly, this would be a big deal."
— Foreign Affairs
"The Money Problem is one of the best financial books of last decade or long. Policy makers should pay attention to Morgan Ricks."
— Bob Litan, author of What Should Banks Do?
"Ricks’s new book provides a fresh take on the crisis that sharpens our understanding of it. It does so by looking at the design of our monetary system and considering its implications for financial stability. This novel approach is useful not only for thinking about the prevention of future recessions, but also for better understanding what exactly money is."
— National Review
"A provocative new book. The Money Problem provides a beacon of light amid the morass of complexity that has come to plague financial institutions, financial markets, and efforts to regulate both."
— Harvard Law Review
"Explores how the fragility of the short-term funding markets affects financial-stability policy and how shadow banking functions as a problem of monetary-system design. Presents a blueprint for the modernization of the current monetary architecture. Discusses taking the money market seriously; money creation and market failure; banking in theory and reality; panics and the macroeconomy; a monetary thought experiment; the limits of risk constraints; public support and subsidized finance; the public–private partnership; a more detailed blueprint; and financial reform revisited."
— Journal of Economic Literature
"Ricks’s book is thematically rich, theoretically bold, and conceptually elaborate."
— Journal of Cultural Economy
TABLE OF CONTENTS
Preface
Introduction - Morgan Ricks
DOI: 10.7208/chicago/9780226330464.003.0001
[monetary system, money creation, shadow banking, financial stability]
The Introduction frames the problem of monetary system design and lays out the book’s central themes and arguments. The shadow banking system—basically, the system of private money creation—serves as an entry point. The chapter offers a brief overview of this system and the central role it played in the recent financial crisis. It then explains what it means to say that shadow banking is a monetary phenomenon. Armed with this recognition, we can see that asking “what should be done about shadow banking” is tantamount to asking “how should our monetary system be designed.” Next, the chapter sketches the book’s blueprint for a revamped system of money and banking. The approach would confine the issuance of monetary instruments (functionally defined) to a designated class of chartered entities, and it would make the money supply sovereign and nondefaultable. The chapter concludes that, before embarking on a vast array of costly and speculative interventions in the financial system, we might be well served by trying to get money right. It might then turn out that many of the supposed problems of finance are not as big as we thought. (pages 1 - 26)
This chapter is available at:
https://academic.oup.com/chica...
Part I. Instability
Chapter 1. Taking the Money Market Seriously - Morgan Ricks
DOI: 10.7208/chicago/9780226330464.003.0002
[medium of exchange, money market, cash equivalents, deposit]
This chapter documents the explosive growth of the market for cash equivalent instruments (the money market) during the two decades preceding the recent financial crisis. This growth went virtually unnoticed in both academic and policy circles. The chapter then reviews the various legal, accounting, financial, and economic contexts in which cash equivalents are treated “as if” they were checkable deposits, even though cash equivalents do not generally function as a medium of exchange. Within economics, there is a notable cognitive dissonance in this area: one sees a conceptual tendency to group cash equivalents with ordinary bonds rather than with acknowledged forms of money like checkable deposits. With this discussion as a backdrop, the chapter investigates what it means to say that cash equivalents are money-like, whereas other financial instruments—like longer-term bonds, or shares in equity mutual funds—are not. There is a remarkable lack of any clear account on this score in the existing literature. This analysis provides an important foundation for the book’s institutional design. In particular, the analysis suggests that the legal category “deposit” is formalistic and obsolete. Our current system of money and banking does not take the money market seriously as a legal-institutional matter. (pages 29 - 51)
This chapter is available at:
https://academic.oup.com/chica...
Chapter 2. Money Creation and Market Failure - Morgan Ricks
DOI: 10.7208/chicago/9780226330464.003.0003
[banking, shadow banking, money creation, fractional-reserve banking, John Maynard Keynes, coordination problem, bank runs]
This chapter examines the issuers of monetary instruments. The goal here is to shed light on the business model of money creation, which for our purposes is synonymous with “banking” (or shadow banking, as the case may be). The chapter begins with a stylized account of the emergence of this business model. The account departs from the conventional textbook story in important ways. In particular, rather than depicting fractional-reserve banks as institutions that “take funds” from depositors and then “lend them out,” the account depicts banks more realistically as issuers of monetary instruments. (In this respect, John Maynard Keynes was an important precursor; it turns out that his insights on banking have not been absorbed by the mainstream academic literature.) The chapter then illustrates the instability of the banking business model through a simple (and novel) game-theoretic analysis. It argues that existing “toy game” accounts of banking and bank runs have chosen the wrong toy game—and that, from a conceptual standpoint, this mistake matters. The chapter concludes that it is doubtful that there is a market solution to the coordination problem that is inherent in the banking business model. (pages 52 - 77)
This chapter is available at:
https://academic.oup.com/chica...
Chapter 3. Banking in Theory and Reality - Morgan Ricks
DOI: 10.7208/chicago/9780226330464.003.0004
[Diamond-Dybvig model, shadow banking, bank runs, banking panics]
This chapter reviews the modern theoretical literature on banking and bank runs. In particular, it examines the three leading modern theories of banking in the academic literature, and it identifies problems with each of them. One of these theories, sometimes called the “risk sharing” theory, receives special attention because it forms the basis for the canonical model of bank runs: the famous Diamond-Dybvig model. The chapter offers a critique of this model on the basis of its underlying theory of banking, which is essentially nonmonetary. Next, the chapter argues that financing structure “matters” for banks in a way that it does not for other firms—a proposition that has recently been challenged by prominent financial economists. The chapter concludes with a fairly detailed account of the shadow banking panics of 2007 and 2008. It shows how the analysis of the first three chapters provides a framework for understanding these events. (pages 78 - 101)
This chapter is available at:
https://academic.oup.com/chica...
Chapter 4. Panics and the Macroeconomy - Morgan Ricks
DOI: 10.7208/chicago/9780226330464.003.0005
[panics, short-term debt, financial crisis, Great Recession, bubbles, financial crises, systemic risk]
This chapter argues that panics—widespread redemptions of short-term debt—should be viewed as the central problem for financial stability policy. This is not a novel argument, but it is a surprisingly controversial one. It is common today to see panics as mere symptoms or manifestations of other, purportedly more “fundamental” problems: “debt-fueled bubbles,” “overleverage,” “excessive risk-taking,” and so on. The chapter makes the case that these other phenomena are unlikely to pose a grave threat to the broader economy in the absence of a panic. The chapter adduces evidence from the recent financial crisis and the Great Recession, and from previous historical episodes, in support of this position. The chapter focuses on a particular mechanism through which panics damage the broader economy—the “panic-induced financing crunch”—and it suggests that financial market anomalies during the recent crisis provide dramatic evidence that this mechanism was at work. The chapter concludes that panic-proofing, as opposed to, say, debt-fueled bubble prevention or “systemic risk” mitigation, should be the main objective of financial stability policy. (pages 102 - 142)
This chapter is available at:
https://academic.oup.com/chica...
Part II. Design Alternatives
Chapter 5. A Monetary Thought Experiment - Morgan Ricks
DOI: 10.7208/chicago/9780226330464.003.0006
[payment system, seigniorage, administrative independence, banking regulation]
This chapter tables the problem of banking instability in order to examine what may at first appear to be an unrelated topic. Specifically, the chapter investigates the key practical challenges of monetary institution-building, from the state’s perspective. It proceeds by way of a simple thought experiment. Suppose that a hypothetical government wanted to establish a (fiat) monetary system from the ground up. How might it go about this task? An initial practical decision concerns the channel of distribution. The chapter describes why the state might choose to “lend” money into circulation rather than “spending” it into circulation. It then discusses the advantages of outsourcing certain core functions to private specialists through a “public-private partnership” framework. The chapter also touches on other key structural topics, including payment system mechanics, seigniorage revenues, and the administrative independence of the monetary authority. While the analysis of this chapter is quite intuitive, it is entirely novel: one will search the existing literature in vain for a straightforward account of these basic design considerations. The chapter ends with a brief review of the history of U.S. banking regulation, which sets the stage for the chapters that follow. (pages 145 - 163)
This chapter is available at:
https://academic.oup.com/chica...
Chapter 6. The Limits of Risk Constraints - Morgan Ricks
DOI: 10.7208/chicago/9780226330464.003.0007
[portfolio constraints, capital requirements, narrow banking, 100% reserve banking, mutual fund banking]
This chapter evaluates the usage of regulatory risk constraints as an antidote to banking panics. In particular, it considers two forms of substantive risk constraint that are widely used in financial regulation: portfolio constraints and capital requirements. It finds that these techniques, standing alone, do not provide a satisfactory answer to the panic problem. The chapter demonstrates that, at some level of stringency, such risk constraints will compromise the banking system’s ability to assist the state in achieving its monetary objectives. Furthermore, there can be no assurance that any set of risk constraints that is compatible with the state’s monetary objectives will succeed in stabilizing banking. This analysis forms the basis for a critique of various “narrow banking” proposals, which continue to claim very prominent adherents in the economics profession. The chapter also finds problems with recent proposals to impose extremely high capital requirements on banking firms. Finally, the chapter identifies serious shortcomings in laissez-faire approaches to banking, including so-called “mutual fund banking” proposals. (pages 164 - 183)
This chapter is available at:
https://academic.oup.com/chica...
Chapter 7. Public Support and Subsidized Finance - Morgan Ricks
DOI: 10.7208/chicago/9780226330464.003.0008
[lender of last resort, too big to fail, subsidies, debt, leverage, moral hazard, bubbles]
The lender of last resort (LOLR) is widely viewed to be a sound and adequate response to the panic problem, at least if used judiciously. This chapter aims to challenge this widespread view. There are three problems. First, the very existence of the LOLR gives rise to a wealth transfer from the public to potential LOLR beneficiaries. This subsidy is independent of any “too big to fail” (TBTF) policy, although TBTF is certainly an aggravating factor. Second, the LOLR presents an unavoidable tradeoff: to the extent that it is effective in arresting panics, the LOLR generates bad incentives (i.e., moral hazard) for financial firms. Third, those bad incentives can reasonably be expected to introduce distortions—such as excessive leverage (debt) and asset price bubbles—into the financial system and the broader economy. The chapter concludes by describing a little-noticed 1991 change in U.S. law that removed any ambiguity that LOLR support would be available to securities firms and other nonbanks. It is perhaps no coincidence that, at roughly the same time, the shadow banking system began a period of very rapid growth. (pages 184 - 199)
This chapter is available at:
https://academic.oup.com/chica...
Chapter 8. The Public-Private Partnership - Morgan Ricks
DOI: 10.7208/chicago/9780226330464.003.0009
[public-private partnership, market discipline, deposit insurance]
This chapter examines a public-private partnership (PPP) approach to money creation. Under this design, all monetary instruments are sovereign and default-free, and the state charges the banking system ongoing fees in return for its unconditional commitment to honor their monetary liabilities. The chapter shows that such a system does not compromise the state’s ability to accomplish its monetary objectives. In addition, unlike the alternative approaches from the previous two chapters, the PPP system has no private money and therefore is not susceptible to panics. The chapter analyzes the incentive problems that arise under such a system, and it suggests that a well-structured PPP system should mimic standard features of private financial arrangements. It argues that the PPP system compares favorably to the realistic alternatives, and that the desire for money-claimants to impose “market discipline” on banking firms is misguided. The chapter concludes with an analysis of the U.S. deposit insurance system, which can be understood as a rough form of PPP system. It makes the case that, despite some notable missteps, that system has been a remarkable policy success. (pages 200 - 220)
This chapter is available at:
https://academic.oup.com/chica...
Part III. Money and Sovereignty
Chapter 9. A More Detailed Blueprint - Morgan Ricks
DOI: 10.7208/chicago/9780226330464.003.0010
[private money, wholesale funding, Wall Street, regulatory arbitrage, Basel Accord]
This chapter returns to the institutional blueprint that was described in the Introduction, which represents a particular form of the more generic PPP system from chapter 8. Much of the chapter is concerned with the regulatory challenge of confining money-creation to the licensed banking system. In practice, this would mean establishing and enforcing a generalized prohibition on the issuance of cash equivalents (private money) by nonbanks, subject to de minimis exceptions. This is less radical than it sounds: we already prohibit “deposit” funding in the absence of a special charter. Many financial firms that currently rely heavily on short-term “wholesale” funding, such as the major Wall Street firms, would be precluded from doing so under the proposed design. The problem of “regulatory arbitrage” is discussed in some detail. The chapter then discusses the international dimensions of the institutional design. Ideally, the reformed system would be accompanied by a modification to the Basel Accord (the central international accord on financial regulation). Essentially, the modification would recognize the issuance of monetary instruments as a sovereign prerogative. (pages 223 - 247)
This chapter is available at:
https://academic.oup.com/chica...
Chapter 10. Financial Reform Revisited - Morgan Ricks
DOI: 10.7208/chicago/9780226330464.003.0011
[Dodd-Frank Act, macroprudential regulation, systemic risk, resolution, financial institutions]
Prior to the recent financial crisis, the U.S. monetary system was characterized by the absence of legal restrictions on the issuance of private money (cash equivalents), coupled with an implicit commitment by the state to honor these instruments. This dubious structure remains basically unchanged. Rather than addressing the deep structural defects in the existing monetary framework, we have opted (through the Dodd-Frank Act and other reforms) for a staggeringly complex and hypertechnical regulatory overlay. This chapter provides an overview of the key components of these reforms, with a particular focus on so-called “macroprudential” or “systemic risk” regulation and on the development of special “resolution” tools for complex financial institutions. The chapter argues that these reforms’ prospects for success are doubtful: the system that has emerged is unworkable. The chapter suggests that a thoughtful revamp of the monetary framework could largely obviate the need for other forms of financial stability regulation. It concludes with some final thoughts on the legal engineering of monetary institutions. (pages 248 - 264)
This chapter is available at:
https://academic.oup.com/chica...
Notes
References
Index
