Bankers would not be allowed to lend out their customers’ money without explicit permission and full disclosure of the risks. Large private losses could still take place within the financial system but without endangering the rest of the economy or burdening taxpayers. In short, Kotlikoff’s proposal stops bankers from being able to gamble with other people’s money.
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“The Clash of Generations is so well written that Scott Burns and Laurence Kotlikoff should be considered the Stieg Larssons of economics. But there is one difference: the horror story they tell—about the debts that burden the young—are not fictional. This is a great book of great importance, and every paragraph contains some new and interesting observation.”
—George Akerlof, Nobel Laureate in Economics, 2001
Is the Modern Central Bank In Need of Reform?
CENTRAL banks aren't the problem. The problem is the financial system that the central banks are charged with protecting. That system is fundamentally corrupt, not because of the bad apples it attracts, but because it operates in the dark with extremely limited disclosure and transparency. Proprietary information is the ultimate villain and cause of our financial meltdown. It's the cover for the financial system's secret-keeping. If you can't see what a bank is doing because it's "their" proprietary information, you can't see if they are selling you snake oil or a valid security. Hence, you make them loans that give you some power over them if they don't repay.
But even that's not enough. So you get the government to explicitly or implicitly back your loans (some of which are called deposits). And since the government doesn't have the taxing capacity to back up these loans, the central banks have to stand ready to print money to do so. They also are obliged to try to babysit the banks to the extent they can. This whole system of "trust me banking" just failed spectacularly and can readily fail again. We need to move to "show me banking", by requiring full and real-time disclosure by all financial intermediaries of all their assets and liabilities. It's only by turning on the lights that governments can turn off their guarantees and get the central banks off the hook for guarantees that they, themselves, can't cover in real terms.
Were there a run on all US financial intermediaries tomorrow, the Fed would need to print $6 trillion to cover the deposits, $3 trillion to cover the money market funds, and $3 trillion to cover the insurance company cash-surrender policies. That spells hyperinflation, which spells meeting guarantees with worthless paper, which means running to get your money out and buy something real before prices rise. So, in the limit, if there is an extreme tail-risk event, the central banks can't deliver the goods. They can only deliver hyperinflation and be on auto-pilot to do so. This is why our current system is so fragile and dangerous, why central bankers don't sleep at night, and why nothing short of Limited Purpose Banking can fix it.