In response, politicians have enthusiastically espoused “resolution mechanisms”,

yes, that’s one of the things being done, the idea is that if a bank goes bad, it can be allowed to fail without bringing down the global financial system

The focus should instead be on ensuring that no single financial institution is capable of bringing down the global financial system.

umm, come again?

oh, OK, you think resolution mechanisms won’t work and we still need to break up the banks. Fine.

Why should a bank like Barclays channel resources towards lending to small businesses, when it can deploy these same resources on the capital markets, and earn a much higher return?

I need some help with this. In which “capital markets” are returns “much higher” than lending to small businesses? What assets do you think banks are holding, instead of making loans to businesses? Please explain how holding, say, government bonds, prevents banks from lending to businesses – I thought your lot thought banks can create money at will and operating under no financing constraints. What’s the return on government bonds, by the way, relative to the return on lending to small businesses?

A significant part of the problem is the very high regulatory barriers. These increase the costs to the extent that it is very difficult for anyone to create a new entrant to the market. Also as we have seen over the past 15 years or so, merging banks is very attractive as this spreads the dead weight costs of such regulation.

The trouble with solving this is that you can point out the facts above and bring in the point that part of the reason top level banking is so high is the lack of competition, but anyone saying “deregulate” is likely to be hanging from a lamp post in short order.

“Why is nothing being done about banks still ‘too big to fail’?”

The short answer is that we are waiting for the Banking Commission to report:

Sir John Vickers to Chair the Independent Commission on Banking
http://www.hm-treasury.gov.uk/press_11_10.htm

“The commission’s interim report is to be published on 11 April before a final report in September which will be scrutinised by a cabinet committee chaired by the chancellor, George Osborne.”
http://www.guardian.co.uk/business/2011/mar/09/lloyds-boardroom-shakeup

Hi Luis,

The high returns I am referring to stem from, for example, speculation using derivatives.

Whilst derivatives can be used for hedging existing risk, they are also a source of leverage, and thus they are frequently used in a highly speculative manner. They allow investors to speculate on the future price of a product, without having to buy the product itself, which would require a large upfront cash outlay. Whilst a certain amount of speculation is useful, as it expedites price discovery and provides liquidity for hedgers, many markets are now overwhelming dominated by speculators. For example, approximately 80% of the CDS market consists of “naked” CDS trades, i.e. CDS trades that are purely speculative, and not used for insurance purposes.

This excessive speculation has no real social value; it ties-up financial resources, and primarily benefits only bankers, hedge funds, etc. These resources should be being put towards initiatives that create real value; for example, by increasing lending to small and medium sized businesses, the engine of growth in any economy.

Lydia

Lydia,

and what makes you think that’s relevant to Barclays and other banks?

The only sense in which Barclays could be indulging in speculation rather than lending to small businesses (itself a speculative activity) is the extent to which it allocates its money for proprietary trading in derivatives and such like. Otherwise all that stuff you mention in done by hedge funds etc. and is more likely a source of fee income for an investment bank (like Barclays Capital) rather than something that “ties up resources”.

What reason to you have to think that when a bank like Barclays decides to allocate more/less money to proprietary trading that entails allocating less/more money to small business lending? It’s not as if the size of a bank’s balance sheet is fixed, and it’s just a matter of deciding the composition of its assets. (Which would entail that allocating more to prop trading could mean allocating less to SMB lending)

“Why should a bank like Barclays channel resources towards lending to small businesses, when it can deploy these same resources on the capital markets, and earn a much higher return? ”

That’s a good question – quote:

“The top 10 hedge funds, measured by total dollar returns since they started, made profits for their investors of $28 billion in the second half of 2010, the Financial Times reported, citing research by LCH Investments.

“That was more than the combined profits of Goldman Sachs Group Inc., JPMorgan Chase & Co., Citigroup Inc., Morgan Stanley, Barclays Plc and HSBC Holdings Plc, the newspaper said.”
http://www.bloomberg.com/news/2011-03-02/top-10-hedge-funds-profits-surpass-those-of-banks-ft-reports.html

I believe that it’s fairly well known that banks like making personal loans because the yields for the lending banks are usually better than with making loans to SME businesses while the default rate is usually lower. The problem is that SME employing up to 250 employees provide over half of private sector employment in Britain:
http://stats.bis.gov.uk/ed/sme/Stats_Press_Release_2009.pdf

The answer to the headline of the post is simple. The easiest place to start with the breaking up the banks are the two banks that the state owns a majority of. But the Treasury wants to sell them off for the maximum return, which will most likely be as big banks.

“It facilitates the funnelling of capital away from the real economy and toward unproductive speculation. Why should a bank like Barclays channel resources towards lending to small businesses, when it can deploy these same resources on the capital markets, and earn a much higher return?”

Luis, Lydia is displaying the “not economics frankly” thing again.

If you’re enjoying a higher return then you are by definition at the very least capturing more value, if not creating it.

Thus, that Barclays can make more money playing with bonds and shares (recall, just other ways of financing a company instead of direct loans) is evidence that Barclays is adding more value by playing with bonds and shares than it would be by lending to small business.

It simply violates the instructions of the economists’ secret decoder ring to say “you’re making more profit over there so you must be adding less value over there!”.

But then Lydia is at the nef…..

Hi Tim,

You write:
“Thus, that Barclays can make more money playing with bonds and shares (recall, just other ways of financing a company instead of direct loans) is evidence that Barclays is adding more value by playing with bonds and shares than it would be by lending to small business.”

Costs and benefits are not always fully reflected in prices. This is a widely acknowledged phenomenon. Thus, you cannot automatically equate maximum profits with maximum value.

Although it is obviously important to have secondary markets for securities (as this provides liquidity and thus lowers the cost of capital for companies and governments), it is important to acknowledge that secondary markets primarily redistribute wealth, they do not create new wealth like small businesses do. Furthermore, many markets add substantially less value than those for shares and bonds do. For example, many people would question the value that has been added by CDO markets… which, for a while, were hugely profitable for banks.

Lydia

Ever since the first taxpayer-funded bank bailout, the question on everyone’s lips is: “How can we ensure this never happens again?”

And the answer is to elect a government that will stay at arms length from the big corporations and will not bail out failing businesses in the future, no matter how big.

But don’t ask me how you do that.

“Costs and benefits are not always fully reflected in prices. This is a widely acknowledged phenomenon.”

Externalities, yes.

“Thus, you cannot automatically equate maximum profits with maximum value. ”

Yes we can. For we are now measuring internal value creation. That is, value creation excluding the value of externalities.

“it is important to acknowledge that secondary markets primarily redistribute wealth”

No, they don’t. They enable the redistribution of wealth. I can sell my BP shares in my pension fund and use the cash to buy an annuity.

That’s why secondary markets exist, so that the owners of wealth can redistribute it as they see fit. Having secondary markets which lead to lower capital raising costs is true, but that’s a (forgive me) secondary consideration.

“they do not create new wealth like small businesses do.”

I’d love to see evidence of this really. I tend to think (no real evidence though) that the average person starting a new small business is destroying, not creating wealth. Certainly, I think the median person doing so is. And I am most certainly not convinced that increasing the number of small businesses financed or creatdew would lead to increased wealth creation.

“For example, many people would question the value that has been added by CDO markets”

I wouldn’t. Syndication, been around for centuries. It’s what both insurance markets and shareholding itself are based upon. This particular instance of it didn’t turn out well but the idea that we’re going to abandon syndication is insane: we’d have to abandon any large scale economic activity at all if we did that.

oh crap, it ate my comment

shorter version

Tim don’t bloody try and argue that a bank doing what earns the highest short-term profits is “adding more value” in any sense other than contained by the phrase “highest short-term profits”. Not after what’s just happened.

Lydia

you need to demonstrate that

1. banks like Barclays actually do allocate (significant) quantities of capital to speculation, as opposed to making fees from the speculation of others

and

2. if the answer to 1. is yes, why doing so reduces small business lending

directly unproductive profit seeking

possibilities include:

1. exploiting an advantage to win in a zero sum game
2. shifting profits and losses over time to win today at cost of losses tomorrow

Interesting bit from the original post:

1. It means that the too-big-to-fail subsidy will still remain, and large banks will be able to borrow at lower interest rates than would be the case in a free, unprotected market.

2. In addition to unfairly inflating their profits, the too-big-to-fail subsidy gives large banks a huge commercial advantage over smaller banks, and it exacerbates the barriers new firms face when trying to enter the market.

Is the justification for wanting to break up the banks to limit the danger to the global market (government intervention) or to liberalise the market (not government intervention). I appreciate that in this case the end result may be the same, but I do not think you can be concerned with government management of the effects on the global economy and the working of the free market at the same time. If you were actually working the very small interface between the two viewpoints, the words monopolies or oligopolies would presumably have been forthcoming – as this is the only free market justification for the sort of state intervention seemingly suggested here.

Anyway, nice to see the New Economics Foundation recognise that the free market is the solution, not the problem.

Hi Luis,

You write:
“What reason to you have to think that when a bank like Barclays decides to allocate more/less money to proprietary trading that entails allocating less/more money to small business lending?”

It is widely acknowledged that banks face a trade-off between speculation and lending. For example, Harvard economist Andrei Shleifer argues:
“Financing of new investment by banks [via lending to business] is always competing with speculation. If speculation is more attractive, it is going to draw the attention of banks.”

Moreover, it is not just an issue of banks committing resources to proprietary trading. For example, Nobel Laureate, Jo Stiglitz, argued that in the run-up to the recent financial crisis:
“The lure of easy profits from transaction costs distracted many big banks from their core functions. The banking system in the United States and many other countries did not focus on lending to small and medium sized businesses, which are the basis of job creation in any economy, but instead concentrated on promoting securitisation, especially in the mortgage market.”

Lydia

Lydia,

so now you’re arguing that the lure of capital markets diverts managerial attention and causes them to neglect their traditional business. There might be some truth in that, and your original post used the word “resources” which might refer to managerial attention.

How large do you think this affect is? For example, Barclays has a network of high street banks with small business lending teams – how large a reduction in lending by these teams is explained by a lack of attention from senior corporate management? Because high street bank managers aren’t going to have their attention diverted by prop trading.

otherwise, if by resources you mean funds, then you are committing something like the Junker Fallacy, something that Shliefer himself was also accused of. (that link actually takes you to a partial defence of the fallacy)

@7: But the Treasury wants to sell them off for the maximum return, which will most likely be as big banks.

Sure – because there is too little competition between retail banks in Britain. Businesses facing limited competition can earn higher rates of return than businesses serving more competitive markets.

“The UK banking market is too concentrated and not serving consumers well, according to Metro Bank co-founder Vernon Hill.

“’We have a very concentrated market with a small number of banks essentially offering the same products and the same services and the customer has very little choice,’ Hill, 65, told a House of Commons committee today. ‘The larger a retail bank is, once they get past a certain point, the poorer they serve the consumer.’”
http://www.bloomberg.com/news/2010-12-14/u-k-banking-market-too-concentrated-metro-bank-s-hill-says.html

“Leigh Goodwin, an analyst at Citigroup, says the UK is one of the more concentrated banking markets in Europe. He estimates that the big four banks – Lloyds, Royal Bank of Scotland, Barclays and HSBC – have 70 per cent of loans and deposits.

“France’s four biggest banks have a similar share of their domestic market, but elsewhere the industry is more fragmented.

“In Spain the top five banks hold about 40 per cent of loans and deposits, while in Germany they only account for about a fifth, according to Citi estimates.”
http://www.ft.com/cms/s/0/67b2d98a-968c-11df-9caa-00144feab49a.html#axzz1GCqVKXR7

Activities undertaken by banks can be broadly divided into retail & commercial banking and wholesale & investment banking.

The 340 strong UK banking sector is relatively concentrated, compared with Germany (2,000 banks) and the US (8,000 banks).

The retail/commercial banking sector is especially concentrated. The top 6 banks account for 88% of all retail deposits (cf. France 10 – 88%, Germany 7 – 68%, US 8- 35%).

What matters is not competition per se but competition to provide what customers want. Where markets are not functioning well, suppliers may compete amongst themselves, but not necessarily in areas that customers care about. Possible distortions of incentives in financial services markets are (a) ill-informed choice by customers – leading to their being exploited, (b) mis-alignent of incentives between owners, creditors and managers of the firm – leading, for instance, to managers being unduly rewarded on the basis of short-term performance measures, and (c) implicit state guarantees – leading to excessive risk-taking.
http://www.regulation.org.uk/financialservices.shtml

See, too, this submission to the Banking Commission by Diane Coyle:
http://bankingcommission.independent.gov.uk/bankingcommission/wp-content/uploads/2011/01/Enlightenment-Economics-Issues-Paper-Response.pdf

“It is widely acknowledged that banks face a trade-off between speculation and lending. ”

Only among those who aren’t thinking hard enough.

Direct lending so that people can buy a house or buying bonds which are made up of mortgages…..one you would call lending, the other speculation. But the only trade off there is between *which method* we’re going to use to finance the purchase of housing.

With large company financing, we could have banks loans (lending) or commercial paper or bonds (speculation). For smaller company funding, we could have lending or equity investment (anything from VC through private equity to angel investing). For former would again be lending, the latter speculation.

It’s simply an observation about the world that the Anglo Saxon system does more financing through “speculation” than the Rhineland version of capitalism which does it through lending. There are indede arguments about which is the “best” system, but to see them as anything other than simply different methods of arriving at the same goal is, well, it’s the sort of thing we expect from nef (and Will Hutton, obviously).

Tim Only among those who aren’t thinking hard enough.

Yeah, there’s an unlimited supply of capital out there isn’t there?

@ TW

“For example, many people would question the value that has been added by CDO markets”

This particular instance of it didn’t turn out well

I trust your tongue was very firmly in your cheek when you wrote that………

“Yeah, there’s an unlimited supply of capital out there isn’t there?”

You’re absolutely right Sunny, there isn’t an unlimited supply of capital. Which is why we have fractional reserve banking, leverage, markets, futures, options and the whole damn shebang, in order to make that limited supply go further…..

Tim, as previously stated, I am not arguing that bond and equity markets do not provide any value. I am merely arguing that whilst retail and investment banking remain under one roof, there will always be a problem with resources being directed towards speculative activities rather than lending to businesses. Given the lack of competition in UK retail banking, and the too-big-to-fail subsidy these giant banks enjoy when raising capital (which increases barriers to entry in the market), this concern is all the more pertinent.

Luis, surely your argument about the Junker fallacy only holds if the recipient of funds invested in speculative activities then deploys those funds in productive investment? If instead the person who has sold the share/bond/derivative/etc purely uses the proceeds to speculate themselves, and so on and so forth, then surely this money is just circulating between banks, hedge funds, etc. Whilst, obviously, some of the money would exit the system and get used productively, surely a lot of capital would remain in this unproductive loop?

Lydia,

if it was the case that every £ spent on ‘speculation’ entered an infinite loop, by purchasing a financial instrument where the seller just turns round and buys another one, and round and round, it sounds like you don’t need many £ for an awful lot of speculation. not clear why it would cause a shortage of £s elsewhere.

I’m not arguing that the asset allocation decisions of banks don’t matter, I am arguing that the idea banks aren’t lending to small businesses because they are speculating instead, doesn’t have a lot of traction.

Sunny, if anything there is a savings glut, not a capital shortage.

Tim Worstall: Which is why we have fractional reserve banking, leverage, markets, futures, options and the whole damn shebang, in order to make that limited supply go further…..

How that relates to the original point is unclear, but thanks for the quick primer. Still means capital is limited doesn’t it.

This is the same fractional reserve system that meant banks were vastly under-capitalised when everyone realised the loans were dud… yes?

“Still means capital is limited doesn’t it.”

Yup, which is why we work so hard to make it go further.

“This is the same fractional reserve system that meant banks were vastly under-capitalised when everyone realised the loans were dud… yes?”

Not quite. Fractional reserve banking doesn’t particularly imply a certain level of capital. Capital levels are associated with whether a bank goes bankrupt having lost a certain amount of money: with solvency.

Fractional reserve offers a different problem: that banks are illiquid. This is why banks are always possibly subject to bank runs. It’s a very different problem indeed.

Solvency and liquidity problems are different: you can be illiquid and solvent, insolvent and liquid.

The liqudity problem of fraction reserve is why we have deposit insurance. For the general thought is that having 100% reserve banking would restrict our supply of capital way too much.

That the banks themselves should have higher capital cusions, sure, with you there. But then again, before, they were just obeying international regulation (Basel II) and in the future they will have more capital under the changes to that international regulation (Basel III).

But again, it doesn’t matter how much capital a bank have if it’s illiquid…..which is the major problem with fractional reserve banking.

Tim Worstall Yup, which is why we work so hard to make it go further.

True. so far, in fact, that it ended up financing dud speculative projects that nearly brought the world economy down.

what we need Tim is ways to extend that money EVEN FURTHER… right?

“ping” – dang, I think the money extended too much again …

I love the way Tim calls it “value creation” when anybody else might call “expropriating synthetic profits before the shit hits the fan”.

Lydia, I can’t think what possible model you can be using to think that raising the banks cost of capital will make it easier and cheaper for SME to borrow? Yes prop trading is mostly speculative and gambling. However, it is a tiny part of the universal banks business. The vast majority of what the investment banks do is genuine hedging. It is no surprise that this has grown as globalisation has progressed. Capital knows no geographical borders and a great many people and firms are exposed to cross-border inflation risks, interest rate risks and currency risks. Therefore, they need to be hedged and that means they need large cross-border universal banks. A two bob bank with 100 branches are no use to someone like Rolls Royce doing business all over the world.

I agree that the banks enjoy an implicit subsidy and they should pay for it. There is no size of bank no matter how small that we would allow to fail. We are not prepared to see depositors households and firms lose their money. That is just the reality of realpolitik, the depositors are unsecured creditors like all over creditors and would be in the queue with all other creditors for years after a bankruptcy. So Mr King can spout all he likes about orderly failures but absolutely no one would believe the promise was credible.

Competition is quoted as a solution to everything. Hey, competition is usually great for consumers. However, it was competition that made high street retail banking unprofitable and led to the rise of off balance sheet securitisation in SIV etc. If competition was a problem you would be able to demonstrate that UK consumers wee paying higher costs for personal banking vis-a-vis other countries. Here is a clue, they are not. Furthermore, one of the least competitive banking systems is in Canada, and in the banking crisis it also proved one of the safest.

Where you do have a point is in financing for SME and more competition is required for that market. However, no amount of competition and capital will turn a bad idea or a bad business plan into a good investment. Most small businesses go bust so they do have large risks attached. Germany does better financing SME so I agree we could do better. Bank debt financing is not the only way to get capital to SME. What is badly needed in Britain is a bigger bond market for the small caps.

The likes of Adam Posen when he joined the MPC was shocked that a finance country like the UK did not have much of a bond market for SME. I noticed recently that John Lewis are planning on issuing bonds to raise capital and we need to see more of that to get firms away from relying on bank financing. The large caps can easily issue bonds but minimum lots of £50,000 are usually too high for small investors. The government ought to try and nudge a SME bond market going down to £100 into life through tax incentives. That way you get financing for SME but wean them off relying on the banks.

The bankers and the global elites own the politicians so that is why noting happens.

@28 Richard W.

I appreciate most of your post, but can you respond on a few points.

A two bob bank with 100 branches are no use to someone like Rolls Royce doing business all over the world.

But isn’t that pure investment banking, or rather there’s no (necessary) overlap between the function of investment banking and retail banking. Rolls Royce is not like Joe Bloggs in the street.

There is no size of bank no matter how small that we would allow to fail.

Well, quite a retail bank shouldn’t be allowed to fail. But nobody cared to much when Barings went down. Or to put it another way, Rolls Royce aren’t going to be protected too much by the £50k protection cap on savings. Essentially, the two systems shouldn’t need to meet.

However, it was competition that made high street retail banking unprofitable

Really? I don’t think the building societies were unprofitable, if that really mattered in any case, as they were mutual. It was more that carpetbaggers saw an eye for a quick profit, and then the larger banks saw more profit in consolidation and access to all those nice retail balances that they could leverage.

I like the points about SMEs. The large banks just aren’t interested in them because they’re too much hard work and they are not really in the same market. We need to do much more to provide them with a better finance market.

30. gastro george

The point I was trying to get across is often on here people will refer to too big to fail. Automatically people will assume if they are TBTF just have multiple small banks by breaking them up and the problem is solved. Small banks could not provide the financing for even medium sized firms never mind the big caps. The other issue is the one that Mr King is always on about and that is the idea of splitting investment banking division from the retail bank. The impression given is that investment banking is all speculative and there used to be a separation in the UK. We never had anything like the US Glass Steagall and there is no need for it now if we get the capital requirements right.

” But isn’t that pure investment banking, or rather there’s no (necessary) overlap between the function of investment banking and retail banking. Rolls Royce is not like Joe Bloggs in the street. ”

There is an overlap. Firms like the universal model where the same bank who provides them day to day banking services can also hedge their currency exposure, sell their bonds and advise on mergers and acquisitions. Although some politicians, economists and Mr King have called for this split. I am unaware of any non-bank British firms actually asking for it.

” But nobody cared to much when Barings went down.”

They were a pure merchant bank what the Americans call an investment bank. However, so were Lehman and the whole system nearly collapsed when they failed. I see what you are getting at that an investment bank who take no deposits can be allowed to fail and if the universal banks were split to narrow banks and investment bank that side could fail without costing Joe Bloggs. However, I don’t recognise that investment banking is the problem per se. The real problem in 2008 was the shadow banks and off balance sheet secularisation.

” Really? I don’t think the building societies were unprofitable, if that really mattered in any case, as they were mutual. It was more that carpetbaggers saw an eye for a quick profit, and then the larger banks saw more profit in consolidation and access to all those nice retail balances that they could leverage. ”

High street retail banking is not very profitable and their margins have been deteriorating since the 1980s on both sides of the Atlantic. They really do not make much margin from plain vanilla lending on mortgages etc. That is why they had to grow in scale to make any money and sell the loans they made on to others rather than leave them on their own balance sheets. Where they make their profits is selling other products like insurance etc to customers. They lose money on most bank accounts because they are free but the bank costs are not free. The lack of the retail balances was a big contributory problem in the UK banking crisis. The British have not been saving very much over the last fifteen years or so. That meant a lot of the banks were highly exposed to the interbank market for funding. When that started to freeze in 2008 they were screwed. Here is Gary Gorton on the loss of profitability of high street retail banking and the rise of shadow banking.

http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=4596

@31 Richard W

Thanks for the reply.

Sure, breaking up big banks is not the cure-all. From my perspective, the problem is that we now have dominance by just one kind of bank. Big cover-all banks. As I think you suggest, we need to have a more complex mixture of banks, that can offer different services to different sectors. That is what we used to have. What we need is a more comprehensive set of regulations that can enforce this.

Firms like the universal model where the same bank who provides them day to day banking services can also hedge their currency exposure, sell their bonds and advise on mergers and acquisitions.

Firms may like that model, but I would argue that the national interest should override that.

However, so were Lehman and the whole system nearly collapsed when they failed.

But is it not true that it was not Lehman going down that collapsed the system, but the effect of Lehman going down. If the owners of the Lehman trades had just been other investment banks, then they could have been let go. But the owners of the trades were the big banks.

Re retail banking, it may not have been very profitable or very glamorous, but I think there is a case for the creation of “boring retail banks” because, by definition, you want them to be safe. They need protecting from predators.

The lack of saving is, of course, related to the credit bubble, which should never have been allowed to extend so far.

Doesn’t so much of this stem from certain assumptions though? Firstly in the public mind that money in the bank is safe. It’s an investment in the same way you can invest in stocks and shares; the return is low, but so is the risk. Nevertheless there is a risk.

Secondly that there is such a thing as “too big to fail”. If you’re in debt to a bank and it fails another bank can buy the debt. From the debtor’s point of view they’re still paying out money on the loan it just goes somewhere else. In terms of savings; see point one. Alongside that the government gives a safety net, why would one be required if there was no risk? In terms of assets these can be sold off to other banks.

Sure a huge institution will have a greater impact, but the meat of it is little different to a small company going bankrupt.

Hi Richard W,

You write:
“Lydia, I can’t think what possible model you can be using to think that raising the banks cost of capital will make it easier and cheaper for SME to borrow? Yes prop trading is mostly speculative and gambling. However, it is a tiny part of the universal banks business.The vast majority of what the investment banks do is genuine hedging.”

But splitting retail and investment banking would not stop retail banks from hedging. For example, building societies currently hedge their risks by trading derivatives with investment banks.

I’m afraid I disagree with you that prop trading is a tiny part of the universal banks business. Prop trading is widespread, but most of it isn’t officially classified as prop trading. For example, all market makers have to engage in prop trading; this is what makes market makers different from brokers: they do not simply just earn the bid-offer spread. However, this prop trading will not be listed as prop trading in a bank’s annual report.

Much of modern banking activity is rent seeking, something that economists – free market or otherwise – have historically sought to curtail. Hence high marginal tax rate on the top 1% for such a long time (a policy that was hugely successful up until the 1980s when it was abandoned for an ideology that has since almost destroyed the world economy).

I’d honestly like to see Tim Worstall try to take on Michael Hudson on this issue. Probably the most clear thinking economist of the last few decades:

http://www.youtube.com/watch?v=CnrEHFwZ9hk

“I’d honestly like to see Tim Worstall try to take on Michael Hudson on this issue.”

Why would I want to “take on” someone arguing for Georgism?

Well you reduce it to that, but his broader point is that – as I said – much of the activity the financial sector performs is of a zero sum, rent seeking nature.

That seems to go directly against much of your defence of its activities, or am I missing something?

“but his broader point is that – as I said – much of the activity the financial sector performs is of a zero sum, rent seeking nature.”

That is something that has to be proven, not something to be assumed.

And no, no one has proven to me that this is true as yet.

Companies have to raise money; people-as-housebuyers have to raise money; people-as-savers need somewhere secure to keep their savings. People who do business internationally need someone to deal with those transactions, and someone to hedge the risk from those transactions. All of those things are unequivocally true, and are the reason why banks do add value.

The question is, do they charge more than the value added for providing those services, and if not, do they capture too much (from an “optimal for society” point of view) of the value added by providing those services?

My guess would be no, and probably yes, respectively. But from a UK point of view specifically, it’s not as simple as that. The US banking industry is mostly domestic; it’s a tax on US companies and workers in exchange for providing them with essential services, that’s probably higher than it needs to be. Compulsory regulation of US banks that forcibly lowered profits and pay packets would reallocate surplus from bankers to non-financial companies (ie their shareholders) and workers. It might also reduce the efficiency of the overall US economy, or it might not – that’s a hard empirical question.

But the UK banking industry, especially outside of retail consumer banking, mostly isn’t. We provide those services to countries across Europe and developing markets, and the value captured from that goes to the UK taxpayer (yes, perhaps less than it might – Barclays etc – but more than 0), to UK landlords, employees, professional services firms (and their landlords, employees), etc.

If we were to legislate in a way that stopped banks from making Copious Quantities of Money, that might be a good thing for the world at large, but would definitely and unequivocally make the UK poorer, because the premium that foreign companies that *actually do stuff* currently pay to UK banks would fall.

Tim,

There will be no convincing you because you have made up your mind in advance, but I’ll have a go anyway.

Interest rates are a form of rent. They are a ‘free lunch’ activity; the bank has to do nothing and is merely exploiting their position as a holder of capital. Interest is a way of extracting wealth from the economy without producing anything.

This was broadly deemed unacceptable by all sides of the political debate throughout economic history. Then the train of economic thought was slammed into reverse in the 1980s, inequality went vertical and the initial seeds (not saying it couldn’t have been prevented after this) were sown for the crash.

Stock is similar – it is a zero sum game. One person’s gains are another’s losses and the trading of stocks adds little to no social value. It’s not ‘normal’ trading where values are subjective and both parties gain; it is gambling. Inevitably, since there is no real economic activity (i.e. labour+resource = thing), crashes happen.

As for everything else banks do, well, it is mostly a combination of the above two. These activities are no more sustainable than a housing bubble, because, to coin a popular phrase ‘there’s no there there’.

That’s why banking is the area where Adam Smith advocated regulation, Conservatives advocated high tax rates. Everybody agreed that some sort government action was necessary to prevent wealth from being suctioned out of the economy by ultimately unproductive activities.

“Interest rates are a form of rent.”

Bollocks. Interest rates are simply a recognition that there is a time value of money. $100 today is worth more than $100 in a year’s time. You’re getting hung up on hte usury argument: and no, sorry, St Thomas Aquinas, Muhammed and all the rest were wrong on this.

“Stock is similar – it is a zero sum game. One person’s gains are another’s losses and the trading of stocks adds little to no social value.”

Bollocks. The trading of secondary stocks is what allows companies to raise new money more cheaply. If there was no secondary market then you would have to hold any investment you made forever. Make it pretty tough to cash out your savings and buy a pension really, among other things.

“That’s why banking is the area where Adam Smith advocated regulation”

I think you’ll find that Adam Smith advocated interest, fractional reserve banking and even joint stock companies. All of which you seem to be complaining about.

@41: “Bollocks. Interest rates are simply a recognition that there is a time value of money. $100 today is worth more than $100 in a year’s time.”

Good old Bohm-Bawerk – who “gave three reasons why interest rates are positive. . . ”
http://www.econlib.org/library/Enc/bios/BohmBawerk.html

With Keynes, the theory of interest becomes a great deal more complex. The interest rate no longer depends on just the forces of productivity and thrift.

Determination of the rate of interest depends on a general equilibrium model in which the interest rate and national income are both dependent variables and where the supply of money, as determined by the banking system, is an independent variable – see Hicks on: Keynes and the Classics (1937)
http://stevereads.com/papers_to_read/keynes_and_the_classics.pdf

Unlike pre-Keynesian economics, money is no longer “neutral”. For a critical survey – see Victoria Chick: Keynes’s monetary theory – a partial survey (1993).
http://eprints.ucl.ac.uk/16329/1/16329.pdf

With Keynes, interest is the reward to the holders of paper assets other than money for giving up liquidity and holding an asset for which the market price could change for any of several reasons, such as more or less uncertainty on the part of capital market participants or because the rate of interest changes – when interest rates go up, the prices of government bonds go down so bond holders would sustain capital losses if they sold their bonds so they need to be compensated for taking that risk: