Book Review the Importance of “Money”

BOOK REVIEW THE IMPORTANCE OF “MONEY” THE MONEY PROBLEM: RETHINKING FINANCIAL REGULATION. By Morgan Ricks. Chicago, Ill.: University of Chicago Press. 2016. Pp. ix, 336. $45.00. Reviewed by Kathryn Judge∗ In a provocative new book, The Money Problem: Rethinking Fi- nancial Regulation, Professor Morgan Ricks argues that the government should reclaim control over money creation. Money, Ricks argues, is not just the cash in your pocket or the balance in your checking account. Instead, at least for purposes of financial stability policy, money is best equated with short-term debt. For most of the twentieth century, such debt was issued primarily by regulated commercial banks and insured by the Federal Deposit Insurance Corpora- tion (FDIC), resulting in a fairly stable financial system. As a result of financial innovation, however, much of today’s short-term debt is issued in the far-less-regulated shadow banking system — a market- based system of intermediation that serves many of the same functions traditionally performed by banks. Runs by money claimants in the shadow banking system were central to the 2007–2009 financial crisis (Crisis). The Dodd-Frank Wall Street Reform and Consumer Protec- tion Act1 and other post-Crisis reforms, however, have done relatively little to shut down this unauthorized money creation. That, in Ricks’s assessment, is a mistake. The book provides a seemingly simple blueprint for reform: the government should allow only banks to issue demandable debt, it should heavily regulate and insure all such debt, and it should prohibit anyone else, other than the government, from issuing debt with a maturity of less than a year, thereby preventing private money creation (pp. 12–24). According to Ricks, this set of reforms would “panic- proof[]” the financial system and prevent the type of recessions that leave lasting scars on a country’s economic health (p. 3). Moreover, ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– ∗ Professor of Law, Columbia Law School. I am grateful to Jeffrey Gordon, David Skeel, Scott Hemphill, Eric Hilt, and Patricia Mosser for helpful comments and conversations, Francesca Cocuzza and Catherine Walsh for exceptional research assistance, and the editors of the Harvard Law Review for thoughtful feedback throughout the editing process. I also wish to thank Morgan Ricks, whose thought-provoking book inspired this response and with whom I look forward to decades of ongoing debate. 1 Pub. L. No. 111-203, 124 Stat. 1376 (2010) (codified as amended in scattered sections of the U.S. Code). 1148 2017] THE IMPORTANCE OF “MONEY” 1149 this approach is sufficiently certain to work that the government could roll back the myriad other financial regulations aimed at promoting stability. Even the Federal Reserve would be optional in the new landscape that Ricks envisions (p. 229). Regardless of whether one buys into his proposed reforms — and let me state at the outset, I don’t — the book makes a lasting contribution by demonstrating the importance of money, broadly construed, and the shortcomings inher- ent in the current academic and regulatory efforts to understand and address money claims. A virtue of the book’s reform proposal is the way it brings to life the incredible oddity of money as a financial asset. According to Ricks, the best way to promote financial stability is to allow banks to fund themselves with debt from creditors who are indifferent to whether the bank fails or succeeds. No matter how large or sophisticated the creditor, so long as maturity of its claim is less than a year, Ricks does not want that creditor to undertake any due diligence, en- gage in any ongoing monitoring, or impose any discipline on the bank.2 Those roles would be left to the bank’s shareholders — who will often want the bank to assume more risk than is socially optimal — and the government. At first blush, many might agree with then–Treasury Secretary Timothy Geithner, who described the author’s first iteration of the idea in 2009 as “wacky” (p. xi). In most financial markets, information generation and discipline are the types of activities that we want market actors, not government regulators, to undertake. In equity markets, for example, stability is often assumed to flow from efficiency and promoting private information generation is widely viewed as the optimal, even if imperfect, route to enhancing efficiency.3 In this frame, intentionally short-circuiting market-based information production by making a firm’s debt insensitive to any kind of information would seem like a recipe for disaster. And that’s before layering on the challenges posed by the contrary interests of the firm’s shareholders. Yet, Ricks argues thoughtfully, and at times quite persuasively, that this is the best way to achieve financial stability. As Ricks shows, the assumptions that underlie corporate finance have only limited applicability when the financial asset in question en- joys some degree of moneyness. Moneyness alters the premium a holder will pay for a claim and the amount of due diligence the holder will undertake before acquiring the claim, rendering the efficiency- ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– 2 Ricks would allow, but not require, banks to obtain funding by issuing long-term debt, leav- ing open the option, but no obligation, of long-term creditor discipline. 3 E.g., GARY B. GORTON, MISUNDERSTANDING FINANCIAL CRISES 48 (2012); Ronald J. Gilson & Reinier H. Kraakman, The Mechanisms of Market Efficiency, 70 VA. L. REV. 549 (1984); Kathryn Judge, Information Gaps and Shadow Banking, 103 VA. L. REV. (forthcoming 2017). 1150 HARVARD LAW REVIEW [Vol. 130:1148 oriented assumptions underlying standard asset-pricing models largely inapplicable to money claims.4 At the same time, when short-term debt funds longer-term liabilities, a defining characteristic of banks and much of the shadow banking system, the institutions that result are inherently fragile. If money claimants withdraw their funds en masse, as they do in a run, the institution issuing those claims will be compelled to sell its relatively illiquid assets at discounted fire-sale prices, potentially rendering even a solvent institution insolvent. This fragility alters the incentives of money claimants, who now must wor- ry about the behavior of their fellow claimants in addition to the health of the institution issuing their claim, setting the stage for financial panics and the deep recessions that often follow. Although these insights are not new, The Money Problem demonstrates in new light the importance of recognizing money as a type of financial claim that can be readily produced by private mechanisms, absent a prohibition, and one that poses unique public policy challenges. This is the book’s most important contribution and it alone justifies the undertaking, for author and reader alike. Shifting from the author’s claim that money poses a distinct policy challenge to his proposed solution to that challenge reveals the limits of his analysis. His claim in the abstract is simple and appealing. Be- cause money claims created in the shadow banking system are not insured like bank deposits, the shadow banking system is more prone to runs, which in turn inflict lasting damage on the economy. We should, accordingly, update and expand the banking system and prohibit any money creation outside of that system. The details of the proposal, however, reveal that he wants to significantly expand, not just update, traditional bank regulation. Ricks proposes a scheme of government control over money creation and short-term debt that is, to my knowledge, unprecedented in any advanced economy.5 According to Ricks, the government should significantly expand government- provided insurance to cover all bank deposits, no matter how large the deposit or how sophisticated the holder and irrespective of any system- ic threat. The government should also limit the aggregate deposits that the system could create, control the terms pursuant to which banks accept deposits, and prohibit virtually all private debt with a maturity of less than a year — no more traditional money market mu- tual funds, sale and repurchase agreements (repos), or commercial pa- per (p. 226). Despite this significant expansion, Ricks contends that traditional bank regulatory tools will suffice to constrain bank risk ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– 4 See infra Part III, pp. 1163–1173. 5 See infra Part I, pp. 1153–1158. 2017] THE IMPORTANCE OF “MONEY” 1151 taking and counteract the moral hazard and other distortions that the massive insurance scheme would induce. The breadth of Ricks’s proposal allows almost countless angles of attack. Concerns could be raised on issues as diverse as operational challenges (e.g., could the government rely on market actors to provide elasticity when it is most needed?), desirability (e.g., how would the proposal impact the status of the U.S. dollar as the reserve currency?), and political feasibility (e.g., could the proposal overcome a significant challenge on both the domestic and international fronts?).6 As a result, any assessment of The Money Problem is likely to reveal as much about the person launching the critique as it does about the book’s strengths and shortcomings. Rather than hiding from this fact, let me make my biases plain. Ricks and I agree on a number of key issues. We both see shadow banking as central to the Crisis. We agree that the shadow banking system grew outside

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