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I engage people of all stripes on Facebook, and I press them when they make political statements I don't like.  One source of sustained pressure for me of late has been Ron Paul's views on banking.  "Just read the website!" his faithful say, as though I don't know what Ron Paul might be saying.  I was a vice president at a commercial bank earlier in life, and I have been watching Ron Paul and people like him for years.  If you want to send America from slump to stone age, follow Ron Paul--that's my opinion.  But even before one gets to his or her own opinion on banking, they need to know what a banker exactly is.  People who think they have credible ideas on how banking should be nonetheless seem to fold when simply asked what a banker does.  How can this be? How can it be that people imagine they know that something is right for banking, when they don't even know what bankers do?

Banking is more complicated than right wing bumper sticker sloganeering. The word "banker" itself is widely misunderstood--someone who works at a shadow bank in the public eye's is just as much a "banker" as someone who works at a commercial bank as is someone who sits on the Fed. They're almost as different in fact, as paper airplanes from 747s from the Space Shuttle.

A banker at a shadow bank, like Long Term Capital Management, is simply a veritable cowboy, a kind of nomad existing nearly completely outside of government regulation.  Of all the wikipedia pages to digest, this one is likely one of the most complicated and remote of all for ordinary readers.  But mostly, shadow bankers pull financial instruments (which bankers call "products") out of thin air and sell their products to ultrarich investors and institutions who are anxious to make money on the quick and without doing much work.

These bankers are, generally, trouble.  In the late 1990s, their whole appeal to investors was the fact that they didn't have audited balance sheets.  I remember seminars with named like "Off-balance sheet ways to manage risk."  Think about that. One financial institution in a position to offer "risk management" to another, off its balance sheet--which is, ordinarily, all about risk management.  If you were a financial institution, you might like to invest in one of these products, because they won't appear on your balance sheets and they apparently make money anyway.  But maybe not--there were a lot of bankers in the late 1990's who didn't know what they were doing, and they were usually young, and they were looked at by senior bankers as somebody young and bright and who might know better what a derivative was than the senior banker.  But they didn't really know either.  All they knew was that they would be pleasing their bosses by getting involved with these products, and even acquiring a few.

Now, the thing is, if we deregulate even more, we'll produce more of these kinds of bankers, not less.  These kinds of bankers were among the bankers at the heart of the recent financial meltdown, and if we deregulate more, we'll have more of these people.  But never mind that, let's talk about commercial bankers.

Commercial bankers sit on two sides, or should I say two floors, of a bank.  On one floor are the bankers who handle corporate and business (and government) deposits.  These are largely relationship managers, and if something bad happens to a corporation's deposits in the course of business, these guys and gals can fix it.  These are the bricklayers of the corporate financial world.  They can get you the exotic product you might need, a banker's acceptance, a wire transfer for $100 million to buy a satellite (interest on $100 million is about $21,000 a day, by the way), any cash management tool a corporate treasurer needs to conduct business.  These people are largely responsible, somewhat profitable to the bank, and compete for accounts with others of their kind.  These people so little resemble the bankers at shadow banks or even investment banks that they might as well be on another planet.

On the other floors of a commercial bank are lenders.  Commercial lending also is, at bottom, a relationship management business--but commercial lenders are by far and away the wariest bankers of all.  At the end of the day (and commercial bankers are fond of saying "at the end of the day" more than just about any other stock phrase) and they will engage in long, long, LONG discussions with businesses about how their businesses might work if only the bank gave them all this money.  Despite what anybody may claim, there is no formula for this.  Credit/bond ratings are helpful and cash flow is of course important, but at the end of the day--there's that phrase again--the commercial banker on the lending side has to answer to her boss, and seals whatever deal is made based on intuition and heart.  This person before you is as good as gold, that one is not.  Look around your city--it is not the vision of the best architects or even the best developers.  It is mostly the vision of the people who could make the best case to bankers that they would get paid back.  What gets built, what gets done in a city is the result, nine times out of ten, of a commercial banker being willing to loan a project money.

The top commercial bankers at the top commercial banks have access to something called the "Fed window"--they can borrow money from other banks overnight to do what they feel they need to do.  Imagine a banking environment where, say, the cowboys at the shadow banks had access to this same kind of window! It would fall apart in nanoseconds.  But when Ron Paul talks about abolishing the Fed, he necessarily talks about abolishing the Fed window, and that would put commercial banks on the same playing field as...shadow banks and investment banks.  The need for short-term money wouldn't go away, but the whole way money was lent to businesses would change.  Anybody could lend money to anybody for any reason.  We'd have a whole new class of commercial lenders, and sharking in on the new "windows"--wherever they emerged--would be these other kinds of bankers too--not only the extremely wary commercial lenders but shadow bankers and other quick-buck artists.  Certainly the quality of what kind of projects got money would diminish; certainly there would be even more failure.  As it is, 7 of every 10 startup businesses fail within three years, and every banker knows that.  But commercial loans have to succeed at minimum 7 out of 10 times for banks to stay solvent.  If the failure rate goes higher, even more banks will fail.

Of course, the bankers at the Fed are a different breed of banker too.  These are people who first and foremost, believe it or not, puzzle over the nation's money supply.  They may make important noise about interest rates, but that noise is, quite frankly, eminently predictable.  What is not predictable is where the nation's money supply is going, and when the Fed publishes out of St. Louis the stats on money supply for the week, that's the document that every top banker wants to read, never mind the interest rates, which they already knew.

The fact that we have people who puzzle about what an appropriate money supply level (I'll not get into the variety of money-supply measurements here, but it's a good read too) at all is largely a boon to our economy.  In nearly all other countries, one bank, a central bank, controls the money supply.  In America, we don't have a single bank doing this, we have a dialog among top banks, and that dialog is the Federal Reserve.  In America, we also have big investment banks that sometimes get out of line in their "irrational exuberance" for selling stocks.  The fact that we don't have one national bank but several private ones is already halfway to a cowboy arrangement, but only halfway.  The Fed, by and large, is composed of sober, responsible bankers who sometimes work to check irrational exuberance.  Without them, you either have paralysis--instant death--or exuberance--slow death.  It's a system that's fairly unique to America but it's got some pluses and minuses, and indeed the upside is the whole key to American vitality and the creation of cowboy bankers in the first place.

I say that because the people at the investment banks don't have much to do with the Fed.  These people make their money by underwriting--enabling companies to issue stocks and thereby succeed or fail in attracting other investors.  That's not precisely the same thing as lending; it is more of a hit record economy.  But the investment banks are also always eager to get into the same kinds of businesses that the shadow banks are in, and that's where they get in trouble.  And when a consortium of largely commercial bankers get together, they can set policy that makes the cowboy bankers more manageable when they're getting out of line.

Our banking system, in truth, is already closer to a "free market" system than just about any other country's, save, say, Somalia's, where banking barely exists at all.  Eliminate the Fed and we'll eliminate all checks and balances on the people who put us where we are now: investment banks and shadow banks.  Everyone in banking mostly knows this, and even accepts it, but the incoming Chair of the House Subcommittee on Domestic Monetary Policy does not.

The Constitution is generally beloved to the Paulists.  Let's look at that for a minute.  The Constitution always mentions "regulation" and never "deregulation."  The Constitution originally even provided for a central bank.

When you read the preamble, look at the verbs: "establish" "provide" "ensure" "promote" "secure"--it's the language of regulation, identical to the verbs you find in an insurance policy or a banker's disclosure language, in fact.  Alexander Hamilton in a Federalist paper said that we need government "Because the passions of men will not submit to the dictates of reason and justice without constraint."  The Fed is--barely--the constraint that exists in our banking system.  The people who won't submit to the dictates of reason and justice--they're the same people as those who are currently out of the Fed's direct reach.  Take away the Fed and you take all those Constitutional verbs out of banking.

My only recommendation is to do what I do: whenever you see someone who is a Paulist, ask them precisely why they think they way they do.  If they refer you to the website, don't settle for that, ask them what THEY think is correct about Ron Paul's appraisal of the Fed.  I haven't found a single Paulist yet who even knows what a banker does or the difference between a shadow bank, an investment bank, and a commercial bank.  I hope Ron Paul learns too sometime soon.

Originally posted to joseph on Fri Dec 17, 2010 at 02:13 PM PST.

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