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.