The value of banking according to Mark Carney and Alan Greenspan

In a recent post I added to the never-ending saga of  the criminality, corruption and incompetence of global banks (see https://thenextrecession.wordpress.com/2013/10/25/bad-bankers-bad-debts-and-bad-banks/).  Within days of that post, yet more scandals and subsequent fines on banks by the respective national banking regulators have been announced. There were fresh revelations from UBS and Deutsche Bank, which became the first banks to admit their involvement in the manipulation of the supposedly ‘free market’ in foreign exchange.

At the same, Dutch bank Rabobank agreed to pay a $1bn settlement over its role in the Libor-rigging scandal (see my post, https://thenextrecession.wordpress.com/2013/02/07/a-right-royal-banking-fiddle/). It had rigged Libor and other important benchmark rates for six years.  As many as 30 employees of Rabobank, including seven managers, from New York to Utrecht and Tokyo made more than 500 improper documented requests to change Libor and Euribor.  The bank’s chief executive was forced to resign as he said he did not know what was going on but it was his responsibility.

Similarly, Swiss global bank, UBS said that it had begun an internal investigation of its foreign exchange business and had “taken and will take appropriate action with respect to certain personnel”.   It has been forced by the Swiss regulator to increase by half the amount of capital it holds against the risk of litigation.  And then Deutsche Bank said that it had set aside €1.2bn to deal with litigation.  In the UK, part-publicly owned Lloyds Bank revealed that it had ‘provisioned’ another £750m for compensation payments for mis-sold payment protection insurance in the third quarter.  Its total misconduct bill has now exceeded £8bn, at the expense of the tax payer, in effect.

So it was pretty ironic that the new Canadian-born head of the Bank of England should make a keynote speech to the City of London lauding the role of the financial sector in the UK economy and the need to ‘move on’ from excessive regulation, so that big business could have the freedom to move its money about without too much supervision, Hong Kong-style.  Carney proclaimed that “organised properly, a vibrant financial sector will bring substantial benefits”.   As the official representative of the City money, Carney was keen to point out the importance of banking in London: with almost four times as many foreign banks as in 1913, with assets of UK banks up from 40% of GDP to more than 400%.  For Carney, this was nothing but beneficial to all: “If UK-owned banks’ share of global financial activity remains the same and financial deepening in foreign economies increases in line with historical norms, by 2050, bank assets could exceed nine times GDP, and that is to say nothing of the potentially rapid growth of foreign banking and shadow banking based in London…The UK’s financial sector can be both a global and a national asset – if it is resilient.” 

This forecast filled leading Keynesian Martin Wolf at the FT with horror (http://www.ft.com/cms/s/0/08dea9d4-4002-11e3-8882-00144feabdc0.html#axzz2ir5xoi00).  Wolf commented: “this would turn the UK into the Iceland of 2007.”  And he cited a new paper by the Bank for International Settlements (https://evbdn.eventbrite.com/s3-s3/eventlogos/67785745/cecchetti.pdf) that found a “negative relationship between the rate of growth of finance and the rate of growth of total factor productivity”.  In other words, the faster a financial sector grows in an economy, the worse is the rate of productivity growth for the whole economy.  Why?  Because finance disproportionately benefits “high collateral/low-productivity projects” i.e. banks invest in safe assets like houses and real estate rather than in innovating employment creating enterprises.

Wolf quoted the latest data on UK bank lending: as of August 2013, loans outstanding to UK residents from banks were £2.4tn (160% of GDP). Of this, 34% went to financial institutions, 42.7% went to households, secured on dwellings, and another 10.1% went to real estate and construction. Manufacturing received just 1.4% of the total!  UK banking’s principal activity is just leveraging up existing property assets. I identified the same point in work done for the pamphlet for the Fire Brigades Union on the need for public ownership of the banks (https://thenextrecession.files.wordpress.com/2012/11/s-time-to-take-over-the-bankslr.pdf) and found that the big five banks in the UK hold £6trn in assets. This is equivalent to the amount that more than 60 million British people produce in four years. Yet the banks have earmarked just £200bn of this to investment in industry in the UK, a measly 3% of the total.

Andy Haldane, responsible for financial stability at the Bank of England, estimated that when all the extra long-term and indirect costs have been added in, Britain may have lost between one and five years’ GDP as a result of the banking crisis.  And more recently, he has attempted to estimate what extra value Britain’s huge financial sector, so praised by Carney, actually adds to the wider economy (http://www.voxeu.org/article/what-contribution-financial-sector).   Indeed, Haldane, a senior employee of Carney, says that banking’s contribution is way over-estimated . The headline national accounts numbers point to a significant contribution of the financial sector to the economy.  For the US, the value-added of financial intermediaries was about $1.2 trillion in 2010 – equivalent to 8% of total GDP. In the UK, the value-added of finance was around 10% of GDP in 2009.  And on this measure, the contribution of the financial sector to GDP in the US has increased almost fourfold since the Second World War. But Haldane reckons these contributions really express high risk-taking in lending and investment by banks that eventually come a cropper when a financial or property bubble bursts, as they do periodically.  For example, the return on tangible equity in UK banking fell from levels of 25%+ in 2006 to – 29% in 2008 in the Great Recession.

Haldane poses the question: “In what sense is increased risk-taking by banks a value-added service for the economy at large?”  He answers, “In short, it is not.”  Echoing Marx’s value theory, Haldane concludes: “The act of investing capital in a risky asset is a fundamental feature of capital markets. For example, a retail investor that purchases bonds issued by a company is bearing risk, but not contributing so much as a cent to measured economic activity. Similarly, a household that decides to use all of its liquid deposits to purchase a house, instead of borrowing some money from the bank and keeping some of its deposits with the bank, is bearing liquidity risk. Neither of these acts could be said to boost overall economic activity or productivity in the economy. They re-allocate risk in the system but do not fundamentally change its size or shape. For that reason, statisticians do not count these activities in capital markets as contributing to activity or welfare. Rightly so.”

How banks and the credit system contribute under capitalism is by reducing the costs of transferring money (taking deposits and making loans) so that businesses can borrow efficiently and keep capital circulating at lower cost.  But this contribution to the circulation of capital has increasingly taken a back seat to the risk-taking role of investing in fictitious capital (bonds and stocks).  Haldane concludes that “A banking system that does not accurately assess and price risk could even be thought to subtract value from the economy.. and if risk-making were a value-adding activity, Russian roulette players would contribute disproportionately to global welfare.”   Thus casino banking, as lauded by Carney, makes no contribution to society – on the contrary.

Other papers show that the financial sector’s contribution turns insignificant at higher levels of economic development and another IMF paper reckons that the relationship even turns negative at very high levels of financial development ( http://www.imf.org/external/pubs/ft/wp/2012/wp12161.pdf).  The authors conclude that “finance starts having a negative effect on output growth when credit to the private sector reaches 100% of GDP. We show that our results are consistent with the “vanishing effect” of financial development and that they are not driven by output volatility, banking crises, low institutional quality, or by differences in bank regulation and supervision.”  In other words, it is not just that banks trigger financial collapses, the finance sector has a generally negative effect on the productive sectors of the capitalist economy over time.

Another study (http://www.voxeu.org/article/finance-and-growth) rejected the idea that building a financial sector as a ‘national jewel’ for an economy, as Carney envisages, was productive. “This view towards the financial sector sees it more or less as an export sector, i.e. one that seeks to build an – often – nationally centred financial centre stronghold by building on relative comparative advantages, such as skill base, favourable regulatory policies, subsidies, etc.  But based on a sample of 77 countries for the period 1980-2007, a large financial sector stimulates only growth at the cost of higher volatility in high-income countries… While these results were obtained for the period before 2007, recent experiences – including the 2008 collapse of the Icelandic banking system and the collapse of the Cypriot banking system in 2012 – have confirmed the high risk of pursuing national financial-centre strategies.” 

Interestingly, in a recent interview, Carney admitted that the so-called economic recovery being proclaimed by the UK government was based on the stimulation of a new real estate boom, not on productive activity: “Right now in the UK as a whole the recovery is being led by the housing sector.” But don’t worry, “the property market is not in a bubble”, and the Bank will be “vigilant” in watching it.

That brings me to the central banker now regarded as most responsible for advocating risk-taking banking, the now retired Alan Greenspan.  Remember Greenspan was the man who claimed that nobody could predict a property or credit bubble . He has just written a new book called oddly “The Map and the Territory”.  In an interview to publicise it, he now says that he knew there was credit bubble of ‘fictitious capital’ in the US economy.  “It’s not that leading forecasters didn’t know we were in a bubble … That’s very easy to tell.”  So why did he do nothing?  When asked if he had known everything that was going to happen when he was Fed Chairman during the credit boom if would he have acted any differently? “It is very difficult to say,” Greenspan replied. “I suspect not, but I can’t say that for sure.”

The reason that Greenspan sees no reason to change his views is that he continues to uphold ‘free market economics’ and, like Carney, argue for the minimum amount of regulation of the value-destroying banking sector even now.  In his interview, Greenspan warns about “the massive burden of massive new financial regulation that is becoming increasingly counterproductive.” What is needed is not more controls on banking but a reduction in the size of government, according to him. It was not banks that have damaged economic growth but ‘too much welfare spending’ that could have gone to productive sectors of the economy. “The rise of the role of the government has coincided with, and is doubtless a cause of, increasing market rigidity,” Greenspan says in his new book:“Competitive flexibility is a necessary characteristic of an innovative growing economy, and we are at the edge of losing it.”

Sure, all that competitive flexibility exhibited so well by the financial sector.