Let Markets Regulate the Financial Sector

Economists Larry Kotklikoff (Boston University) and John C. Goodman (NCPA) have proposed an over haul of the financial sector that would improve transparency and accountability while reducing the role of the federal government. Their idea, called Limited Purpose Banking, would require fully backing checking and other cash accounts with a 100% reserve requirment while using transparency to policy riskier investments.

As John write’s on his blog,

“Here’s the idea. No one should be able to put you at risk without your knowledge or consent. Individuals should be free to take any risk they like and our financial institutions should facilitate risk taking. But institutions should not be able to use your funds to make highly leveraged, risky gambles that you know nothing about. Nor should they be permitted to gamble at the taxpayer’s expense.”

This model would fundamentally change the role of the federal government.

“The role of the government would not be that of regulator. Instead the government would create transparency by rating, verifying, certifying, and disclosing all the financial securities purchased by the mutual funds. It would not tell anyone how much they can borrow or how much risk they can take. Under Limited Purpose Banking, individuals would decide what mutual funds to buy, but they would do so knowing, to the maximum extent possible, what it is they are buying.”

More can be found in their co-authored paper here.

Samuel R. Staley, Ph.D. is a senior research fellow at Reason Foundation and managing director of the DeVoe L. Moore Center at Florida State University in Tallahassee where he teaches graduate and undergraduate courses in urban planning, regulation, and urban economics. Prior to joining Florida State, Staley was director of urban growth and land-use policy for Reason Foundation where he helped establish its urban policy program in 1997.