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American Economic Review Vol. 102 No. 3 2012

Limited-Purpose Banking—Moving from “Trust Me” to “Show Me” Banking

Christophe Chamley1; Laurence J. Kotlikoff2; Herakles Polemarchakis3

1 Department of Economics, Boston University, 270 Bay State Road, Boston, MA 02421. · 2 Department of Economics, Boston University, 270 Bay State Road, Boston, MA 02215. · 3 Department of Economics, University of Warwick, Coventry CV4 7AL, UK.

Abstract

There are many alleged culprits for the bank runs of 2008 and their devastating economic fallout. But proprietary information and leverage top our list. Claims of proprietary information forced financial markets to operate on trust, while providing the perfect breeding ground for fraud. And leverage permitted creditors to run at the first whiff of fraud, leveling one financial giant after another. Limited Purpose Banking (LPB), presented here, is a financial reform that sharply curtails proprietary information and eliminates leverage and, thus, the possibility of financial collapse. LPB's adoption is supported by our simple model showing how fraud can destroy finance.

DOI
10.1257/aer.102.3.113
Volume
102
Issue
3
Pages
113-119
Language
en
Sources
bibtex:phds-export.bib openalex crossref

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