Larry Kotlikoff and Ed Leamer, writing at Forbes.com on Friday, propose to make the financial system safer by outlawing all intermediation funded by debt, i.e. outlaw ordinary banks, thrifts, finance companies, and insurance companies. The only intermediaries allowed would be mutual funds, where all customers are shareholders. If you think I'm exaggerating, read it yourself. And yes, to all apperarances this is a completely serious rather than a Swiftian proposal.

I'm happy to see that the financial crisis has widened the scope of debate over monetary and banking reform. But this particular proposal would throw the baby out with the bathwater.

They defend the proposal thusly:

If such mutual funds sound revolutionary, they're not. Funds of this kind have been around for centuries.

In truth, no one doubts the viability of mutual funds. The real issue is the desirability of a financial system consisting only of mutual funds because it bans debt-based intermediation. Is debt-based intermediation never mutually beneficial? Are there never any good reasons for people to want to hold debt claims on intermediaries? For example, is it never prudent from someone approaching retirement to shift some of their pension funds into TIAA traditional or certificates of deposit with a pre-determined nominal return? Is it never convenient to have a checking account where this morning's account balance is knowable without going online? More generally, shouldn't we presume that there are efficiency reasons why debt-based intermediation has evolved and survived over the centuries even where government guarantees have been absent?

One can readily agree with Kotlikoff and Leamer's suggestion that deposit insurance has over-amplified the share of debt-based intermediation, without concluding that the best remedy is to reduce its share to zero by outlawing it. First let's try taking away the subsidies: no taxpayer-backed guarantees, no intervention to shift losses from holders of debt claims to taxpayers.