Saule Omarova On The Weaknesses Of The Current Banking System & Her Proposal For A ‘People’s Ledger’

Saule Omarova Is Professor of Law At Cornell University Law School. She has served as a Special Advisor for Regulatory Policy to the Under Secretary for Domestic Finance at the U.S. Department of the Treasury. In 2021, she was nominated to serve as Comptroller of The Currency by President Biden.

By Aiden Singh, November 2, 2023

Table Of Contents

I. The Current Banking System

II. The People’s Ledger (TPL) Reform Proposal

A. The Liabilities Side of The Fed’s Balance Sheet

B. Monetary Policy Under TPL

C. Implications of TPL For Central Bank Communications

D. Administrative Benefits Of TPL

E. Escrowing of Fed Accounts Under TPL

F. Asset Side Of The Fed’s Balance Sheet Under TPL

G. New Macroprudential Tools Under TPL

H. TPL, A National Investment Authority (NIA), & Climate Change

I. TPL & Central Bank Digital Currencies (CBDCs)

J. Private Banks

K. The Politics

I. The Current Banking System

Question: You’re a scholar of the regulation of financial institutions and of banking law. And you’ve written both about the intrinsic flaws in our current system of banking and on how they might be remedied. Could you begin by discussing the flaws within the existing system of banking?

Answer: Well some of the flaws in the current system of banking are quite visible to the eye: our system is unstable and we keep running into different crises.

The fundamental reason we keep experiencing these issues is the structure of the modern banking system. The modern system of banking is, in effect, a public-private partnership of a certain kind; a franchise-like arrangement, if you will. It is an institutional arrangement for outsourcing the creation of an elastic currency, effectively sovereign credit-money, to specially-chartered private banks. These private banks are granted a government monopoly on the creation of deposit money that effectively circulates in the economy as an equivalent of sovereign money. And this is enabled by an elaborate government backing that supports banks. This backing includes, for example, deposit insurance and access to the balance sheet of the central bank. In the United States, this means access to the Federal Reserve’s balance sheet. In effect, how this works is that the Federal Reserve pre-commits to monetize and accommodate these private deposit-money liabilities created by banks as if they were its own. And that institutional arrangement allows private deposit-money to circulate in the economy. And from the perspective of all of us private actors in the economy, this bank-created private deposit-money is basically indistinguishable from sovereign money. 

And this hybridity is taken for granted because in the mainstream policy and academic discourse the Fed’s role as the public institution in the background that commits to the continuous clearing and settlement of bank liabilities is considered a ‘plumbing function.’ In other words, it’s treated as something menial, something purely mechanical, something in the ‘back office,’ if you will. And what banks do - seek out lending opportunities and create deposits when they extend loans - is considered a ‘front office’ function. They are, in this view, the more active decision-makers in this particular arrangement. 

And because this is the narrative around this system, we lose sight of the fact that, ultimately, at the base of this entire monetary system is the full faith and credit of the sovereign, of the public. 

So the Fed’s role, in the background, is to regulate the supply of these private liabilities that circulate as public liabilities. The Fed does this primarily by using its monetary policy tools, but also through its system of supervision and regulation. And it’s not just the Fed; it’s also other regulatory agencies that exercise oversight. And this is necessary because, in this franchise-like system where private banks are licensed to create sovereign money, these private banks can cross the line and overgenerate sovereign money credit because this serves their own private profit-seeking objectives. So the Federal Reserve, in its capacity as the monetary authority, and other banking regulators have to stand ready to ensure that such overgeneration doesn’t happen. And this is not easy because the private banks are well-equipped to find ways of producing these private liabilities that generate their private profits but also, effectively, put the public on the hook and subject the public to the dangers that come with overgeneration of credit-money and the dangers that come with the misallocation of credit-money.

And this brings us to the second function that private banks perform in this hybrid finance franchise system, in addition to money creation: they conduct credit allocation on a nation-wide basis. And the genius of this system is precisely that these two functions - money creation and credit allocation - are melded and bundled together in a very close manner. In other words, banks create new purchasing power in the economy by crediting deposit accounts when they extend loans. And when they extend these loans, they assess the creditworthiness of borrowers, and they look for profitable and supposedly socially beneficial investment opportunities, because when they make loans they are essentially making investments. So banks have historically performed this credit allocation function and we are used to thinking of banks as better allocators of credit because they are supposedly in possession of on the ground information about prospective borrowers’ creditworthiness, business plans, assets which can be used as collateral, and so on. So, in this system, credit allocation is the other side of money creation. 

However, interestingly, the entire system of bank regulation and supervision is not primarily geared toward managing this function of private credit allocation by banks. To the extent that there are regulatory and supervisory tools that look at the asset side of individual bank’s balance sheets (e.g. loan portfolios, securities portfolios), the fundamental rationale for that regulation and oversight is not necessarily the best allocation of credit to productive economic enterprise but from the perspective of the stability, safety, and soundness of individual banking institutions and the banking system as a whole. And while the goal of ensuring the stability of the banking system and the goal of ensuring the best allocation of credit to productive economic enterprise are related, they are not the same.

So we have a system in which private banks create, effectively, public money with public backup. And they do so by allocating credit, supposedly, to productive economic enterprise. And the regulatory structure is in place to make sure that, as banks pursue private profit, they do not overdo the creation of money and allocation of credit or perform these functions in a way that harms the public. The problem is that this regulatory oversight is not necessarily nimble enough nor effective enough in spotting troubles in either one of these channels, in either one of these functions that banks perform. 

So, for example, in 2008 we saw how problems arose due to the misallocation of credit-money toward speculative trading in subprime mortgages, subprime mortgage-backed securities (MBSs), and other financial instruments that are related to this market, as opposed to channelling money into truly productive economic activities like public infrastructure or loans to small and medium-sized businesses. This misallocation of resources ultimately destabilized the entire financial system. 

And to the extent that the existing regulatory tools do not serve us sufficiently well to prevent these kinds of imbalances in the banking system, our financial and banking system is not structurally sound. 

II. The People’s Ledger (TPL) Reform Proposal

A. The Liabilities Side Of The Fed’s Balance

Question: In The People’s Ledger (TPL), you laid out a proposal for reforming the banking system which you believe would alleviate the shortcomings you’ve just detailed. Could you describe your proposal?

Answer: My proposal is not absolutely brand new - the idea of separating the function of money creation from the function of credit allocation has been around for a while. And it’s become more popular recently with the advent of digital technology that makes a lot of the functions that banks are currently bundling much easier to manage separately. And the opening I see at this moment is that we can actually get to the core of the inherent problem that is built into the existing hybrid public-private franchise system of banking that we currently have. In other words, we can actually unbundle the creation of the public good that is fully safe public money from the allocation of credit. Lending can be performed by private institutions for private profit without necessarily being publicly subsidized quite to the same extent and quite in the same way that they are today. 

So my proposal is to unbundle the two and we make public money a fully and directly publicly provided good. In other words, the central bank would actually open deposit accounts for everyone in the economy - individuals, businesses - not just for banks, which currently have the exclusive privilege of banking directly with the central bank. And then the private banks would no longer be burdened with the need to provide deposit accounts to everyone and they would be able to focus on what they presumably know and do best, which is utilizing their on the ground micro-level informational advantages to go out and actually seek the best investment opportunities. In other words, they’d be free to go out and locate those credit-worthy borrowers and projects that need financing. 

So what would happen in this scenario is that the function of the Federal Reserve will fundamentally change. Instead of dealing only with banks on the liability side of its balance sheet - which currently have exclusive access to reserve accounts - the Fed would now have to expand its relationships to all the actors in the US economy. And what the Fed would do is provide free checking accounts to everyone. These accounts would be very basic, providing the ability to store your money, write checks out of, and withdraw cash from at ATMs. These would not be savings accounts like we can currently open with private banks. And these checking accounts would be the liabilities directly of the Fed, rather than of individual private banks guaranteed by the FDIC and backed by the Fed. In this scenario, when you open a deposit account, you would know that the entity in charge of safe-keeping your money is the central bank, which is basically the most credit-worthy borrower you could possibly find. So your money is absolutely and fully safe.

And these accounts would be available universally, which is a great plus from the viewpoint of financial inclusion and offering banking services to everyone regardless of how much money they have. 

So these accounts - let’s call them ‘Fed accounts’ - can be administered through a system of specially-licensed banking institutions, community banks and credit unions for example. And the choice of community banks and credit unions for this type of deposit administration function is deliberate. In this country we have a long-standing tradition of preferring smaller local institutions to deal with on a day-to-day basis. And these are the institutions that are less likely to overgenerate and create risks by abusing access to depositors’ money. And these institutions are also, historically, the primary lenders to locally-based small and medium-sized enterprises, family businesses in particular. So to the extent that we want to continue supporting these types of locally-based community embedded type of financial institutions, it is important that we allow them to be participants in this new depositor system, where they would effectively be conducting all the same functions that private banks are performing today vis-à-vis depositors. In other words, local community banking institutions would be the ones opening and managing the accounts for individual depositors. So for me, for instance, nothing would change. I would go to my local community bank and open a checking account with that community bank, except the liability produced by my deposit with the community bank is not going to be a liability of my community bank but of the Federal Reserve. But my community bank would be doing the onboarding, checking my identity, conducting know-your-customer anti-money laundering screenings, and so forth. It would be doing these things as an agent of the Federal Reserve. And all of my day-to-day transactional information will be going through this particular community bank. The institutional design and technology can be setup in a way that the Federal Reserve doesn’t necessarily need to see all that transactional information on a daily basis. All of that information will be seen and managed by my community bank as an agent for the Federal Reserve, much like how it is today. This would be a layer between depositors and the Fed which ensures the same degree of privacy, familiarity, and customer facing convenience that a lot of Americans like to have. Under this arrangement, the community banks would be paid a fee by the Fed which would serve as a reasonable and steady source of income for these small institutions. And these fees should be generous enough to justify this line of business for the community banking institutions. And this would put the community banks in a highly advantageous position in terms of the ability to offer additional financial services to the customers that would be coming in to open their Fed accounts. The community banks could offer, for instance, savings accounts, certificates of deposit, investment services, and a variety of other financial services. I think this would really enhance the business model of these institutions. 

B. Monetary Policy Under TPL

Question: Let’s begin by looking at how this would affect the monetary policy side of things. How would your proposed reforms change the process of money creation?

The key here is that, in partnering with private service providers - be it community banks or payment service providers -, the Fed has to make sure that no money creation is done by those private partners. The Fed has to ensure that what these private partners do is enhance the customer-facing functionalities of this arrangement. But actual money creation should be done directly by the Fed, and it’s the Fed who credits and debits these accounts in the last resort. In other words, no private institution can decide to create new purchasing power by imposing liabilities on the Federal Reserve by crediting an account. 

Question: How would your recommended reforms change the process of monetary policy transmission? And, from the perspective of monetary policy, what would be the benefits of Fed accounts and changing the liabilities side of the Federal Reserve’s balance sheet in the way you propose?

In this scenario, the Fed would have a direct relationship with every economic actor. This would allow the Fed to conduct monetary policy in a much more direct and decisive manner, and much more transparently.

So, for example, the Fed could decide what interest rate it will pay on balances held in Fed accounts. And by establishing the interest rate on Fed accounts, it can manage the cost of money. The Fed would be able to achieve the results that currently it needs to achieve through indirect manipulation of a very complex structure of interest rates in the economy (involving the Fed Funds Rate). 

It can also potentially use this direct relationship to directly credit these Fed accounts if there is a need for expansionary monetary policy and a need to increase the purchasing power in the economy. Currently, this has to be done through a very indirect system and the Fed has found itself in many instances having to push on a string where private actors were not willing to lend no matter what. Under this reform, the Fed could potentially engage in a sort of direct ‘helicopter money’ type of policy. I realize that in established economic theory this idea has long been treated as a radical, outlandish, not particularly pragmatic idea, and as a risky idea. But all of this depends on what else is happening on the Fed’s balance sheet and what other policy tools the Fed has at its disposal. This could be designed such that it would be used in a very targeted way and in conjunction with a variety of other tools so that it achieves the desired results without undesirable consequences. 

The reason this would be potentially a more effective channel for conducting monetary policy is that the Fed would be able to implement policy much faster, in a much more targeted way, and much more directly. If we more directly connect the reasoning behind a monetary policy decision to the actual impact of that decision by eliminating slack created by the use of multiple intermediaries that may or may not act with an eye towards this public goal, we have a better chance of rationalizing that monetary policy.

Question: So the idea is not only to alleviate the issue of banking sector instability, but also to make monetary policy transmission potentially more effective than it is currently? 

Answer: Potentially more effective and more transparent, because now you can see what the Fed is doing. The Fed would have to communicate its decisions much more clearly, much more granularly, and much more continuously because the Fed makes a decision, then implements the decision, and it affects everybody. So there will be more pressure on the Fed to be upfront and more transparent about what it is doing. And we will see the actual implementation of monetary policy directly on the Fed’s balance sheet, rather than needing to figure it out through indirect mechanisms. 

C. Implications of TPL For Central Bank Communications

Question: That’s a very interesting implication because, for example, when the Fed adjusts its interest rate it puts out a statement. If you’re in finance, you can dissect what that statement is saying, but if you’re not in that particular industry, you’d probably have no idea what they’re talking about.

Answer: That’s absolutely right. The Fed knows how to manage its messaging and frequently views opacity as its friend. But if monetary policy was all direct and explicit, if we eliminate this veneer of pure technocratic mysterious aloofness and apolitical process that is hard to communicate to the average Joe on the street, we eliminate the mystery by basically giving every Joe on the street a direct window into what the Fed is doing because every Joe on the street will have an account that is a directly with the Fed that makes everyone a direct creditor of the Fed. And then the Fed would have to talk to its creditors, to explain to its creditors what it is doing and how it’s doing it. And all the tools it uses and decisions it makes are going to be so much more important but also they will have to be made much more transparent and understandable to people. This is one aspect of democratizing the Fed: you put the Fed in direct relationship with the people rather than having the Fed deal with only a narrow circle of initiated special entities, including private banks and then having everyone else deal with those private entities and being unable to speak directly with the Fed and having the Fed never speak directly to everyone. Under this proposal, it would have to speak to everyone. 

Question: So this would very much change the job description of the Fed chair. Right now Jerome Powell is carefully wording his statements so that the market doesn’t get spooked and hears what it wants to hear. That wouldn’t be the job anymore under this proposal. It would require more communication with the general public.

Answer: Exactly! Tell the public what’s going on; don’t obfuscate. And tell ahead of time and keep talking to them. The Fed will have to keep talking to the public, to the Treasury, to private institutions, to everyone because the intermediary layer would be gone.

Question: Alan Greenspan’s approach to being Fed chair was to obfuscate and to leave people confused and unsure what exactly the Fed’s intentions were. That would no longer be a useful or relevant strategy under this reform.

Answer: That’s exactly right! And it’s kind of fascinating to think about what a different Fed we would have to have if the Fed actually thinks of us as its direct client, its direct creditors. And we’ve never had that. I think it’s important not to underestimate the power of that shift.

D. Administrative Benefits Of TPL

Question: Might the idea of public checking accounts at the Fed simplify other functions currently performed by the government such as the provision of social security or unemployment benefits?

Answer: Absolutely. The current state of technology makes the idea of Fed accounts much easier to implement. And it also is what makes it much more versatile in terms of the purely administrative benefits that the federal government will have in its management of the economy, financial policy, and fiscal policy. 

So, for example, if every American had a Fed account we wouldn’t have had some of the problems we had during the early days of the Covid pandemic when there was federal government assistance to families. A lot of people who were unbanked had to receive physical checks, and those checks would sometimes get lost in the mail or people were not able to get to their mailboxes because they were locked-down somewhere else, maybe staying with family. With Fed accounts, you don’t have to worry about any of this for emergency payments or regular government payments such as unemployment benefits, veterans benefits, or social security payments. All these payments could be routed directly, digitally and deposited directly into the Fed accounts basically instantaneously. 

Question: So this proposal wouldn’t just simplify our relationship with the banking system but also the administration of federal agencies such as the Department of Veterans Affairs?

Answer: The is definitely true. And it would be all on one platform and very easy to adapt to a variety of needs. 

E. Escrowing of Fed Accounts Under TPL

Question: Under what circumstances might a public checking account be debited?

Answer: So this is also with respect to monetary policy. 

One of the potential criticisms commonly made about allowing the Fed to credit peoples’ accounts directly is that it would also be able debit peoples’ accounts and that would be scary. The context in which people typically have this conversation is as if everything else stays exactly the same as it is today and then suddenly the government can put money into your account and can take money from your account.

But this is not the right context for discussing the possibility of debiting accounts because this is a tool that would be part of a broader reform. 

So for example, suppose we’re in an inflationary environment and inflation is raging. Under TPL reforms, the Fed could, of course, try to use the interest rate on the Fed accounts just like it uses its interest rate today to indirectly dampen inflation and see if that works. The Fed would also have a whole slew of much more potentially effective asset-side tools that it doesn’t currently have. But if nothing works, in the last resort, the Fed could potentially drain some purchasing power by debiting certain Fed accounts. 

So how do we make this measure less scary, more transparent, and less punitive than it otherwise appears? For example, we could envision a situation in which the Fed would transfer some amount of money out of transactional Fed accounts into sub-accounts - let’s call them reserve sub-accounts. So everyone would have a Fed account, administered through community banks. And in that Fed account, there would be two parts: 1) a transactional Fed account, which is the account you use everyday to make payments, to receive pay checks, and so forth, and 2) a reserve sub-account into which the Fed would transfer funds when it needs to, in the last resort, drain purchasing power. So it’s still your account and your money, but it will be temporarily escrowed into a sort of savings account portion of the Fed account - the reserve sub-account. So it wouldn’t be available for spending, but it wouldn’t evaporate. And when the money is in this reserve sub-account, the Fed would pay a higher interest rate on that sub-account than it pays on the transactional account.

So why is it important to pay a higher interest rate on the reserve sub-account? The Fed would communicate ahead of time clearly its plans to drain purchasing power so that people are prepared and they can figure out how much liquidity they may need. For example, it would announce that it will escrow a certain amount of purchasing power for a certain amount of time, let’s say three months. And it would announce that it will pay a certain higher interest rate on this escrowed amount in the reserve sub-accounts than it’s paying on the transactional sub-accounts. In this scenario, some people who have plenty of money sitting in their transactional sub-accounts and don’t need it currently may choose to transfer an amount of money from their transactional to their reserve account that is higher than what the Fed says would be mandatorily escrowed. 

So this debiting of Fed accounts becomes a compulsory but lucrative investment opportunity for a specified period of time. And it is extremely important that this period of time is set in the right interval and communicated ahead of time. 

And after this period of time passes, if the Fed sees inflation easing, it would release the escrowed amount, so you could transfer it back into your transactional sub-account. 

Another important thing here is that the Fed will need to be very careful about figuring out which accounts may need to be exempted from this debiting. One can imagine situations in which particularly low-income households simply cannot afford to have any percentage of their deposits be escrowed even for a short period of time. On the other hand, more affluent households may actually be able to bear this inconvenience for a short period of time. So there would have to be a policy for exempting the accounts of individuals and households with particular levels of income or with particular needs from this type of escrowing. And here again, technology should make figuring out who needs to be exempted easy enough to do. 

I also think that, for example, a decision could be made that the deposit accounts of local governments and perhaps various public agencies that provide critical services to the public could be exempted from any kind of debiting of this type because we don’t want this money to be withdrawn from circulation because this money actually supports critical public functions and economic activity in the community. 

So to really have this tool as a last-resort monetary policy tool in the Fed’s arsenal, one would need to think through various design features that would minimize the potential harm to households from these types of moves by eliminating the element of surprise, by counteracting any element of unnecessarily harsh impact - particularly on specific segments of depositors -, by communicating ahead of time the positive side of this policy (i.e. a potentially lucrative savings opportunity for those with extra money on hand), and by managing it openly and efficiently so that people stop being afraid of this policy tool. 

Question: So maybe escrowing is a more accurate word to use rather than debiting?

Answer: Yes, absolutely escrowing is more accurate than debiting because debiting implies taking your money away. The government can only take away some of your immediate spending capacity, while remunerating you for it sufficiently well so that in the end, you’re actually gaining.

Question: So under your proposal, the Fed would have two policy interest rates: the interest rate on your checking account and the interest rate on your  escrow account?

Answer: That’s exactly right. And the idea behind the escrowing scheme is to reduce immediate spending. It combines an element of compulsory policy decision by the government with a financial incentive. And this sort of goes back to what Keynes back in the 1930s proposed with respect to how to finance the war for Britain - escrowing some money by issuing mandatory government liabilities to people, thereby immobilizing some spending power. 

Question: So it’s sort of analogous to what the Fed does now - but through commercial banks - where, when it wants banks to loan less, it increases the interest rate offered to those banks on deposits held at the Fed. So it’s essentially a very similar tool, but without the banks as a middle man. 

Answer: Essentially it is. And the Fed also currently does the same thing by selling bonds to primary dealers and banks, taking money out of the system. So it’s essentially the same: the Fed ‘sells’ its own liabilities - the reserve account liability - and individuals now hold that claim. 

A lot of what would happen on the liability side - in terms of monetary policy - very much builds upon existing tools. But because it would involve a direct relationship between the public and the Fed, the rhetoric around the possibility of deploying such tools is so political. 

F. Asset Side Of The Fed’s Balance Sheet Under TPL

Question: In TPL you also envisioned a restructuring of the Fed’s portfolio in which its assets would be comprised of 1) loans made at discount window, 2) loans for large infrastructure projects, and 3) an expanded portfolio of financial assets. Could you elaborate on the types of assets you see the Fed holding? 

Answer: One of the principle obstacles to any form of Fed accounts type proposal and to issuing any so-called universal or retail central bank digital currencies (CBDC) is that all of these proposals envision potentially significant increases in the liabilities of the central bank.  

And, of course, we know that on a balance sheet you need to match the liabilities and assets side, so this immediately raises the question of what will happen on the asset side of the Fed’s balance sheet. 

And this is where many economists and politicians are extremely cautious about expressing an opinion. There is a tremendous fear of hypothesizing about changes to the asset side of the balance sheet. Why? Because what happens on the asset side of the Fed’s balance sheet shows us a picture of where the money goes, of how publicly created money is allocated. So the asset side really tells us about the allocational distribution of public finance. And this is a political issue - no matter how you look at, it’s about not only what is or isn’t a good investment, but also about who gets or doesn’t get that investment and for what purpose. 

So typically all the discussions around CBDCs - to the extent that they talk about the asset side of the balance sheet - will say, well that’s actually a big problem and a reason why we shouldn’t pursue direct issuance of digital currency by central banks nor have Fed accounts, because we don’t want to mess with the asset side of the Fed’s balance sheet. Or they will say, well the central bank will simply have to do more of the same type of asset allocation that it does now: potentially buy more treasury bonds or if there aren’t enough treasuries, buy blue-chip corporate debt. But this is a tricky and dangerous idea because it would create distorted incentives for private debt overgeneration. The Fed could buy stocks, but then it would be picking winners and losers. So it creates these thorny issues and economists just seem to throw up their hands and just walk away from this question. So they conclude, well let’s not do too much on the liabilities side; let’s not do CBDCs that are directly available to everybody and if we do it let’s minimize the amount of CBDC that anybody can have, let’s administer it synthetically through commercial banks, basically let’s keep the current system as intact as possible because we don’t know what to do on the asset side and we are not willing to hypothesize about what can be done. 

So in The People’s Ledger, I confront that issue directly. I think, at some point, we really need to think about these issues. So I thought why not look at the asset side,  not as an obstacle and a problem, but as an opportunity. If we go back to the beginning of our conversation, one of the problems with our existing hybrid finance franchise system is that private banks and private financial institutions that are allocating credit often misallocate credit because it serves their private profit interests to do so, even though it doesn’t serve the public interest. And they have the right to prioritize their private profits; it’s not their job to think about the economy and society, they have to think about shareholders’ profits. So misallocation happens regularly and we see this misallocation everywhere.

In the United States, for example, we have a woeful shortage of financing for critically important public infrastructure. And it’s not just the roads and bridges, it’s also social infrastructure and industrial infrastructure. For example, we’re trying to re-onshore the production of certain industrial goods and a lot of that base has eroded over the years. Somebody needs to rebuild those industrial capacities. This also involves rebuilding the social infrastructure around these enterprises. And there is not enough capital, apparently, to get this off the ground. There is plenty of private capital, but it’s all going into, for example, private equity funds that invest in projects that can become profitable over a shorter time horizon. And a lot of capital is going into pure financial speculation. In the last decade we’ve seen, for example, the explosion in crypto finance. And part of the reason why is because there is a lot of institutional investors’ money that is looking for new asset classes. So we have instances where there is a lot of capital to allocate, but that capital doesn’t get allocated to the kind of productive transformative enterprise that we need to allocate capital to. So restructuring the Fed’s balance sheet opens up an opportunity simply by creating a much larger capacity for the asset side of the balance sheet; it creates a unique opportunity to alter the incentives in capital markets to channel more capital into productive enterprise - public infrastructure, social infrastructure. 

The following three asset classes are what I think would make the most sense for this purpose. So how would the Fed do it? The first category is what I call the ‘new discount window’. Currently the Fed already has a temporary liquidity facility for private banks - its discount window. We can take this principle and expand the discount window to replace the cheap deposit funding that private banks would lose under a Fed accounts arrangement - there would be no deposit funding for the banks. The discount window could become a permanent more longer-term cheaper funding source that is publicly provided by the Fed to those banking institutions that are interested in building their business models around providing loans to productive enterprises in the economy: industrial loans, mortgage loans, consumer loans. Let’s say a private bank extends a loan to a company that produces widgets. To the extent that this is a sound loan that meets the eligibility criteria that the Fed establishes for its new discount window, then the bank could pledge this loan as collateral to the Fed at a very good rate. So now the good widget company has gotten a loan to produce its product and employ people in the local community, and the bank that made this loan is not on the hook because it got cheap financing from the Fed. So now the bank can redeploy this cash to extend another loan. So that’s basically how the Fed would help to channel the deposit money that we deposit into the lending that is conducted by private lenders - who have micro-informational advantages on the ground - and would now have an incentive to do a good job because they want to make profits on the spread between the interest they earn on loans they extend and the interest they would pay have to the Fed. And the Fed is not in the game of making a profit on those loans and it is interested in allowing private lenders to make reasonable profits, as long as the loans are extended for productive purposes - and this would be a policy decision. And high risk loans, for example margin loans to traders in securities, would not be eligible for discount at the Fed discount window. This doesn’t mean that the same lender is prohibited from extending high-risk loans; the lender can still make these loans, it just won’t be able to finance that loan through the discount window at the Fed and would have to finance it in a different way - either out of its own shareholder equity or by raising funds in capital markets. This would incentivize market discipline for these lenders and would make these high-risk loans subject to the analysis of the dispersed investors in the capital markets, rather than being subsidized by the Fed. But the Fed will end up effectively subsiding private credit in private markets extended to the vast majority of borrowers that we want to be able to borrow. So that’s the ‘new discount window’.

The second asset class is the new public issuances. So going back to these infrastructure projects. The restructured Fed balance sheet will create this new platform for financing direct or indirect public investment by existing authorities - for example by state and municipal authorities that are dealing with transportation and energy and so on, but also by newly created public entities, for example, state green banks or state infrastructure banks, or a federal investment bank. We currently don’t have such a federal entity. But, in other work, I have put out a proposal for creating a National Investment Authority (NIA), which would be essentially a federal entity for conducting federal industrial policy on a nation-wide basis. It’s a mix of a federal infrastructure bank and a sort of secondary market-maker for infrastructure bonds issued both by public authorities - like states - and by private companies, and a kind of an asset manager or publicly-owned venture capital fund, making equity investments in various publicly beneficial infrastructure projects. This would involve not only traditional infrastructure, but also industrial and social infrastructure. And so the NIA is an institution that would be lending and guaranteeing and providing secondary markets for loans geared towards long-term transformative infrastructure projects that are not getting financed in public markets, and perhaps leading and co-investing through publicly-managed new types of collective investment funds in more longer-term transformative, technology based projects in public infrastructure - green finance, for example, or new forward-looking forms of industrial production that are simply too risky and too long-term for private investors and private financiers to take on. When the NIA focuses on doing that, the Federal Reserve could effectively provide credit support for the NIA’s activities. In this way, the newly expanded capacity on the asset side of the Fed’s balance sheet could be used to support publicly beneficial activities by other entities within the Federal government and at the state level which in turn will support and mobilize private capital along side public money. So, currently, the Fed doesn’t do it. During the Covid pandemic, it did set up a municipal liquidity line, but it is telling that there wasn’t much take-up of the facility because the Fed treated it similarly to liquidity facilities for private borrowers and the interest rates were too punitive. So the Fed doesn’t currently have anything in place to do this kind of work. But this kind of work is an important new channel, a new tool of coordinating and increasing the synergies all throughout the layers of the government for the purposes of really allocating capital - both public and private - to where we need it to go. And this is a very important function that the new Fed balance sheet could perform, without embroiling the Fed in the process of picking winners and losers because it is not going to directly allocate money to specific firms and specific borrowers. That job would stay with other institutions - either private lenders or other public institutions. The Fed would just provide credit support for them.

And finally the third asset class is systemic stabilization portfolio. This would basically be an expansion of the current trading operations that the Fed - through the Federal Reserve Bank of New York - is conducting when it does open market operations, when it basically - for purposes of setting the interest rates in the economy - purchases and sells treasury bonds and enters into repo transactions with other financial institutions. So the Fed would maintain a trading portfolio of assets. Currently these assets only include treasuries and repos and only for the purposes of monetary policy. But why not use this existing platform for, for example, maintaining a broader set of financial instruments, not just treasuries and repos but maybe mortgage-backed securities or corporate bonds - basically tradable instruments that have some form of systemic significance in financial markets. In other words, if the financial asset bubble in that particular segment of the market can reach potentially dangerous proportions, and if the bust that potentially follows that bubble could potentially spill over into other areas of the market and potentially create destabilizing asset sales and other destablizing dynamics throughout financial markets, then why not have the Fed and its asset managers in charge of this systemic stabiliziation portfolio watch these prices and see the point at which the prices are moving into asset bubble territory - in other words the Fed’s researchers do not see the fundamentals based reason for this particular rise in prices, then they can enter that market and short that asset. The intervention doesn’t even have to be anything tremendously huge, but the signal that it would send that the Fed is shorting this particular stock or this particular asset class is that the trends in this particular asset class are on the Fed’s radar; that the Fed is concerned about a potential bubble brewing in this asset space. This would change the incentives for various speculators to keep pushing prices up. And vice versa. If, for example, there is some kind of an irrational sell-off in a particular asset segment and the Fed makes a decision that this sell-off is not commensurate with the fundamentals and can potentially destabilize the system - maybe it’s the short-sellers that are creating some kind of crazy dynamic - then the Fed can get into that market and basically go long on that asset, again sending a signal that this particular market is on the Fed’s radar. And so it’s not like quantitative easing when there is already a problem exposed and the Fed basically tells everybody well now we know that this particular asset is considered toxic and I’m here to buy it off of your hands. It’s not for that purpose; it’s for the purpose of never getting to that point in the first place. So it’s much more nimble, faster, and in smaller amounts for purposes of signalling to the traders that the Fed is on alert. 

So those are the three main new asset classes that one can envision but of course, there can be other asset classes that one can talk about. 

G. New Macroprudential Tools Under TPL

Question: The expanded portfolio of financial assets, essentially, is like a new macroprudential tool that the Fed would have that allows it to pre-emptively act against bubbles?

Answer: That’s exactly right. And it would be in addition to the macroprudential oversight through the rules and supervision that we have on the regulatory side. And we know that those tools are notoriously blunt and slow, whereas this tool has nothing to do with regulation; it is a participatory tool, acting directly in the market much faster and much more effectively. 

Question: So back in 2006, Nouriel Roubini and Adam Posen had a bit of a debate about whether or not the Fed should burst bubbles. Roubini argued that the Fed should while Posen argued that monetary policy is too blunt of an instrument and using it to prick bubbles may demand other parts of the economy that you’re not really trying to slow down. What you’re essentially proposing here is let’s get around this whole problem by giving the Fed another more focused tool which would allow the Fed to intervene directly in that asset that is subject to excessive speculation. 

Answer: That’s exactly right. It’s precisely because we don’t have such tools that we are forced to rely on monetary policy which has only one blunt tool, which is an indirect manipulation of an interest rate that may or may not reverberate through the economy. We could use this other tool, which has nothing to do with monetary policy, to burst the bubbles before they form, which would tremendously simplify the job of regulators. 

H. TPL, A National Investment Authority (NIA), & Climate Change

Question: You’ve mentioned that loans for large infrastructure projects would be part of the Fed’s portfolio under the TPL proposals. And you’ve discussed your proposal for the NIA. One of the first things that comes to mind is that these tools could be quite useful for addressing something like climate change. Was this something that was on your mind when you were developing these proposals. 

Answer: Absolutely. That was absolutely one of the primary drivers for how the NIA idea came about. Climate change is one of those challenges that are global and far beyond any private entity’s ability to deal with. And there is so much uncertainty around it because it’s so difficult to model for forecasting purposes. So we can’t really leave it to private institutions. And the federal government as it stands right now is so hamstrung in its ability to publicly address this issue: the treasury or any federal agency can only finance various projects, even if they decide it’s important to do it, if there is enough budget allocated to it, and that’s a political decision. Under these circumstances, how can we be sure that the Federal government will ever have enough money or the ability to foresee how much money it would need. So the NIA is a kind of a hybrid entity, very similar to the Federal reserve in its design, but the idea is that it is first and foremost a public institution, but it functions as a direct market actor, and it’s designed in a way so that it can undertake all of the same activities as private investors undertake - the lenders, the investors, investment funds - and the federal government undertakes, but without being hamstrung by short term returns, commercial viability, the budget, or political processes. So that is the beauty of this type of an institution, but it also introduces complexities. 

I. TPL & Central Bank Digital Currencies (CBDCs)

Question: Central banks are currently investigating the possibility of issuing central bank digital currencies (CBDCs). You’ve argued that the current discourse on CBDCs is generally too narrow, focused on things like faster payments. How might CBDCs fit into your proposal?

Answer: So the People’s Ledger proposal is, in effect, a CBDC proposal. I think of it as the outer limit of designing a CBDC with the full potential of that new digital power to be used for purposes of democratizing money and making the payments better but also making the financial system more resilient; more democratically accountable and more efficient in a way. So it is a CBDC to the extent that for the Fed accounts to really be manageable, they would have to be digital also.

The CBDC debate is conducted by a fairly narrow set of actors - basically central bank economists who are looking into CBDCs from a very narrow perspective as simply a form of payment, as simply a new method of executing payments. It’s the idea of CBDCs as a tokenized form of what central banks otherwise do in the form of cash. 

But of course the digital side of it is the novel side. So central bankers are discussing how this new means of payment would co-exist with other digital tokenized forms of payment like stablecoins or tokenized deposits or other  cryptocurrencies, things of that nature. And pretty much the entirety of the debate is framed in this sense: that there are these parallel alternatives for us to make payments. And this is basically all the use for money that is in question here: when I pay you do I use bitcoin, dogecoin, tether, checks from a bank, or do I use the “Fed coin” (the CBDC). 

In this framing, you already pre-set in terms of what alternatives you see. For example, there is already a decision, pre-made but not articulated, that CBDCs are only a means of payment, a means of exchange and it needs to be considered in terms of the pros and cons it offers vis-a-vis other existing private forms of digital money like cryptocurrencies, stable coins, and so on. 

But that is not the right way of looking at it, because CBDCs are sovereign money - it’s central bank money. We know that even now it is also the final settlement asset. All the settlements in the financial system, no matter how the payments are made among two counterparties, ultimately the final settlement always takes place in central bank money because central bank money is the most reliable, the base of all the other money on top of it.

And yet when they talk about CBDCs, that hierarchical structure of the system kind of gets lost; the discussion is, well, the CBDC is just going to be one option among many, but it’s not. Because once you introduce CBDC you know what you’re doing is taking the most superior form of money and digitizing it. If I have the most superior form of money in the same convenient digital form, why do I need other inferior forms of money? That’s the question that drives a lot of design discussions today without being openly articulated and admitted.

So a lot of the design options that are currently discussed are about how to manage this co-existence between more superior digital money and less superior digital money. How can you do it? Well you can’t make inferior money more superior, but you can make superior money less so; you can weaken the superior money. So the current discussions, it seems to me, limit the amount of CBDCs that anybody can use, make it less convenient (perhaps it won’t be available 24/7 whereas private money will be), impose various conditions and so forth. But implicit in these discussions is that they don’t want to disintermediate banks, they do not want public digital money to drive private digital money out. And it’s really interesting because people take the thought of disintermediating banks or getting rid of private digital money as just sort of that’s the ultimate thing to fear. But nobody is asking, well would it really be such a bad thing. And in The People’s Ledger, that’s exactly what I mean when I say we should look at CBDCs as an opportunity. Would it really be such a bad thing to get rid of private money which we pretend is equal in safety to public money. Because there is always that slack and that’s where a lot of risk gets created. And when that slack becomes visible, that’s when we have crises. 

So this is why the People’s Ledger is kind of a CBDC proposal as well as a public money proposal. But I harbour absolutely no illusions about central bankers anywhere anytime soon actually admitting that this kind of CBDC would be superior, although what’s interesting is that just recently there was an op-ed by the former CEO of Citigroup Vikram Pandit. And he basically endorsed the same idea: unbundle money creation from lending, make all money public directly created by the Fed. But the switch was that all of that will be in the service of the private sector: the private sector would still control the allocation of credit; the federal government would take on the public utility function on it’s own but everything else in finance will stay the same. And I worry that a lot of the CBDC proposals that are currently being discussed will effectively lead to that; that CBDCs will only empower private financial institutions but not necessarily the public. And that’s what I find worrisome.

K. The Politics

Question: You’ve argued that banking is inherently political - that decisions about how society chooses to structure the banking system involve making political decisions and that these decisions in turn are influenced by who has political power. I’d like to end on this final question. The full title of the paper we’ve been discussing is The People’s Ledger: How to Democratize Money & Finance the Economy. The implication of this title is that our monetary system currently lacks democratic features and that your proposal would remedy this. Could you summarize for us how your reform package would democratize money?

Answer: The current system allows the abuse of public subsidy by private banking institutions, which ultimately leads to a very dysfunctional pattern of privatising gains and socialising losses. 

Under this proposal, if we separate public money creation from private lending, we would basically eliminate the grey area in which alot of the abuse public trust and public subsidy happens.

But the private sector would still remain very important. This proposal is not meant to eliminate the private sector or make it unimportant. It will, in effect, free the private lenders and private investors to do what they do best: use their superior ability to gather and process information and pick up on certain risks and make loans and investments in various assets based on the private market’s logic and subject to private market discipline. Without public subsidy there would be no incentive and no temptation to engage in some kind of an arbitrage so that a disproportionate amount of benefit enures to private owners and a disproportionate amount of harm or risk is left with the public. 

We will separate the two and that will actually be a much healthier foundation for a more democratic system of money and finance. So there will be a public platform for managing a critical public resource which is the full faith and credit of the United States - of the sovereign. And that public platform is basically centred around this newly redesigned, restructured Fed balance sheet, which would now be very transparent and where our collective resources would be effectively channeled into the kinds of lending and the kinds of investment that benefits us as a public and that helps to build public infrastructure and helps to channel credit into credit-worthy economic activities, that provides deposit transactional payment services to everybody free of charge, that helps to prevent destabilizing asset booms and busts. So all of these public services are going to be performed with the use of public resources by the public institutions acting together. 

On the other hand, on the private side of the market, there would be a lot less need for an overly intrusive or complex financial regulatory oversight of private banks because those private institutions will not be able to abuse public subsidy; there would be no need for a public subsidy. And once there is no need for a public subsidy, there is a lot less need to police the conduct and investment decisions in the private financial system directly the way currently the way banking regulators are forced to do. What that means is, to the extent that you believe that free financial markets subject to market discipline are democratic because those markets allow the multitude of individual investors and lenders to make their own decisions freely based on their own calculus of risks and returns, and the potential losses from those decisions fall purely on them and not on the public as a whole - to the extent that’s a democratic principle, then the private side of financial markets will be able to be more democratic upfront because that logic will be truly in operation, not just a rhetorical claim that it is today. To me democratization is not about sheer access to some financial products to a greater number of people because we know that sometimes expanding access for less educated or disadvantaged people enables financial actors to abuse and exploit those people so it’s not about access per se, it’s about in whose interest the financial system operates and who has the power to influence how finance is produced, controlled, and allocated. Currently most people don’t have that power simply because we are relegated to being passive providers of raw fuel for the financial system that is run and control by private financial institutions that in turn have exclusive access to public subsidies. So if we change that system, I think we would make money and finance more democratic and more efficient.

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