Saving the banks

The Vickers Report on the UK banking sector ( is supposedly aimed at avoiding any future financial collapse by making the banks safer.  This committee of bankers and economists propose to increase the amount of capital funds that banks must hold relative to the loans they make and financial assets they purchase.  They also want to reduce the holdings of ‘risky’ assets that banks can hold.  And they have gone halfway to separating the activity of banks between their ‘traditional’ role of lending to business and households and their ‘investment’ role of gambling in bond and stock markets and inventing all kinds of exotic instruments of ‘financial mass destruction’ to make bigger profits and bonuses.

The argument is that it is the latter role that brought the capitalist world to its knees.  So if banks want to gamble or speculate, then that should be separated from any liability of the taxpayer to bail them out.  The Vickers committee has not gone the whole hog and demand a complete separation of banks into two sorts.  Instead it has said that, within each bank, some bulwarks or firewalls must be introduced to keep any losses from speculative activities feeding through to ‘ordinary’ practices of the banks.  But the devil is in the detail.  It won’t be easy to make these separations clear and indeed the banks have been left to come up with their own definitions for separation.  Moreover, the whole implementation process  has been put off until 2019!  Who knows whether another crisis won’t have happened before then.

Anyway, as former UK Labour Chancellor Alastair Darling commented, what makes the committee think that a banking crisis can only happen in the ‘speculative’ part of banking?  In Britain, the banking crisis first erupted in the ‘ordinary’ banks like Bradford & Bingley, Northern Rock and HBoS.  Only later did the ‘universal’ banks that speculated in US mortgage-backed assets and credit derivatives like RBS get into trouble when the whole banking world began to implode.  As Marx would have argued, loan-bearing capital is inherently vulnerable to the possibility of crisis, because loans may not be paid back and deposits may be withdrawn and transactions can break down.

And boy was the banking collapse in the UK expensive to capitalism and, of course, mostly to working households who are still paying for it in extra taxes, reduced public services, lower economic growth and incomes.  One-third of the decline in the income of the UK economy since the crisis began was due directly to the banking collapse.   The UK economy is still 4% smaller than its peak in March 2008 and 2.8% lower than September 2008 when Lehman Brothers went bust in the US and the banking crisis began in earnest.  Of that fall, about one-third can be accounted for by a fall in banking activity, even though banks account for just 5% of UK GDP.  If you add in the ‘second round’ effects of tighter credit for businesses and houseeholds in the ‘ordinary’ part of banking, the losses caused by the banking sector are even larger.  So far this year, the banking industry has contracted by 2.6%, which followed a 5.1% fall in 2010 and a 7% decline in 2009.  And yet  an estimated £6.7bn of bonuses were paid in the City of London in the 2010-2011 financial year.  It’s business as usual in that department.

The banking collapse that the Vickers Committee wants to avoid again led to the big five UK banks receiving a £46bn ‘too-big-to-fail’ subsidy in 2010.  These large banks were able to borrow at lower interest rates than the average Joe because government guaranteed their bonds.  On top of this , the government (under Alastair Darling) bought shares in these top banks.  This was very far from nationalisation with management and control going to the public.  And the cost of this investment was very generous to existing bank shareholders.  It was made in three tranches – £15.0bn @ 65.5p in October 2008, £5.3bn in March 2009 and £25.5bn at 50p in December 2009.  By the time the last tranche was made, the share price at RBS had fallen to 29p and yet the government paid 50p.  The current price is 23p.  So the taxpayer is currently losing billions. 

The same generous bailout terms were instituted in the US.  About $1.2 trn of public money was handed over in loans, share purchases and guarantees to the banks.  The largest borrower. Morgan Stanley got $107bn, Citigroup got $100bn and Bank America $91bn.   This has been kept secret for over two years.  US bailout funds also helped the UK’s RBS which took $84bn, UBS $7bn and Hypo Bank in Germany got $29bn, or $21m per bank employee.  The banks were saved, but homeowners continue to lose their houses and households their jobs.

And yet, there are some mainstream economists who continue to insist that it should be ‘banking as usual’.  Indeed, banking profits and bonuses are seen as essential to the well-being of capitalism.  Take this new paper by Nobel prize winner Roger Myerson (A model of moral hazard credit cycles, 4th meeting in Economic Sciences, 2011).   With not a hint of a tongue in his cheek, Myerson tells us that investment bankers may be paid too much i.e. they get ‘moral hazard’ rents because banks are backed up by the government.  But the cost to the taxpayer can be spread over years and we can pay bankers their bonuses on performance if they make successful investments.  Booms and cycles in the economy may continue but that is the way of the world.  Indeed, Myerson says, “a tax on poor workers to subsidise rich bankers may actually benefit the workers as the increase of investment and employment can raise their wages by more than the cost of the tax.”   Trickle down economics is still alive and well.

I’ve argued in this blog many times that banking plays an important role in a modern capitalist economy and credit mechanisms will do so for many generations even if capitalism were to go as the dominant economic system.  But banks need to be run as a public service to small businesses and households providing credit for projects that create jobs and incomes, with loans at reasonable rates.  But this ‘traditional’ role has all but disappeared in the binge of financial speculation.  The assets of British banks, for example total #6trn, or over four times the UK’s annual GDP.  But loans to business is just #200bn or 3% of that total!

The Vickers Committee does not want to stop banks speculating and gambling. It just wants to separate that activity from ‘ordinary’ banking so that taxpayers don’t suffer.  But if banks collapse because of their speculations that will still have a huge impact on the economy even if the ‘ordinary’ part  of the banks are safe.  Creditors will lose money, jobs will disappear and all the connecting employment that goes with them.  Moreover, these new proposals may never see the light of day or be watered down to nothing by 2019.  In the US, when former Fed chairman Paul Volcker proposed similar measures to the US administration, they ignored him.  The governments of the major capitalist nations want banks to continue as much as possible as before.

The real issue is whether we want banks to provide a public service to the wider economy or just be dangerous risk-takers that could take the economy down with them.  Banks cannot be a public service by just returning to regulation with new ‘firewalls’ in their structure.  How well did that work last time?  The answer is proper public ownership of the sector with democratic accountability, so banks operate as part of a social plan for growth and employment.  The Vickers Committee report will do nothing for that.


2 Responses to “Saving the banks”

  1. George Hallam Says:

    “The answer is proper public ownership of the sector with democratic accountability, so banks operate as part of a social plan for growth and employment.”

    I agree.

    Have you heard of Lewisham People Before Profit’s policy of starting a local investment bank to help Lewisham’s economy ?

    Here is some of the pitch:

    Why do small businesses fail?

    People who set them up are “following their dream”. They lack the business experience and expertise to make the dream work. Often the dream has no basis in reality.
    The other main reason is lack of capital. Even with a good idea and the right expertise it takes time to build a viable business. This makes small businesses dependent on the financial sector.
    Commercial banks can make money out of impossible schemes by extending high interest loans or overdrafts and then pulling them when the entrepreneur’s own capital has been exhausted. The assets are liquidated and the Bank gets its capital back. Perversely, the financial sector can make more profit by financing failure (with high interest overdrafts and short-term loans) then by investing in successful ventures (through lower interest long-term loans).

    The Bank of Lewisham’s aim would be to develop the local economy as a whole – not short term profit.

    Anyone wanting to start, yet another, hairdressers in Lewisham would be politely told to look for capital in the commercial sector. However, a firm making solar panels would get a hearing. Once the bank had identified sound schemes it would then work to make sure they had the maximum chance of succeeding. That would mean help with tasks like record keeping and accounts, chasing up creditors (a big problem for small firms, especially when dealing with large firms). Above all interest rates would not be extortionate. They would not have to be because the reduced failure rate would mean less losses to cover.

    Lewisham council has a budget is about £1 billion per annum and net assets are a similar ammount.

    These assets would provide the capital base of the bank. Since the aim of the bank would only be to finance local business this would mean that , from a commercial point of view, it would be massively over-capitalised and extremely robust.

    If a large numbers of local authorities sep up similar banks then they could displace banks as the providers of finance for SMEs.

    This would be a major step towards a modular banking system.

  2. michael roberts Says:

    An interesting piece about the role of state-banking was brought to my attention. It comes from North Dakota, US. North Dakota boasts the only state-owned bank in the nation. The Bank of North Dakota (BND) was established by the state legislature in 1919 specifically to free farmers and small businessmen from the clutches of out-of-state bankers and railroad men. The bank’s stated mission is to deliver sound financial services that promote agriculture, commerce and industry in North Dakota. By law, the state must deposit all its funds in the bank, which pays a competitive interest rate to the state treasurer. The state guarantees the bank’s deposits, which are plowed back into the state in the form of loans. The bank’s return on equity is about 25%, and it pays a hefty dividend to the state, which is expected to exceed $60 million this year. In the last decade, the BND has turned back a third of a billion dollars to the state’s general fund, offsetting taxes. The former president of the BND is now the state’s governor.

    The BND avoids rivalry with private banks by partnering with them. Most lending is originated by a local bank. The BND then comes in to participate in the loan, share risk, and buy down the interest rate. The BND provides a secondary market for real estate loans, which it buys from local banks. Its residential loan portfolio is now $500 billion to $600 billion. Guarantees are also provided for entrepreneurial startups, and the BND has ample money to lend to students (over 184,000 outstanding loans). It purchases municipal bonds from public institutions, and it backs loans made to new farmers at 1% interest. The BND also has a well-funded disaster loan program, which helps explain how Fargo, when struck by a disastrous flood recently, managed to avoid the devastation suffered by New Orleans in similar circumstances.

    North Dakota has also managed to avoid the credit freeze, through the simple expedient of creating its own credit. It has led the nation in establishing state economic sovereignty. In California and other states, workers and factories are sitting idle because the private credit system has failed. An injection of new money from a system of publicly-owned banks on the model of the Bank of North Dakota could thaw the credit freeze and bring spring to the markets once again.

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