Odd Lots - How To Create The Safest Bank In America

Episode Date: September 24, 2018

What if there were a bank that could never experience a run? And furthermore, what if it paid higher interest rates on deposits than what you could get at other banks? That sounds pretty good, right? Well it might be possible. On this week's episode of the Odd Lots podcast, we talk with Jamie McAndrews, the co-founder and CEO of The Narrow Bank. See omnystudio.com/listener for privacy information.

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Listen on Bloomberg Radio, stream the show live on the Bloomberg business app, or listen to the podcast. That's Bloomberg this weekend. Saturdays and Sundays starting at 7 a.m. Eastern. Make us part of your weekend routine on Bloomberg Television, and wherever you get your podcasts. Welcome to another episode of the Odd Lots podcast. I'm Joe Wisenthal.

And I'm Tracy Alloie. Tracy, you know what I'm really happy about? It could be any number of things, Joe. Your life is great. That's true. But specifically, I'm happy that the 10th anniversary of the Lehman Brothers Crisis happened on a weekend this year because I'm not really that.

I'm not really that crazy about all the anniversary coverage. Oh, no, come on. We have to relive our glory days. No, I don't really like reliving it and everyone telling their stories over and over again. And I think a lot of the lessons from that time are important and we should still talk about them. But I'm just kind of a little bit over like, oh, this is what happened that day and all the details from them. So are you telling me that we are not going to do a Lehman Brothers' Act? anniversary podcast. We are skipping over that one. Plus, by the time it would even come out,

because we're talking about this, it would be too late. So I think there are interesting lessons and all that from the crisis and the collapse of banks and stuff. But I'm just sort of glad that the 10th anniversary is over. Do you know what people forget about that was actually arguably scarier than Lehman Brothers collapsing at that time? And it happened like, I think it was the day after Lehman Brothers or maybe a couple days after. Are you going to say the reserve fund, the money market fund? Yes. Yes, the money market fund that broke the buck. That was huge. People forget about that. Right. And that's also the thing that prize got that while every ball, the mainstream remembers

Lehman or Lehman, the sort of in the know people talk about the money market fund that broke the buck. Anyway, I bring this up because one thing that I do think is very relevant in terms of 10 years after is this general frustration that after the financial system was rebuilt post crisis, it basically looks the same as it did pre-crisis. Like there might be less risk and bank balance sheets might be healthier and households aren't so as leverage to their homes as they were in 2005, But by and large, we rebuilt the same financial system we had before. Right. I think you could say there's been some tinkering around the edges. Like, for instance, you did have money market reform. But certainly when it comes to the banks, a lot of the criticism that you hear nowadays is that not only did we not reform the banks, but the biggest banks have gotten even bigger.

Right. We definitely didn't as a country, as a regulatory system, as a financial system, did not. use the crisis of 2008, 2009 to think about whether there are different models that could be fundamentally safer. We essentially just put the, you know, the sort of humpy-dumpty and put it all back together again. Yeah, pretty much. Anyway, I bring that up because our guest today, I think, is someone who is trying to still push forward with a different model of banking. And we're going to be talking to Jamie McAndrews. He was a longtime veteran of the New York Fed, and he is the founder and CEO of what he hopes will be a new type of bank that is much safer for retail customers

than any currently existing bank. Right. So I'm really excited about this conversation because this idea comes up every once in a while. As you say, it hasn't really gotten much traction. just yet, but the notion of narrow banking or full reserve banking or it's sometimes called the Chicago plan, I think. It's a really interesting one. And this company is probably the one that's gotten furthest along with that idea, although, as we're about to discuss, there have also been some roadblocks. Right. So I don't want to get too into the business model of it before we bring Jamie on, because, of course, he'll describe it best himself. We should note at the outset of this that the bank, which is called the narrow bank, and listeners will discover why, is not up and running yet.

It doesn't actually exist. It's still getting off the ground. And there's currently a lawsuit happening. Narrow Bank is suing essentially to have the right to exist. Currently, it hasn't been approved to exist. And we can't really get into the details of the lawsuit too much because it's ongoing. but in our conversation, listeners will discover what the goal of the narrow bank is and the sort of opportunities that it presents as a safer model of banking.

Yeah, it's going to be good. All right, let's bring in Jamie. So Jamie McAndrews, thank you very much for joining us. Thanks, Joe and Tracy. It's great to be on odd lots. Thank you. So what do you describe what the narrow bank is? Okay, I'll be happy to.

And just to, there were a couple of things you said in your intro that I'd like to clarify. Sure. The narrow bank does exist. It has received what's called its temporary certificate of authority from the Department of Banking in Connecticut. So it's a chartered state bank. The dispute with the Federal Reserve Bank of New York is not about its regulatory status or anything. It's about whether the Federal Reserve Bank of New York will provide. provide TNB with an account.

So we're simply looking for account services from the Federal Reserve, not any regulatory approval of any sort. And the other thing is TNB is not insured by the Federal Deposit Insurance Corporation, so it won't be dealing directly with retail customers. It's for institutional investors. And so those are just a couple things I wanted to make sure your listeners understood. But, yes, getting back to the basic question, what is TNB? TNB is designed to provide institutional investors with very high or competitive but safe deposit rates.

It's specifically designed to perform this function because what we've seen since the crisis is that the interest on resorts. that the Fed pays to banks has not been passed through very well to bank customers, to bank depositors. And we designed, my colleagues and I who founded TNB, designed the bank to perform this specific service. And its design features are intended exactly to get higher deposit rates safely to institutional investors. So, Jamie, could you maybe, in a nutshell, describe how traditional banking actually works? Because I think that's going to help our listeners kind of understand what's different about your bank.

So, you know, the commercial banks, they get a bunch of interest that's paid on the reserves they have at the Fed. I think it's currently like 1.9 something percent. Why do they get paid that interest? and why are they unable to pass most of it on to their customers? Right. Let me raise money by issuing deposits to customers. And so customers come in, they put money into the bank and receive a claim on the bank, which is called a deposit. And they're able to withdraw 100 cents on the dollar at any time.

That's the unique feature of deposits. And banks have capital as well from their founders. and perhaps external investors, there's capital on the balance sheet. So typically the money in a bank comes from depositors and the equity from investors. On the other side of the balance sheet, banks keep some funds in what are called reserve deposits, and those are usually at the central bank or they can take the form of currency and a vault. And those allow the bank to honor their depositors' withdrawal requests very quickly. And with other investments, the bank makes loans to households and businesses.

So that's a typical bank. And so in the conventional bank, there's only a fraction of their deposits that are held in these reserves. And consequently, banks have a instability built into them, which is that if all depositors withdraw their funds at the same time, the bank may have difficulty sourcing. seeing enough reserves to honor all their depositors withdraw requests that would be a run on the bank. And if they can't borrow against the loans that they've made, they would be in difficulty. Now, historically, the Federal Reserve throughout its history has not paid any interest on reserves. The deposits at the Federal Reserve were non-interest-bearing. But in 2006, the Congress,

the United States authorized the Federal Reserve to pay interest on reserves. And the basic idea behind this was that the Federal Reserve was requiring banks to hold reserves and they weren't paying any interest on the reserves. So that can be considered a type of tax because it was required for the people to hold it and they didn't earn any money on it. Of course, the Federal Reserve could invest those funds in government securities and earn money on it. So the lost earnings that people suffered by holding required reserves is a type of tax. So Congress agreed with the Federal Reserve and the banking industry that there should be payment

of interest on reserves, just like banks pay interest on deposits. And that authority was granted in 2006, it was first used in 2008. October 2008 where the Federal Reserve paid interest on reserves. The other aspect of paying interest on reserves is it's a way for the Federal Reserve to implement its monetary policy, its interest rate target. Again, prior to the financial crisis and prior to 2008, the Federal Reserve affected the money market interest rates, the rates, for example, that banks lend to one another, called the federal funds rate, by affecting the supply of reserves in the market. So if they

provide a lot of reserves to banks, many banks would have excess reserves and wish to lend in that market. That would drive the overnight rate down. And on the other hand, if they put only few reserves in the market and had a scarcity, there would be very few lenders of reserves. Other banks would be short of reserves, and that would drive the overnight interest rate up. But with the financial crisis, the Federal Reserve had many excess reserves in the market. And so the interest rate would be zero on those, except for the fact that the Federal Reserve achieved the ability to pay interest on them. Once they were paying interest on reserves, then banks had a new source of demand for reserves, because the reserves would earn this interest

rate, and so banks, theoretically, in a competitive market, would be happy to pay depositors to put funds into their bank and then earn the interest at the Federal Reserve. That would tend to drive deposit rates and overnight interest rates up towards the interest on excess reserves. So it's become a monetary policy tool in the wake of the very large levels of reserves that the Fed has held that the Fed has created since. the crisis. So I mentioned at the beginning that you, prior to having founded the narrow bank, you were at the New York Federal Reserve. And this idea of launching a new bank, if I've read

properly, came out of research that you did while at the New York Fed about essentially this question, which is, why aren't depositors at retail facing banks getting higher rates when the banks are able to collect higher rates from their reserves? That's about right, Joe. There was a lot of concern throughout the whole financial system that after 2008, when banks were earning interest on reserves, the overnight rate was not very close to the interest on reserves. It was lying well below the interest on reserves, 10 or 15 basis points or more than a

tenth of a percent, which is surprisingly large amount. Things are a little bit better today, but for several years, the banks were paying rates on overnight funds that were very low compared to what they could earn on reserves. And it was a puzzle for economists to determine why isn't the competition for large deposits driving the interest rate up towards the interest on reserves. And there have been several economic, economic explanations for that. Daryl Duffy and colleagues have explained that there's the market for federal funds and other overnight loans is the search model. It's an over-the-counter market where people have to go out and find a counterparty. And that is less than perfect competition.

With colleagues, I did research that pointed out that there's monitoring and credit exposure risks. And for that reason, lenders want to expose themselves only to a few banks, and that grants those banks essentially a monopsony power over the lenders. And Morton Beck and Beth Clee have another theory having to do with bargaining, the nature of the bargaining between two parties over time leads to less than perfect competition. So it was recognized that there was less than perfect competition for these large deposits to banks, and so the Federal Reserve undertook a lot of work to improve the competition in the market. Ultimately, the Federal Reserve chose to create its own narrow bank, you might say, the overnight reverse-re-purchase agreement facility. That serves about

160 non-banks. It's designed as a open market option. operation, and it legally fits that description, but it was designed to be economically equivalent to an account, essentially, that these 160 money market mutual funds, broker-border dealers, federal home loan banks can deposit money at the Federal Reserve overnight and receive an interest rate. It's designed as a repo transaction, but the, the, proffering of this collateral really doesn't improve the credit quality that the participants in that facility received because the Federal Reserve Bank is already extremely highly credit worthy. And the participants don't re-hypocket the securities in the program.

So it's essentially an account that those people, those 160 institutions have at the Federal Reserve. And that was a way that the Fed was able to narrow the range of interest rates overnight so that those large participants in the money market would surely be able to enjoy an interest rate at least as high as what the Fed was paying. And they could go to their private counterparties and say, hey, I'm getting this interest rate at the Fed. You have to pay me more if you'd like my lending into your institution. And that has, from the Fed's point of view, there's a lot of work on that that has been successful in the sense that the overnight interest rate has remained above that level that they pay in the overnight reverse repurchase agreement facility. Right. So we're talking about a couple things here. One of them is how commercial banks operate. One of them is how money market funds operate. And the other one is how they all sort of interconnect, with the Federal Reserve and the Fed's monetary policy, where would the narrow bank sit in that ecosystem and what would its relationship be like with the Fed and, I guess, large institutional

depositors because you said you're not really targeting retail? But there was a market opportunity to enter that. And we asked ourselves, what would be required to enter that market? Because we're hoping to... attract very large deposits. And the first answer that we came to is the bank would have to be very, very safe because we're competing with the largest banks in the world, many of whom are perceived to be too big to fail. So in other words, those banks are considered to have a government guarantee by many depositors. And so the only way to create a de novo bank that, is very, very safe is to design the bank on 100% reserve basis.

And that is possible now, in contrast to back in historical times, because reserves pay interest. And so it was the change by the Congress in 2006 that allowed the Federal Reserve to pay interest that created this market opportunity. A bank could be designed on 100% reserve. basis, and therefore it would be extremely safe, and it would have the hope of attracting depositors. And then, because it was 100% reserves, it would be a very low-cost bank in terms of operating costs. The assets carry no financial risks.

Costly insurance from the FDIC is not needed. And so the bank would be a low-cost competitor in that market. it's important to note that foreign banking organizations that take in wholesale deposits also do not carry the insurance of the FDIC. So in essence, the bank had to match that competition. But by designing the bank this way, then we would have a low-cost operation that could pass on the interest on reserves, earned from the Federal Reserve, to large institutional depositors. And we thought that would be a market opportunity that would be able to compete with those very largest banks in the nation who enjoy the ability to attract deposits of very low rates because of their perceived safety.

I think this is really the key thing here that we've got to, which is your business model. And I just want to make sure people understand it. If right now I'm an institution and let's say I have a bunch of money, $10 million in cash, I want to put somewhere. Right now I would probably go to some big, too big to fail bank, and their assets would be a mix of things, including some things that are very safe and other things which are riskier. And they wouldn't feel particularly compelled to pass on a competitive rate to me because they know I don't have many options and I would just be choosing from other too big to fail banks. But your argument is you can create the safest possible bank in the world.

because I give you my $10 million. I deposit it with you. You will automatically, that turns into $10 million worth of assets for you because you put that $10 million in a Fed account. And that's the safest money in the world. And you don't have many other costs because you don't have a bunch of loan officers and credit people because that's not your business. And you don't have the FDIC fees.

And you just pass that straight on to me. And even though you're not huge and too big to fail, I don't have to worry about any of your asset quality because it's the highest quality money in the world. Well said, Joe. That's a good description. You can get the news whenever you want it with Bloomberg News Now. I'm Amy Morris. And I'm Karen Moscow here to tell you about our new on-demand news report delivered right to your podcast feed. Bloomberg News Now is a short five-minute audio report on the day's top stories. episodes are published throughout the day

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So how does that differ from a money market fund? Because, of course, if I am a large institutional customer, one of the things that I would do if I have a bunch of extra money is maybe park it in a fund that invests in things that are usually considered quite safe. like U.S. Treasuries or commercial paper or something like that. So how is this different? Well, there is a lot of similarity between the two types of institutions. Some of the differences are the T&B has capital and it will have capital to help support the repayment of depositors' claims. Money market mutual funds don't have any capital. The second. thing is the nature of the assets that are being invested in by the two types of institutions. Government-only money market funds invest in U.S. obligations. T&B will invest in Federal Reserve

deposits. There's a difference in liquidity of those two types of assets. There are bid-ask spreads, and there's maturity transformation that's going on in money market mutual funds. Of course, that maturity transformation caused extraordinary problems. As you pointed out at the outset of this podcast, when the Reserve Primary Fund, which was a prime fund, not a government-only fund, broke the buck because they were engaging in both credit and maturity transformation, there was a huge run on money market funds, showing the fragility of that particular financial money. model. The narrow bank does not have that fragility because it can always meet its depositors' demands.

And even government-only money market funds engage in maturity transformation in order to boost the returns. And that's a potential of fragility there. So TNB is simply a safer alternative. And because of the different assets, there are different interest rates that would be earned by, on the one hand, shareholders in the Money Market Mutual Fund and depositors at TNB. and B. And it would depend on market conditions who had the higher interest rate. As we've seen recently, market conditions have changed in the money market. Many people believe it's the very large issuance of treasury bills by the U.S. Treasury, but in recent months, the Treasury bill rate and the repo rate has moved up very close to the 1.95% that the Federal Reserve is paying on its

on reserves. So market conditions have, you know, moved somewhat against the narrow bank model, but we believe that there's a business there. It may not be a huge business in present circumstances, but we believe it could be an important component to the, you know, to the financial system, and a new and very safe alternative for institutional depositors. So I'm glad you, said that about the business opportunity because that's exactly what I was going to ask you next. A, have you estimated how big of a business you think that this could be? And B, I don't want to phrase this in a way that might be sort of condescending or missing the point. But I am curious how much of this endeavor is about a business, money-making opportunity for you and your

partners versus to some extent an implementation of an academic theory that's sort of a kind of a quasi-academic project? Well, let me answer the second question first. This is a business opportunity. This is a very unique business opportunity and one that I think is inevitable given the payment of interest on reserves. I fully believe that narrow banks are something for the future of our financial system, not the past, not these sort of academic exercises that have been drawn on paper in the past. This is the living, breathing business opportunity that we believe is very important for depositors.

And the reason, again, is the sea change that occurred in October 2008 when the Federal Reserve began paying interest on reserves. That's really a very important change in our financial system. But I don't believe even 10 years later that it's been fully incorporated into the structure of the financial system. But let me also distinguish TNB from the sort of historical plan. and proposals for narrow banks. The famous example is the Chicago plan, which was proposed in the wake of the banking crisis of 1933. The T&B proposal is very distinct from that plan, which was purely to make banking perfectly safe, and it was also to outlaw conventional banks, very radical sort of proposal. TNB has no such interest in disrupting the business of conventional banks.

We believe conventional banks are complementary to TNB, and the TNB would complement our financial system. And, you know, retail banking, retail customers enjoy federal deposit insurance. They have safe deposits. This is for the large depositors. So let me talk a little bit about the social benefits of TNB. First of all, there is the benefit to the customers directly of TNB that they would get higher deposit rates. But the first thing that would happen if TNB came into the business, and this is why it's hard to estimate how big TNB might be, it might be very small, is other banks, the banks

with whom TNB would compete would raise their deposit rates. and that's because TNB represents a new competitive force in banking. So as economists would tell you, increasing that competition would lead to improve efficiency in banking. It also would lead to better implementation of monetary policy. The Federal Reserve, as I mentioned earlier, created their own narrow bank, but I consider to be equivalent to a narrow bank, the overnight reverse repurchase. agreement facility. And they did that to have better implementation of monetary policy. And in its

documents, the Federal Open Market Committee repeatedly claims that the OENRP is necessary for the implementation of monetary policy. T&B would be accomplishing a similar goal of getting deposit rates higher and closer to IEOR, something that the Federal Reserve leaves is necessary to its implementation of monetary policy. It also would lead to better efficiency in government spending and better distributional effects as this government expenditure of IOUER is passed on to depositors and doesn't stay solely with banks. A second social benefit of TNB is the effect it would have on the market for these large wholesale funds, but are sometimes called large cash pool. There's a lot of research that has been done by economists pointing out that when the Treasury Department issues, a lot of Treasury bills, that tends to crowd out the issuance of systemically risky short-term liabilities by private firms, such as the issuance prior to the crisis of ABCP, CP, VRDO,

RS's, repos, and so on, all these panoply of these seemingly safe, but ultimately very risky short-term liabilities. So when the, again, when the Treasury issues, a lot of Treasury bills, there's less issuance of those systemically risky short-term liabilities. T&B could have that beneficial effect as well. If it were accepted in the market, then that would be an alternative to those investors who are looking for safe haven. And rather than go into some risky VRDO or something like that, they could go to T&B, and that would be beneficial to society, would reduce systemic risks. The third one is one that the great economist James Tobin pointed out in two papers in 1985 and

1987. His 1987 paper was called The Case for Preserving Regulatory Distinction. and was presented at the Jackson Hole Conference. And in those papers, he recommended that there be narrow banks. His reason for narrow banks was, again, distinct from the Chicago plan or anything. He, again, did not suggest that conventional banks be outlawed or anything like that. He thought the narrow banks would be complementary to the banking system. And what he saw at the benefit of narrow banks at that time was that there would be a less reliance placed on

deposit insurance. As a society, we have placed, essentially, we put all our eggs in the deposit insurance basket. And that's reflected in the fact that the FDIC in April 2011 changed its assessment formula on banks to charge its assessment on all the liabilities issued by bank holding companies. And that made sense because during the crisis, not to go back to 10 years ago, Joe, that you're You're so done with that. You're so done with that. But the FDIC issued, you know, extraordinary guarantees on all transaction accounts and also guaranteed and insured the debt issued by participating large bank holding companies. So it's clear that the FDIC has enormous exposure to the U.S. banking system. And what James Tobin, He foresaw that, and he said, we're placing so much emphasis on deposit insurance. It's so difficult to supervise these firms and actually control the amount of risk that they're taking.

We could provide safety alternatively through a technological mean, not through government guarantees. And the technological means is to create safe deposits through narrow banks. And T&B has that flavor as well. So that would be another potential social benefit from TNB. But those are the social benefits. TNB is organized as a business, and it's not created for some other reason. It's primarily a business opportunity that we see. So, Jamie, you're obviously talking about a lot of the positives that come from narrow banking.

And I have to say as a depositor who currently earns, you know, zero point something on my deposit in the US, the idea of my bank being forced to offer me a higher rate is very attractive. However, there are some people who wonder about whether or not narrow banking could maybe have some negative consequences in the event that we have another Lehman-like situation. So, in other words, whether it might not end up increasing financial instability because what might happen is if you have the hint of a run on, you know, certain money-like assets, like you mentioned commercial paper or ABCP asset-backed commercial paper, which is what we saw in September 2008, that the depositors will just flee all of those and move into narrow banking. And so

you're effectively potentially worsening a run on the sort of interbank system. How would you respond to those sorts of concerns? Well, let me first say that in normal times, some people have said in normal times, even narrow banks might market share at the expense of conventional banks. And I'd like to say, I don't believe that's really a concern, both because the vast majority of deposits in conventional banks are covered by deposit insurance. So they're perfectly safe. And those depositors would not have a reason to leave their banks. Their banks could, again, in normal times, respond by raising their deposit interest rate and retaining their depositors. So there should be no large disruptions of banking in normal times as a result of a narrow bank or many narrow banks

existing. Then the question is, as you described, Tracy, if there were a stressful situation in the marketplace and if there were a run into narrow banks. Currently, if there's stress in the marketplace, people often find refuge in the government-only money market mutual funds, as was seen in the prime fund money market run in 2008. So I think that people would still take advantage of going into money market run, market mutual funds, government-only money market mutual funds. The narrow bank would require many days, if not a couple weeks, to acquire a new customer. So one could not run into the

narrow bank, you know, immediately. And the narrow bank would have the ability to request current customers to slow down deposit inflows if that were at all a concern. So there are natural breaks on the narrow bank. The narrow bank, T&B would not want to be associated with any distress in a market and would not necessarily want to be the recipient of flows that were causing some sort of problem for the U.S. financial system. The other aspect is if there were a situation like this, the Federal Reserve would have many tools to address the situation. If there were a public necessity, Federal Reserve could choose to pay a lower interest rate

to narrow banks relative to conventional banks. and that would thereby for the ability of people to run into narrow banks. So, again, that's sort of like a theoretical academic concern that in the real world would never occur. Jamie, in theory, you mentioned worthy narrow bank to get off the ground and start collecting big deposits. It will likely or could certainly put pressure on the existing banks to offer. higher interest rates. Would it be possible, theoretically, at some point, for existing banks to offer segregated narrow bank-like accounts where they basically tell people that if they want, they can have an account that's 100% backed up with reserves, central bank reserves?

I think that that is a potential direction that banks could go. They would probably need the Federal Reserve to change their policies to allow banks to have a, you know, a segregated account at the Federal Reserve. And I've recommended this and written a paper about the possibility of doing that. So I think that would be healthy, again, for a financial system if any bank could essentially form a narrow bank arm. And that's, again, also something James Tobin recommended in his 1985 paper. But I think it would require a change in policy and operations by the Federal Reserve to accommodate that alternative for banks. And then another thing is, so let's say this became big and your narrow bank launched

and there were other narrow banks. The narrow bank, your bank isn't going to do things like get involved in loans and real estate and all that. What do you see is the future for that aspect of banking, which is the lending side, if more of the world's deposits were to opt for fully backed reserve deposits? I don't see any interruption into conventional banks as a result of the creation of narrow banks. Again, the point of narrow banks in the current world, and the reason TNB was created, is to compete the interest on reserves more towards depositors, to provide competition so that the interest on reserves gets to depositors. That does not in any way affect the conventional bank's ability to make real estate loans or anything else. All it does is it removes a little bit of rent that banks are current.

earning between the amount that they earn on reserves and the amount that paid depositors. If you consider a bank today, and suppose a borrower comes up to the bank and proves to the bank that it is a perfectly risk-free borrower, and they say, what will you lend, at what interest rate will you lend to me? The bank is not going to lend to that person at a rate below 1.95%, even if they're perfectly risk-free, because they can earn 1.95% at the Federal Reserve. That's going to be the same before and after the narrow bank. The narrow bank does not restrict the bank's hurdle rate or change the bank's hurdle rate on lending at all. So the bank, all it does is the bank may have to pay a higher interest rate on their liabilities.

and so they may be affected in that they have a lower level of rent. I would not even call this a lower level of profit because I believe that the earnings that banks get between the interest that are paid to banks on reserves versus what they pay to depositors is really a rent. They get that for being there and for being perceived as safe. They're not out competing for that. And so that's really the effect. It would improve efficiency in banking.

If any banks are actually making a living on that part of their business, they would have their activity curtailed. But it's not going to interrupt in any way the profitable business lending to households and businesses. So, Jamie, you have the banking charter. You applied for an actual reserve account at the Fed, which was rejected, and hence the lawsuit. What next for you and what sort of argument are you going to be making about the Fed's decision? Well, clarified, Tracy, we've not been rejected on a reserve account. It's just that the Federal Reserve Bank of New York has not been willing to provide the reserve account. They've not said no.

So we hope that the Federal Reserve will provide us a reserve account. And we hope they will do this quickly. and we think it's in the interests of the Federal Reserve and the interests of the U.S. taxpayers, as well as the interest of our financial system. Well, as journalists who find this to be a fascinating story, we hope that it goes forward, if only because we'd really like to see how this evolves

and how this plays out in the financial system and the banking system. So Jamie McAndrews, thank you so much for joining us. That was a fascinating conversation. Great. Thank you so much, Joe, and Tracy. I appreciate it. Tracy, I really loved that conversation. I feel like just getting into the mechanics of banking is one of those things that it kind of makes your head hurt a lot, but is really worth it to actually understand how our system really works. Oh, yeah, totally. And the best way to understand, you know, the traditional banking model is probably to talk about a new banking model, which we just did in detail. You know, I sort of feel bad that I started that thing, the thing I didn't like the anniversary of Lehman. Oh, yeah, you should feel bad.

I do kind of feel bad now. But one point that I think Jamie made that I thought was extremely interesting and something that people often forget about the crisis is how much of it was a result of the manufacture of safe assets from things that weren't safe. And so investors set out to take a bunch of crazy risks, but what they really wanted was extremely safe assets. And then the industry complied by essentially fabricating safe assets out of risky assets. And then he listed off, Jamie listed off this alphabet soup of things like, you know, the auction rate securities and asset back commercial deposits and all that stuff, which were all examples of things. of things that were more or less seen as AAA money-like, but the underlying foundations of which were actually pretty risky. Yeah, and that's really, the whole conversation that we just had

was about how to manufacture more safe assets, but in a way where they are actually safe. And I realize the irony of me saying that, but that's always what we're trying to do. The other thing I was wondering about... And in this case, they actually would be. I mean, if they were... In this case, I think it's safe to say that if the funds were, in fact, deposited right at the Fed,

there would literally be the safest kind of money imaginable. Yeah, it's sort of like the magic of banking intermediation in reverse, right? Like normally banks take your money and invest it in a bunch of risky things, but your money is considered safe because it's a deposit. But in this case, your risky money would kind of be put at the Fed and turned into something safe automatically. So financial engineering in reverse. Yeah, that's well put. You were going to say something else though before I interrupted you.

Oh, yeah. Well, the other thing I was thinking about is, you know, you mentioned banking reform at the beginning of the conversation. And I was just thinking like, you know, here we have an idea to create basically the world's safest bank. And, of course, you know, the notion that the Fed hasn't said yes just yet is very ironic. But I also wonder, it's kind of hard to create something new once you have the existing infrastructure, right? And that might be the difficulty here. I think like the Fed's a little bit unwilling to try something new because they're worried about the knock-on effect for existing financial institutions. And you can't really start from scratch.

Yeah, it is really difficult. And momentum and inertia, I always say, is like the most powerful force in the world. Right. Well, speaking of inertia, shall we wrap this up? Speaking of inertia. I don't really get that seg, but yeah, let's wrap it up. Well, I tried. Okay, this has been another episode of the Odd Lots podcast.

I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway. And I'm Joe Wisenthall. You can follow me on Twitter at the stalwart, and you should follow our producer on Twitter, Tofer Forges, at Forges T. And you should follow the Bloomberg head of podcast, Francesca Levy on Twitter at Francesca.

day. Thanks for listening. I'm Francine Lacqua, an award-winning journalist, and I've got a new podcast, Leaders with Francine Lacqua from Bloomberg Podcasts. I've interviewed everyone from heads of state to fashion icons about the news of the moment, but I've always been curious, who are these people as leaders? I don't think there's one right way to be a leader. Make decisions. A poor decision is always better than no decision. Listen to new episodes every other Monday. Follow leaders with Francine Lackwa, wherever you get your podcasts.