Fragmented Ownership

In a capitalist economy, there are two sides to any act of production. There’s the “real,” physical side in which something useful is produced; this side involves physical inputs (machines, facilities, raw materials, etc.) and outputs (finished goods and services for sale). And then there’s the monetary side: for each of those inputs and outputs, some monetary payment is made.

Since capitalist production is carried out for profit, the people paying for the inputs do so in expectation of a profitable return on their investment. And that return, if it materializes, comes out of the flow of payments going in the opposite direction — the payments by the customers who purchase the outputs.

The classic example of this setup in its most direct form would be a proprietary family business — say, a restaurant — in which the owning family directly pays for the inputs out of its own pocket (ingredients, advertising, rent) and directly collects all the payments made by customers, pocketing the difference as income.

But in a modern economy, most production is organized in much more complicated and indirect ways. Unlike a family-run restaurant, most production is financed by people who are far removed from it; in fact, usually they have no involvement in the planning or execution of production whatsoever.

Instead of directly owning the physical materials or equipment and directly collecting payments for the output, what they typically get in exchange for providing capital is some financial instrument that promises to pass on to them a portion of the money proceeds resulting from the sale of the output. These instruments can take the form of equity securities (i.e., stocks), which pay out a fixed fraction of the profits, or they can be debt instruments (e.g., bonds), which promise to pay specific amounts of money on a set schedule.

In fact, nowadays there are usually further layers standing between the ultimate supplier of money capital and the physical process of production. Wealth owners today tend not even to directly hold stocks or bonds anymore, let alone the machines and raw materials that subtend them. Instead they own things like mutual fund shares or pension entitlements, in which case it’s the mutual or pension fund that owns the securities. The fund gets the monetary payout from the proceeds of physical production and then passes on that payout to the ultimate wealth owner.

And the chain of intermediation can get even longer and more convoluted than that.

But the important point is that, however long and complicated, such chains always tie together some specific set of physical productive processes at one end and the personal financial wealth of some specific set of households at the other end. Thus, when a particular set of productive activities fails to pan out, some particular group of people take a hit to their wealth.

This fragmentation of ownership, in which separate individuals own separate bits of the productive infrastructure, is an essential feature of capitalism; it’s almost synonymous with the private ownership of the means of production. And at a micro level, of course, it can have a functional logic: an entrepreneur whose wealth is tied up in their company obviously has a great incentive to devote all of their energies to the project.

But at a macro level, the fragmentation of ownership is deeply illogical — and profoundly destabilizing.

It’s illogical because capitalism has evolved far beyond the era of proprietorial management. The kind of business typified by our example of the family-owned restaurant was once the norm in capitalist production. But the nineteenth-century spread of the “joint-stock company” (what we would call the corporation or public company) where top managers are salaried professionals rather than owners, constitutes a profound shift in the nature of the system — far more so, I would argue, than either the system’s apologists or its critics have been willing to admit.

Karl Marx, however, was acutely aware of the importance of the change. He believed the joint-stock company to be such an important innovation, tending in the direction of socialism, that he called it “the implicit latent abolition of capitalist property” and “the abolition of capital as private property within the framework of capitalist production itself.”

One and a half centuries later, the great experiment with the separation of ownership from control in capitalist business has been a historic success. It may one day do as much to vindicate socialist economics (as Marx believed it would) as its failure within the Bolshevik economic model did to discredit socialism.

Creating Crisis

But besides its historical superfluity, the fragmentation of ownership is also profoundly destabilizing: the ultimate cause of much of the macroeconomic dysfunction to which capitalist economies have always been prone.

The problem is that by linking individuals’ personal wealth to the performance of the enterprises they invest in — even when they have no direct control over those enterprises — the system makes the supply of capital to the production process chronically fickle and deficient, especially for the most valuable projects, which also tend to be riskiest and slowest to bear fruit.

And the most virulent and destructive manifestation of this problem is precisely the one that deposit insurance was created to prevent: bank runs.

Although we don’t normally think of bank deposits this way, the fact is that they are technically a loan — an instantly recallable loan — that we make to our bank. And like any other loan there’s no guarantee that the borrower will be able to repay it when the time comes.

Of course, banks don’t keep the cash we lend to them in a vault; they invest the money by making their own loans or buying securities. That means whenever you request a withdrawal from your account (whether at an ATM or inside a bank branch or whatever), your bank’s ability to come up with the cash depends ultimately on how its investment portfolio has been performing.

A bank deposit is therefore, in one sense, not so different from a mutual fund or any other kind of investment: our individual wealth ends up being tied to the performance of what is, from our perspective — to paraphrase an erstwhile British prime minister — a faraway collection of production processes of which we know nothing.

But with bank deposits, the irrationality I’ve been describing becomes uniquely and explosively dangerous.

That’s because deposits are a unique kind of financial asset: unlike almost every other kind, they are used as money. You can go to almost any store, IRL or online, and buy goods in exchange for a draft on your checking account (nowadays usually via debit card; once upon a time, via check). In a modern economy, in fact, deposits make up the bulk of the money supply.

A bank run happens when people who had become accustomed to thinking of their checking account balances as if they were money sitting in a vault suddenly realize (or remember) that they’re actually more like money invested in the stock market. Just as people do with their stocks when the stock market is crashing, depositors who get wind of trouble in their bank’s balance sheet — like the depositors of Silicon Valley Bank last month — rush to convert their deposits into “real money.” “Real money” in the past meant gold; today it means paper currency or any other asset issued or backed by the Federal Reserve.

No bank ever has anywhere near enough “real money” on hand to make its depositors whole if they all rush to cash out at the same time. That’s why bank runs are “runs”: the depositors know there isn’t enough cash to honor all of their withdrawals, so they rush to the teller window (literally or digitally) to make sure they get their money before the bank runs out.

Bank runs are therefore financial weapons of mass destruction. At best, a bank facing a run will stop making any new loans at all. It will probably call in as many outstanding loans as it can. It will quite likely be forced to sell off as many of its assets as possible — at a massive discount — just to survive. And at worst, it will — like SVB — go bankrupt and disappear. And as we saw in the Great Contraction of 1929–1933, when thousands of US banks failed in the face of a nationwide wave of bank runs, the destruction of the money stock that attends such episodes will cause the whole economy to grind to an immediate and complete halt: US GDP contracted by almost 27 percent over those four years, throwing today’s equivalent of 42 million employees out of work.

This is “fickle capital” at its most convulsively volatile.

But there’s a cure: as soon as the state stands behind an investment, guaranteeing that the investor won’t lose money, fickle capital becomes patient capital. That’s the logic of deposit insurance. It prevents bank runs with nearly 100 percent effectiveness because it reassures depositors that rushing to withdraw their money is unnecessary: they’ll get their cash no matter what.

Of course, anytime you give a blanket guarantee to an investment, you create moral hazard: you eliminate the incentives for both the “investor” (in this case the depositor) and the “investee” (the bank) to do due diligence regarding the soundness of the investments they’re making or funding.

To address that problem, the original design of deposit insurance included two ancillary features, besides payouts to the unlucky: a requirement that insured banks submit to prudential regulation concerning how they lend and invest the money entrusted to them; and a limit on the size of insured deposits, based on the assumption that small depositors — ordinary folk — are incapable of doing that sort of due diligence, but that wealthy depositors can manage it.

Eliminating the Middleman

Not only has the failure of SVB now reminded us that the first ancillary feature, regulation, is all too often insufficient to rule out irresponsible behavior by banks. It has also exploded the pretense on which the second ancillary feature was based: SVB’s large depositors, mainly sophisticated tech companies, had to be bailed out in the end because they evidently were no more able to judge the “soundness of their investment” — that is, the financial health of the bank they kept their money in — than any ordinary Joe.

And the damage they likely would have done to the broader economy had they been forced to swallow their failed “investments” — probably sparking a more general panicked run on uninsured deposits nationwide, and even globally— was judged by the feds to be too great a risk to countenance.

This fact has now sparked a debate over the irrationality of private deposit banking with radical implications. If the Fed must permanently guarantee every deposit owed by every bank to every depositor, why shouldn’t it do so directly, acting in its own right as the depository institution with which the depositor does business?

In other words, why not just let individuals and businesses bank with the Fed?

This is the scheme that scholars like Saule Omarova and Robert Hockett have been advocating for years in articles and books like “The Finance Franchise” and The Citizens’ Ledger: Digitizing Our Money, Democratizing Our Finance. In such a system, individuals would still open accounts at Citibank or Wells Fargo, but the resulting deposits would be liabilities of the Federal Reserve, not the banks themselves; the latter would merely act as service providers, administering the accounts on behalf of the Fed for a fee. Ever since the failure of SVB, the logic of such a scheme has impressed itself on an array of prominent financial commentators. Martin Sandbu of the Financial Times has argued that

the SVB crisis should make us ask: what is the point of banks? . . . If we need those deposits to be backed by central bank reserves or something very much like them, what is gained by interposing private banks out to make profits on the intermediation?

Matthew C. Klein, the influential economic analyst who writes the Overshoot (formerly of Barron’s and the Financial Times) put it this way: “Instead of expanding subsidies to private businesses, the public sector should embrace its role as a financial intermediary” because “money and the payments system are public goods.” And Bloomberg’s Odd Lots podcast, hosted by Joe Weisenthal and Tracy Alloway, recently had Omarova on as a guest to explain the idea, which, according to Weisenthal, “suddenly feels more mainstream because of this tension between private profit in banking and the [outcomes] that everyone expects.” The failure of SVB, he explained, “blew the conversation wide open.”

But it only takes a little thought to see that the same logic justifying the socialization of one particular form of financial intermediation (demand deposits) applies just as well to virtually the whole range of activities linking individual savers to far-flung productive enterprises — that is, to the entire capital market. While other financial instruments might not trigger the same kind of instant, nuclear-level demolition that bank deposits do when they fall victim to a flight to liquidity, all are implicated in the same basic pathology. I’ll explain why — and lay out what a socialist solution might look like — in a subsequent article.