| Why do we have banks? Well it depends on whether you are talking about a traditional bank: by which I mean one subject to tight government regulation: or a new one, which is not so constrained. But whichever type you are talking about there are some basic things that they do and which are central to their business.
1. Banks advance money to countries
2. Banks make loans to individuals (in the form of mortgages and credit cards, for example)
3. Banks make credit available to companies big and small.
4. Banks take deposits from people who want to have their money looked after safely.
Advances to countries are made because it is very unlikely that a country will default, and so those loans are suppose to be very safe indeed.
As outlined above, advances to companies and individuals are secured on assets of one kind or another and, again, are supposed to be safe.
Loans which are not secured, like credit cards, are not so safe: and therefore they are made at ridiculously high rates of interest. That is the safeguard for the lender in those cases.
Bankers and other financial institutions are supposed to be skilled in assessing risk. That is, in fact, the only skill they can claim to have. Before deregulation they were cautious and that led to some frustration for the propective borrower: it was not easy to get loans. Nor should it be. But that changed when the regulations were lifted.
Imagine you are a bank and you make your money in the traditional way: you get money from deposits, when people who wish to put their excess money somewhere safe give it to you to look after. You take that money and you hold some of it in reserve and you use the rest to make loans to people who wish to raise money for some purpose. You pay interest to the person who made the deposit at x%: you charge interest on the loan you made to the borrower at x+y%. The difference is your profit.
Over many years you have learned how much to keep in reserve so that you can give people their money back when they ask for it: Let us say that experience shows that over time, when all is going fine, only 40% of your depositors want to take out their money at the same time: if you keep 50% of those deposits in reserve you can always meet those demands, and you can lend out the other 50% quite safely. Naturally it might happen that folk suddenly panic for whatever reason, and might come to believe you are not solvent: and they they will all want their money at once, then. You can't make any money if you organise your affairs on that assumption: for that to be the norm you would have to make a direct charge for looking after the money, and for any other services you offer to depositors. That was done in the past, I believe, and it was called bank charges. They appear to have been abolished (apart from charges if the depositor does something naughty) but I do not know how that came about. What I do know is that this is not how things are done normally now. Rather, it is recognised that won't happen if everybody is responsible and the people trust the banks: and to foster that confidence the government has a central (national) bank which acts as a lender of last resort. Basically the government guarantees the depositors money if you go bust: and so the depositors are comfy and such guarantees never needs to be invoked.
To make sure that everybody is responsible the government makes rules about what you can and cannot do with this money. I have already mentioned that bank activity was restricted in the UK till 1980: similarly the american banks were restricted by something called the Glass-Steigal Act. That act was passed in 1933 because it was recognised that the crash of 1929 was largely due to banks using deposits to make reckless speculations and irresponsible loans: that they were also doing that in their own interests and with conflicts of interests ignored was also of concern. Glass Steigal made banks choose whether they were to be "investment" banks or ordinary "commercial" banks: they could not be both. It also introduced the government guarantee of deposits mentioned above.
This kind of regulation seems to have worked very well for a long time. Long enough for people to forget the reason for it: and for the bankers and others to revise history, explaining the crash in other ways. In face of their claim that the act was hindering the banking and financial industries the act was repealed in 1999: it was suggested that in these days of bigger banks which relied on their reputation for their profit, they would regulate themselves. Since there has never been a time a bank did NOT rely on its reputation that seems thin, at best. Perhaps more important was the fact that London had already reduced the regulation, and the city of London was competing without the constraints still placed on American banks. Not sure about that. Whatever happened (and capture of government by the neoliberals has to be part of that) the underlying theory was that this leopard had indeed changed its spots: as ever, "this time is different": but in reality, as ever, "it is always tulips".
When banks are not tightly controlled they cheat. There does not seem to be a time in history where this is not true: there never will be. Everybody has a price and the rewards are enormous: as we have seen yet again. It is not enough to rely on integrity; or on expertise; or on the wish to make sure the business has a future: for money like that they will gamble and they will cheat. So they have to be stopped. Only government can stop them: and so predictably they will try to tie government in to their narrative: they will spend to make sure that those elected support their "freedom"; they will point to the apparent success of their prescriptions (and they will be successful at first) and deride those who are not convinced as enemies of prosperity or as dinosaurs. Sadly, as with a lot of things, cause and effect is in play: but the lag is long. Governments think short term and people's memories are short. With the right backing and the right climate and the right legislation they can capture not just the regulators and government: but the surface zeitgeist too. And so they did. Many people who did not like these financiers and bankers were admiring of them in a way: they said they had solved the problem of perpetual growth without adverse effect: and this was believed. The fact that they had actually invented a perpetual motion machine was somehow missed.
So what could we expect of a bank and what has happened?
1. They lend to countries. Even under tight regulation banks could buy government bonds. This is because government bonds were very safe indeed. If push comes to shove, a government can print money to pay the interest and capital on the bonds it has issued, and since governments need credit all the time that is what they will do when necessary. Might lead to inflation, and that is seen as a problem: but since everyone agrees that too much inflation is a bad thing they will take steps to keep it in check. So they are all on the same side.
However that is not always true: there are rogue states and there are unstable states and there are destitute states. It follows that a bank which is buying government bonds needs to take a view on the risk, just as with everything else. That is their skill.
In the current situation we are told that sovereign debt is at risk of default. The banks did not anticipate this, and they have lent an awful lot of money to countries they say are not now certain to repay them. They have done this in two ways: the traditional way of using your money and mine (deposits they held for us): and the other way of using money that does not exist: that is notional assets which are not worth what they are valued at on the balance sheet: like derivatives and subprime mortgages.
If the banks were doing their job they would assess risk. And as shown, the reason lending to a country is safe is because a country can print money if necessary. Only, that is not true in the eurozone. None of those countries can do that because none of them has control of their currency. That is fairly obvious. And it changes the game in their own terms. These expert risk assessors should have noticed that, and it does not seem unreasonable to see them as incompetent if they did not. But in fact they did, I am sure. They relied on the political will to maintain that currency and therefore expected that they would not face the losses arising from their failure to take elementary precautions. They were right. But the bail out, as currently implemented, won't work: the only way that will work in the terms envisaged is the establishment of a proper central bank. And the countries are not ready to do that because in the end it is tantamount to becoming a united states of europe. So instead they have asked the banks to forego 50% of the loans. They might or might not agree: but if they do, having received a lot of money, they will not lend any more. We have already asked them nicely after giving them loads of money and not asking that they accept a loss: it is vanishingly unlikely they will get back to their proper function if we ask them again now. If you doubt that, there is no need to guess: this has already happened in Japan.
I can see no reason to let them suffer only half the loss they risked: it was their risk and they lost: for everyone else if you gamble and lose you lose 100% of your money: and that is what should happen.
2. They lend to individuals on secured and unsecured terms. Secured loans were mainly based on houses, as discussed above. Again, what is a bank supposed to do: assess risk. If house prices rise at astronomical rates it is perfectly obvious that is a bubble. We have seen them before. Any bank which decided to lend on the basis of that inflated value knew fine well it was a gamble. Well not so much a gamble, as absolutely certain not to cover the loan eventually. They knew that, else they would not have bundled those loans up and hidden the danger from other folk they sold them to. Some of those banks face charges over that in America: they probably will get off: they usually do. But the fact is they knew and that this is fraud. It follows they should face the consequences of that: they are awfully keen on that for other folk. Those banks should take the losses: and if they outstrip their real assets they are bankrupt. Limited liability means that the money individuals stole in the form of bonuses and high wages are not legally touchable: but we an fix that. They are the proceeds of crime and can be confiscated. Simple.
If we do that there is no bank, and that is apparently disastrous. Can't see why: I can see nothing at all wrong with taking them over and running them as nationalised industries. It seems that when that is mentioned everybody rushes to say: "of course nobody wants that": indeed, where we have been forced to do it the main aim is to get them back into the private sector ASAP. Why? They can't do any worse in the public sector, and at least the money we give them would be used as we wish to see it used: no more asking nicely. What is the downside?
3. They lend to companies, large and small. Well small companies say they don't: they can't get finance and it is hurting them. They do lend to big companies: but not without conflict of interest: the big companies and the banks and the finance houses are a closed shop and they are complicit in the system they run, so far as I can see. Even companies which makes something make more of their money through finance than through manufacturing: so in effect they are part of the problem.
I cannot see that these banks have done their job in any way: I cannot see what advantage we get from protecting them from their losses: and I cannot see that their loss would be a problem, since we can make loans and take deposits directly in nationalised banks which do what is necessary for society and not for themselves. As with economists, I am not persuaded these people have any skills at all: they are gamblers and they are gambling with your money. Seems odd to let them continue, to me
Edited by FionaK - 30/10/2011, 23:20
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