Just about everyone has an opinion on the proper role of banking institutions as we go forward in the new economy. One intriguing proposal comes from Laurence Kotlikoff and Christophe Chamley, both professors of economics at Boston University. The duo advocates that banks return to their original functions of lending money and facilitating payments and leave riskier activities, like buying and selling subprime mortgages, to others.

In their plan, banks would issue conforming, or government-approved, business loans and mortgages, with the borrowers’ collateral and ability to pay verified with by tax returns, as well as non-conforming instruments. However, just as drugstores sell both FDA-approved medicines and herbal supplements that haven’t been tested, a bank could issue nonconforming loans that wouldn’t carry government backing and would presumably be more expensive.

Moreover, these “limited-purpose banks” would hold reserves against deposits of 100 percent, versus the 10 percent now required, and much higher than the 30 percent being advocated by the Volker Commission.

All this would eliminate panicked bank runs, and investors would have no reason to shun them. After all, bankers wouldn’t expose their organizations to outsize risks, leaving them teetering on the edge of bankruptcy. Instead, banks once again would act just as boring intermediaries in the financial system.

While the changes that Kotlikoff and Chamley propose sound radical –- and, indeed, reach further than most proposals under consideration –- their ideas are similar to the “narrow banking” concept proposed by other economists, like Milton Friedman, Kotlikoff says.

In fact, Kotlikoff says an evolution this direction is inevitable. The government can’t simply hand the banks money and expect to shore up trust, but needs to overhaul the system so that banks no longer can go under, leaving taxpayers to pony up billions to bail them out.

Given the frenetic pace of activity on Capitol Hill over the past few weeks, it’s hard to say what policy changes will eventually result. However, given the gut-wrenching upheaval in the economy, all ideas should be in play. Even those that aren’t implemented can better inform the discussion. ###