Banking and Finance in the UK Made Easy: What’s wrong with banking?

There are a number of problems with finance, first of all there is a problem of perception. Not our view of bankers, we are probably already too lenient. The banking system’s first problem is of self-perception, as illustrated excellently by Alan Greenspan. Greenspan was chairman of the Federal Reserve, America’s central bank, and is both a follower of Ayn Rand and an ardent shill for the financial sector. Recently he had this to say in the FT.

Today’s competitive markets, whether we seek to recognise it or not, are driven by an international version of Adam Smith’s “invisible hand” that is unredeemably opaque. With notably rare exceptions (2008, for example), the global “invisible hand” has created relatively stable exchange rates, interest rates, prices, and wage rates.

“Notably rare exceptions” include the potential permanent loss of £7.4 trillion from the UK economy, and the blighting of millions of lives worldwide with unemployment, poverty, and insecurity. The financial sector sees their errors as just that, simple errors which we should write-off without much further analysis. A better approach would be to see these “notably rare exceptions” as pollution, against which we need to take action. The structure of modern banking means we are exceptionally vulnerable to financial crises, it is the structure which therefore needs to be tackled.

The infamous Glass-Steagall Act was passed in the US in the wake of the Great Depression, it separated commercial and investment banking. Banks which took deposits from people like you and I were barred from the casino side of banking, and investment banks were barred from accepting deposits. This kept the size and exposure of most banks limited from the 1930s until the 1980s.

The 1980s conservative counter-revolution embodied in Thatcher and Reagan had some notable successes, the ardent reformers in the UK and US enjoyed better growth than the lacklustre reformers on the Continent, but one aspect of the New Right’s programme seems to have been a major failure. Divisions between banks, and restrictions on their activities were torn down and market discipline was supposed to police the actions of the financial sector. This appears to have been a mistake. I would be more smug were I to be less poor as a result of this “I told you so” moment for the left.

Since the 1980s banking has become more concentrated as firms become larger and fewer in number. It has also become more interconnected and complex as financial derivatives have become more widely traded. Inevitably, the system has become more diverse and interdependent. This diversity should be good for banks, a diverse investment implies a safe investment because you have multiple sources of income, if one fails another can take up the slack. Unfortunately, when all banks are more or less equally diversified all banks effectively end up holding the same investments and when one goes down, they all go down. This is the banking system which the world currently has and it is a very bad system.

Massive systemic risk is generated by a financial system subsidised by the public, even while it employs the wealthiest people in the world. This is not a good system and neither is it a system which should be uniquely criticised by the left. The state support the financial sector enjoys and the vile behaviour of its upper echelons means everyone from free market liberal to One Nation Tory can and should work to produce a better system of finance. The next post will examine what benefits may come from restricting banking and what a restricted banking system could look like.

Filed under: Economics, Politics, Society

Banking and Finance in the UK Made Easy: Time to get Angrier

On April 11th the UK’s Independent Commission on Banking will report its interim findings. Although much attention, ink, and blood, has spilled on student loans, spending cuts, and NHS reforms, much less been attention has been directed towards banking and finance. This is remarkable given that the financial sector bares most of the responsibility for the catastrophic recession through which we have been living. Mervyn King is right; it is surprising people are not even angrier than they are.

The reason, I think, people are not angrier, is because they do not know much about the arcane world of finance or what solutions to the problems of financial crises are viable. People want to make sure “it” doesn’t happen again and they want to punish the people responsible, but aren’t sure how.

The next few blog posts on this site will therefore outline why you should be angry and what needs to be done about.  First, why to be angry, this was the easiest one to write; next we will discuss the shape of banking today and why it needs to be changed; after that a post will discuss what we can do about the banks. The final post will sum up and pose the question to those better at campaigning than I “how do we get the government to do what is necessary?”

It is difficult to quantify how much the world or the UK has lost due to the reckless negligence of the financial sector. Neither is it possible to say precisely to what extent regulators failed. The damage caused to the UK Government’s balance sheets is well-known and easily understood, however the damage extends far further than that. The graph below merely illustrates one consequence of bankers for the UK as a whole.

The red line is trend economic growth from the start of the past decade, the blue line is actual economic growth. As you can see the financial crisis caused a massive fall in living standards from which we have yet to fully recover (xls). Worse still, evidence cited by Andrew Haldane (pdf) (something from which I’ll being borrowing extensively for these posts) shows financial crises can cause declines in living standards from which economies never recover – a permanent loss of income.

Depending on how pessimistic you are you can roughly quantify the long-term losses to the pocket books of UK citizens. Anywhere from around £1.8 to £7.4 trillion of wealth may have been permanently forgone as a result of the financial crisis. If that has not already made you angry then consider this. Because large banks have long been considered “too big to fail” they have received an implicit subsidy from us to them, something to the tune of £30 billion pounds a year to the five biggest banks. We have been made permanently poorer by organisation which already enjoy an exorbitant subsidy. It being finance, it of course gets even worse. Those supplicants to the public purse are already lobbying for weaker regulation, and this before the Commission has even reported.

Although it is tempting to use this as a justification for the crushing of financiers beneath the boot heel of indignant rage, sadly we do need bankers. Capital needs to be allocated, risks need to be insured, and prices need to be set and the financial sector does all these productive things, and more. However, financial sector failures generate massive generalised and uninsurable losses for the whole economy and some level of intervention is both just and necessary. That is what is to be discussed, stay tuned.

Filed under: Economics, Politics