If you assert it enough it must be true!

“Banks have a complete stranglehold on the economy because they alone create the money that we use to buy goods and services.”

http://en.wikipedia.org/wiki/Quantitative_easing

There isn’t really enough time to properly fisk this piece. But I could start at the top and write a couple of essays by the time I got to the end.

I am curious about no 7, “practices in the investment banking sector that would be illegal if done anywhere else ”

I am surprised that banks are allowed to pledge collateral for lending – do you have an example? Apart from which surely the counterparty would do some due diligence?

Aren’t Ponzi schemes illegal? (Apart from the Governments pension schemes of course)

Mis selling is certainly illegal.

What is mispricing? Surely price is determined by the two parties to a transaction – the banks don’t unilaterally set a price.

[deleted]

The bankers don’t like it when you call them on all their bullsh*t do they.

I’d love to believe that we could let the banks fail, but I don’t find a decent argument here – which is mainly a list of reasons why the OP doesn’t like banks. The key questions that go unanswered are if the banks are allowed to collapse (a) what happens to all the money people have saved – presumably it would disappear to the benefit of people who have been living on credit, and (b) who will lend money in the future? Not, I would think, mobile phone companies.

It is very hard to take this post seriously. All the puff around the excessive power of bankers (which seems to be her main angle) isn’t supported by evidence. Oh, I guess “we all know” bankers have too much power, right? That’s not a serious argument, that’s just a populist appeal.

The focus on payments may make some sense but is undermined by the rest of the post. Clearly banks do more than payments (ie point 6)

Points 2 and 3 are simply about regulation not bankers. Take a look at the difference between Basel I and Basel III.

Much of the post confuses the different forms of banks. If this was argument for a “narrow” regulated retail banking sector it would make more sense.

Point 4 about life savings is valid other than many (British) people’s life savings are actually now held in property, which often has (bank-provided) debt attached.

Point 5 about short-term-ism being new would surprise investors from 1929, or for that matter 1720.

Overall, there’s not a word on the consequences of collapsing one of the main pillars of the UK economy, which seems odd, and broadly adds to the lack of seriousness to this piece.

http://en.wikipedia.org/wiki/Quantitative_easing

There isn’t really enough time to properly fisk this piece. But I could start at the top and write a couple of essays by the time I got to the end.

Forgive me if I’m wrong but isn’t quantitative easing, only ever rarely used. The Bank of England itself estimates that 97.4% of the money in circulation today was created as debt by commercial banks (leaving only 2.6% created as true fiat currency, not backed by debt).

Now I’m not sure to which ‘column’ the Bank of England’s recent bouts of quantitative easing add to (debt money, or genuine fiat currency) but I’m fairly sure you’ve failed to apprehend the spirit of what the author is saying.

I’ve just heard on the news that the American Labour Dept. is considering sueing the banks for their part in the current economic mess.
Sounds good to me but I don’t know how it would work in the UK, I suppose it would be the taxpayer who foots the bill both ways.

“Additionally, there is evidence that securitization encourages riskier lending. After all, if you can get rid of the loans, you don’t have to worry about the risk, do you? But when sufficient numbers of securitized loans go bad, the result is DISASTROUS. The Global Financial Crisis of 2008 was primarily caused by failure of securitized retail loans.”

Err, Frances, the GFC was cause by the banks NOT getting rid of those loans they’d securitised.

They held on to the AAA tranches, so, when they fell in value the bank’s capital was wiped out (or nearly so, depends upon which bank) which then brought on the crisis.

Now, if they’d actually sold all of the loans on then we wouldn’t have had the GFC. Because those securities would be in pension funds, insurance companies, savings accounts. In places where they are not funded by leverage. So, yes, their value would go down. But the holders would not have been bankrupted: because they were not leveraged holders.

The GFC was because the banks DID NOT sell on their securitised loans: because they sincerely believed that they were good loans and thus they held on to them for the (ahem) profit they were going to make.

More on this here: http://goo.gl/10qd4

Well worth watching: http://goo.gl/ZPMuC

@7 if someone says banks “alone” create credit and it takes me about 3 seconds to think of a body not included then it’s not exactly a good start is it?

If I thought about it for another 3 seconds I’m sure I could think of someone else. Like ABCP lenders, for instance.

I could go on.

“I’m fairly sure you’ve failed to apprehend the spirit of what the author is saying.”

Yep, you can be absolutely sure of that. Sometime it’d be great to read someone here writing about finance who doesn’t argue by slogan or polemic.

@9 I think it’s probably more accurate to say the proximate cause of the crisis was a breakdown in the flow of money-market funds providing short-term liquidity to the western financial system. Pure bank lenders had largely been replaced by structured credit vehicles such as SIVs.

However, we’re splitting hairs here. The cause of the financial crisis was the sudden credit explosion from around the start of 2006 to the middle of 2007, which followed years of significant credit growth. This growth was fuelled by low interest rates, lax regulation and a competitive banking sector (and some dumb Germans – see the latest Michael Lewis piece).

The “blame it on the bankers” meme is dull and inaccurate.

@2 – It’s the one-track all the way, can’t let any chance to pass up an attack on the poor, can you. No, government pensions are not a ponzi scam, you’re a con artist trying to defraud the poor of the pensions they’ve paid for.

@ 2 Fungus: Number of points here.
1) Rehypothecation is re-pledging of securities pledged as collateral. Widely used in prime brokerage.
2) Ponzi schemes – yes, they are illegal. The problem is recognising them. The entire derivatives tower we have heard so much about is in effect a giant Ponzi scheme, but it isn’t called that. Any more than Government pensions are, of course.
3)Mis-selling is also illegal, but as the US experience shows (and the UK one, with PPI) that doesn’t stop banks doing it.
4) Pricing depends on accurate information. If the available information is wrong, or the counterparty is deliberately misled, the price will be wrong. In GFC1, the risks of CDOs were misunderstood and the instruments were therefore mis-priced (Lord Turner’s comment, not mine).

@ 5 Barrington Womble
1) There is deposit insurance up to £85K on all forms of savings, and that insurance is backstopped by government. I don’t like that, personally – I think people should manage their own risks using diversification and voluntary insurance. But that’s the present situation.
2) There are a growing number of small banks and other schemes such as credit unions. These are being suppressed to some extent by the dominance of the big banks and the extensive protection they enjoy.

@9 Tim Worstall
We’ve discussed this before, haven’t we, Tim? Yes, the banks should not have held on to the senior tranches. But the point I’m making is that in a securitized model lenders think they can unload risk without worrying about the consequences, and in my view this encourages excessive risk-taking and even fraud.

I will reply to other commentors later on!

if someone says banks “alone” create credit and it takes me about 3 seconds to think of a body not included then it’s not exactly a good start is it?

It took you 3 seconds to think of an institute (which is a bank, albeit a central bank) that creates fiat currency (not based upon debt – unless there’s an expectation that the QE funds will be repaid at some future point?) so very rarely that the normal commercial activities of commercial banks outstrip it by a factor of almost 40:1.

The central banks so very rarely use QE, it is an atypical practice.

If I thought about it for another 3 seconds I’m sure I could think of someone else. Like ABCP lenders, for instance.

I don’t know that much about ABCPs to comment. I shall await the response of someone more knowledgeable of bazaar financial acronyms than me.

@15 ” the normal commercial activities of commercial banks”

Do you mean commercial banks or investment banks or retail banks? Or does it not matter?

Anyway. I’ll stop now. Frances, if you don’t want to reply to my comments it’s fine. I am just trying to stop people lapsing into lazy sloganising and up their game. The net result of Britain’s existing banks “collapsing” would be new banks being set up doing the same things in the same way because need the intermediary function they bring. A mobile phone doesn’t quite cut it.

I’m as frustrated as anyone by the appalling state of the financial sector. But I just don’t see how writing polemics based on semi-understandings of bits of finance is particularly useful. If this piece had been titled “seven reasons why I don’t like banks” it would have been accurate.

Do you mean commercial banks or investment banks or retail banks? Or does it not matter?

I was using the word ‘commercial’ in a somewhat colloquial sense. Read it as ‘banks’ essentially.

I am just trying to stop people lapsing into lazy sloganising and up their game

A mobile phone doesn’t quite cut it.

You accuse the author of ‘sloganising’ and you in the same breath you do it yourself. I don’t think for one second that the author was suggesting that banks should be replaced with mobile phone operators. She was simply using them as an example of one of a few non-bank payment processing technologies emerging now (another one which springs to mind are crypto-currencies such as bitcoin)

I don’t understand economics but can someone kindly explain something to me? Instead of bailing banks out by paying them guzzillions, doesn’t it make sense to give every British passport holder residing in the UK over 18, say, £100,000, to be payable into a UK bank? This way banks get their money, people clear their debts and put the money back into the economy. I suspect this is very naive of me, but I’d appreciate it if someone could explain to me why…

Anubeon – And given the level of shenanigans around Bitcoin lately..
(Heck, some of the idiots have made the normal banking system look like it smells of roses…)

Anubeon – And given the level of shenanigans around Bitcoin lately..
(Heck, some of the idiots have made the normal banking system look like it smells of roses…)

I didn’t say it was a good system now did I.

To be fair, bitcoin is something of a proof-of-concept and heavy investment in it has been discouraged by its inventor for that reason. A number of alternative crypto-currencies forked from the bitcoin codebase purport to solve some of the issues that plaque bitcoin (for example solidcoin’s rapid difficulty retargetting is said to make pump and dump prohibitively expensive). All of that being said, crypto-currencies are a relative new concept and only time will tell if they can be made viable (for one, I suspect we will have a better understanding of their viability once these currencies reach their target circulations of ~20M bitcoins/supercoins/ixcoins).

An interesting experiment in alternative currencies and payment technologies IMO.

Kismet:

“doesn’t it make sense to give every British passport holder residing in the UK over 18, say, £100,000, to be payable into a UK bank?”

This could be done. The only problem would be inflation.Print that much money (which is what is being done). £500 billion I think I make that, a more than doubling of the narrow money supply (I think). You’d roughly expect a more than doubling of the price level from that. 100% inflation over a couple of years.

@14 Leon

How is this an attack on the poor? Everyone is supposedly entitled to a pension and civil service pensions are generally given to relatively well off workers.

There are many who have pointed out that Govt benefits (and other welfare programmes) are a ponzi scheme – google Government ponzi schemes. Most will refer to the US, but the same applies in the UK. Those who get into the system early get the benefits paid for by those who join later. Unfortuantely unless pension entitlements reduce or taxes increase the pension schemes will not be affordable. We are already seeing a deterioration in state pension benefits.

@15

So what is the solution for Ponzi schemes if they are already illegal? How do you stop them? You do at least now admit they are illegal rather than stating in the OP that this was perfectly legal for banks.

You now also admit that misselling is illegal, even for banks! There are many industries that missell and have dubious practices and yes it is illegal for all industries. For example it is illegal to missell guarentees on electrical products, or to missell roofing repairs to pensioners, or for garages to sell you repairs on your car which are not required.

How do you intend to change the system to prevent these illegal activites from happening? Ban payment protection insurance entirely?

So what new system are you going to introduce

“No, government pensions are not a ponzi scam”

Well they are really. To keep the whole thing viable requires there to be more people paying in (working and paying tax) than there are receiving (pensioners). Hence the debate on what age to raise the pension, the result of the working age population not keeping up with the retired population.

Banks have a complete stranglehold on the economy because they alone create the money that we use to buy goods and services.

Which banks do you mean? Central banks issue currency, other banks don’t “create” money.

Banks don’t actually need deposits in order to lend, so they don’t seek to attract them and they don’t offer a good deal to savers. Banks can obtain the money they need to settle lending by borrowing from other banks (particularly investment banks), issuing securities or borrowing from the central bank. Deposits are an optional extra.

There are only really two sources of funds for banks to lend – deposits and their own capital. Yes, banks can borrow from other banks but the money ultimately has to come from one of those two sources. Central banks only lend to the markey to provide liquidity and the banks have to provide collateral.

A friend of mine runs an independent cheque processing company. At present the actual payments side can only be done through a clearing bank, but why shouldn’t his company have direct access to BACS, CHAPS and the like?

The costs of full membership of the clearing systems would be prohibitively expensive – even a lot of banks operating in the UK are not full members and only have access via a clearing bank. Corporates can get direct access to the BACS and Faster payments systems via sponsorship from a clearing banks but it’s only cost effective for larger companies due to the cost of the neccessary software.

“The costs of full membership of the clearing systems would be prohibitively expensive”

Which of course is why we have this special group of banks which invest in these expensive systems. Why, we even have a name for them.

“Clearing banks”.

Comment number 5 has won the thread I think. Can’t say anything else other than that this is an unfocused and ill considered hate-piece. This isn’t “why” in any way, shape or form.

It’ very hard to take this analysis seriously.

I remember rather too long ago than I now wish to recall being advised by an audit manager that a worm’s eye view never paid when determining an audit opinion.

This article represents the worm’s eye view, ignoring at every stage the consequence of the proposed actions. The person who said they could fisk this but it would take too long is right.

Of course this policy could be adopted (and no doubt many from the Austrian school would like that) but we’d have an economic disaster of much greater proportion on our hands if we did.

Only nationalisation can solve the mess banking is creating. That’s constructive failure – but to pretend there is an option for bank failure that does not involve state control and reorganisation – and state acceptance of the liabilities (such as those of pension funds) that will not be paid when the banks do, inevitably, fail sometimes soon is as naïve as the combined economic policies of Osborne, The Mail and Express.

As a result I admit I am rather surprised LibCon published it.

Well, that’s that then.

“Only nationalisation can solve the mess banking is creating. ”

The Oracle has spoken.

There is just one thing I’d like to ask though.

“That’s constructive failure – but to pretend there is an option for bank failure that does not involve state control and reorganisation – and state acceptance of the liabilities (such as those of pension funds) that will not be paid when the banks do, inevitably, fail sometimes soon is as naïve as the combined economic policies of Osborne, The Mail and Express. ”

You, Richard, yes, you, have been a very vocal critic of the fact that the banks were propped up. You’ve complained bitterly about how much taxpayers’ money has been spent on doing this.

Yet now you’re saying that when banks fail all of this is inevitable. So, umm, why have you been complaining?

23 Fungus – I did not state in the OP that these schemes were legal for banks. They aren’t – as the lawsuits currently starting in the US prove.

17 Another Tom: I am not ignoring your points. I said I would reply to other commentors later, and I will reply to yours in due course. Because your points are important I want to give proper considered answers, but that takes time. I will reply at more length later tonight.

However, I will reply immediately to your final point. You’ve unfortunately quoted something I didn’t say in point 15, in fact I don’t think I said that at all. This OP is of course short on lots of detail – inevitably, because although you may understand banking in detail, many people don’t and if I give too much detail they switch off. I’m very clear on the differences between different types of bank, and yes, it does matter. The issues are different in different banks.

23 Andrew Adams: I wish I could agree with you, Andrew, but sadly it simply isn’t true that all lending money comes in the end from deposits. It doesn’t. Banks create new money when they lend. Funding the settlement of that lending may come variously from deposits, from capital, from bond issuance, from interbank borrowing or from the central bank. The money borrowed from other banks may itself have been electronically created, especially in the shadow banking sector, and even if it isn’t it may be the proceeds from trading activity. This is why separating out funding of retail lending is so very problematic.

29 Richard Murphy: I don’t agree with you about nationalisation of banks. I would prefer to see investigation of solutions that don’t require yet more government money and preservation of megaliths to the detriment of smaller, more innovative businesses. In the first part of this piece I made it clear that I do not advocate any form of disorderly collapse, and I think government should be actively involved in putting in place a safety net to protect people and businesses when banks fail. That indeed is the stated aim of the ICB, and many of its proposals are aimed at enabling govt to keep essential functions going in the event of major bank failure, although I think it falls far short of meeting this objective. That is very different from preventing banks from failing at all, which would seem to be your aim. I cannot support that.

@31

So the following from your OP does not say that misselling is legal for banks?

“And finally, there are practices in the investment banking sector that would be illegal if done anywhere else – insuring assets you don’t own, pledging someone else’s property as collateral for lending, ponzi schemes, mispricing and mis-selling”

I guess I must have managed to misinterpret

@23 – Classic attack on the pensions scheme. Scams are shut down, you are hence arguing for shutting down state pensions entirely. Period.

@30

As ever you distort the facts

Of course I have criticised the bail outs – because they did not deliver social objectives and only supported bankers – and that was a massive error of judgement – yes by Labour politicians

But that does not suggest banks are allowed to fail either – because that ignores the fact that the banking system is not a collection of free standing agents – it is a system as a whole – and the form in which it is operated does not match the substance

So Frances is also wrong – she has a naive view that cherry picking is possible as the Austrians suggest

Both of you are wrong – there is a system and it has failed and only state control can gave it the period of stability it needs to be thoroughly reorganised because lets be clear – we need banks and we can’t afford failed banks – but we equally can’t afford that the market resolve this issue – because very obviously it cannot

So I’m arguing for a big dose of macro sanity

It’s been too rare a commodity

@34

“but we equally can’t afford that the market resolve this issue – because very obviously it cannot”

Sure the market can resolve it – let them fail. Why should ordinary people get screwed to save the stinking banks? Let them fail, and where wrong-doing is discovered, prosecute the crooks.

And anyway, Murphy, this is the Keynesian long-run caused by the policies of that charlatan, who you still burn incense to. You want another massive dose of the poison that’s killing us.

The big problem for banks is the old fashioned model of banking is not that profitable any more. Taking money from X, and then lending it to Y for wafer thin margins, does not keep them in the manor which they have become used too. So they began to think up new and very dodgy “New products” which we now know not even their bosses understood.

If bankers want to gamble, which is what they where doing, they should do it with their own money. And shareholders should be under no doubt that if they want to entrust their money to arrogant young men, who no little about anything, who are going gamble it on the giant global casino, then fine.

@29. Richard Murphy: “As a result I admit I am rather surprised LibCon published it.”

This is part two of a series.

Occasionally Sunny goes off on a rant but he is generous with space if a contributor is serious. Tim Worstall was given space to argue why liberals should vote UKIP six months ago at the General Election.

@33

Where have I said state pensions should be scrapped entirely? Jim and yourself do like to make all sorts of ridiculous claims about what I write.

In its current form state pensions are effectively a ponzi shceme – this does not mean it has to be!

Run it like most company pension schemes. Defined contribution with a certain portion provided by Govt, but funds are actually invested. Those on benefits and the low paid have a greater govt contribution. One example of a pension scheme which would not be a ponzi scheme.

Frances, I think you are over-egging the pudding here with some of your assertions.

” And because our economy is so dependent on bank lending it is prone to credit bubbles and credit crunches. ”

Prone? Before 2007, when was the last commercial bank credit crunch that was not caused by a deliberate tightening of central bank monetary policy? There has never been one in any of our lifetimes. So a rather liberal use of the word prone.

” Credit bubbles cause overspending in the economy, consequent overproduction (or importing) and eventually inflation. ”

I think you are confusing price level changes with inflation. The central bank and not the commercial banks are the source of inflation. You know that recent period when we had a ‘ credit bubble ‘, otherwise known as the ‘great moderation.’

” Credit crunches cause rapid deflation and recession. ”

We are currently experiencing a credit crunch, right? See any rapid deflation in the CPI?

” Conversely, the investment banking sector is awash with funds – and contrary to popular opinion these are NOT provided by retail depositors but largely by pension and endowment investors. ”

Correct. Yet, grandstanding populist politicians in the UK consistently lie to the public by claiming the opposite. Yes, Mr Cable. The investment banking side subsidises cheap or free banking for the high st retail customers.

” The Global Financial Crisis of 2008 was primarily caused by failure of securitized retail loans. ”

Actually, haircuts in the repo market would be more accurate.

” Complex maths and big words are used to hide the reality of what is really going on. If an investment banking practice or product is described in words of more than three syllables or priced using formulae containing Greek letters it’s almost certainly dodgy. ”

Who do you recommend that firms exposed to foreign currency risk use for hedging, as invariably when they do it themselves they screw up and cost themselves money.

Who is going to be the primary dealers for all those debt securities governments keep issuing?

Who is going to be the bookrunners for firms who are not relying on bank debt when they issue bonds?

Who is going to be the underwriters for firms raising equity finance?

Who is going to assist and advise companies when they are subject to hostile bids?

Another Tom: Reply, as promised.

@1 Quantitative easing is not lending, it is asset purchase. And the new money it creates only goes to banks. In order for that money to get into circulation it has to be on-lent by commercial banks in some manner. The only means there is at the moment of getting money into the “real” economy is through bank lending to businesses and individuals. That involves credit creation by commercial banks.

@6 1) Re my points 2 & 3: I agree with you that regulation of lending did become very lax, and that, combined with low interest rates and expectation of high returns by institutional investors, fuelled a credit bubble which is now – painfully – deflating. But Basel III is insufficient to deal with the risks banks now take. The process of risk weighting of assets itself is seriously flawed. Part of the problem in the financial crisis was that forms of lending that have historically been “safe” (and therefore low weighted) became high risk. The same is happening at the moment with sovereign debt. But I don’t think it’s entirely fair to blame poor regulation. The integrity of lenders is also in question, especially in the US where serious fraud is now being exposed at the heart of the mortgage lending system. Even without fraud, there is no doubt that ALL types of banks took excessive risks in the run up to the financial crisis – and were allowed to do so by regulators.

I’m certainly not advocating extensive use of external funding sources for banks, simply noting that that is increasingly the case as deposits decline and people put savings into investments instead. Northern Rock is a cautionary tale in this respect: its business model depended excessively on interbank markets and bond issuance for funding. There could be a case for improving regulation around retail bank funding, at any rate, to ensure that they don’t rely too much on one funding source. As you say, the proximate cause of the financial crisis was a money market liquidity freeze.

2) Agreed re many people’s life savings tied up in property. My point though was that use of bank (and building society) deposits for long-term savings is in decline, which affects the funding model for retail banks. I would expect retail banks to rely more on funding from external sources if they can’t attract deposits, wouldn’t you?

3) Short-termism. Yes, there is nothing new about this. But the speed and volume of trading is increasing hugely with the advent of HFT. And fund managers these days do tend to have a short-term view, not least because they are often employed on short-term contracts with performance-related pay. “Buy to hold” is widely dismissed as a sensible investment strategy.

I did, in my original post, consider the consequences of collapse and possible ways forward. Unfortunately my thoughts on that weren’t published in this version, but if you follow the link you can read the original – and maybe you will feel a little better about what I am trying to say. Alternatively read the ICB draft report. It’s feeble, and I don’t agree with a lot of it, but at least it attempts to consider how banks could be allowed to fail safely.

Fungus

Yes, on re-reading it I do appear to have suggested that these practices are not illegal if carried out by banks. My apologies. Most of them are illegal, but as I said, the problem is recognising them for what they are. The terminology used in the capital markets industry is designed to conceal – for example, assets you don’t own (but want to make some money on using derivative products) are called “synthetic collateral”.

@36. sally: “The big problem for banks is the old fashioned model of banking is not that profitable any more.”

Bollocks, as we say in English.

UK banks have pushed cash withdrawal from current accounts to ATMs or cash back at the till in a supermarket via debit cards, and definitely no cheques. In this process, UK banks have saved loads of money.

Assume that you purchase £100 of groceries and and ask for £50 on your debit card. This is brilliant for the bank because they can take the money away immediately from your account. The grocer wins in that s/he has to take less cash to the bank, and the bank wins because they don’t have to count physical money.

But the shop assistant is sorting out the bank transaction (Do you have the money? If so, count the notes) which costs. Your £50 cash back is a cost to the grocer. *Cost*

Old fashioned banking sounds like a sound business.

31. Frances Coppola

” 23 Andrew Adams: I wish I could agree with you, Andrew, but sadly it simply isn’t true that all lending money comes in the end from deposits. It doesn’t. Banks create new money when they lend. Funding the settlement of that lending may come variously from deposits, from capital, from bond issuance, from interbank borrowing or from the central bank. The money borrowed from other banks may itself have been electronically created, especially in the shadow banking sector, and even if it isn’t it may be the proceeds from trading activity. This is why separating out funding of retail lending is so very problematic. ”

The problem Francis is your understanding of what you mean by money is different to the general public and most people reading this blog. When ‘ normal ‘ people hear the term money they think about ten and twenty pound sterling notes. Whereas, you know that actual currency in circulation is a tiny (4%) part of the UK money supply. I am sure Andrew does know, but most people when you speak about ‘ electronically created ‘ think you are speaking about the paper medium of exchange that they have in their pocket.

Richard W

1) You may well be right that I have overstated the pro-cyclical effect of credit creation and reduction. I was using the classic definitions of inflation and deflation, actually – increase or reduction in the money supply. This may or may not feed through into actual price increases or reductions in CPI or RPI. The credit bubble of the 2000′s mainly seems to have created hyperinflation in asset prices, especially property. I’m no economist but it strikes me that CPI may have been kept down during this period by cheap imports from emerging markets? And similarly, the present increase in CPI appears to be at least partly due to imported inflation (high world commodity and oil prices) and tax increases.

There is evidence of successive credit bubbles and crunches throughout history, and many economists have written on this – from Hayek to Marx! Exactly what causes them is debateable. I would note though that massive increases in M2 and (proxy) M3 rather than M0 would seem to suggest that this time, at any rate, commercial bank credit creation had more to do with credit bubble and crunch than monetary policy.

2) Proximate cause of financial crisis was indeed repo market haircuts and interbank lending freeze, as you say. But underlying that was excessive risk and fraud in retail lending feeding through into the global wholesale and investment banking markets industry through the securitization process. The mispricing and mis-selling I refer to arose from lack of understanding of the risks inherent in the instruments backed by these retail loans.

3) Very important point about investment banking funding retail, by the way. So many people don’t understand that. Thank you.

4) Can I point out that I’m certainly not suggesting that there should be no providers of wholesale and investment banking services. But wholesale and investment banking do need to clean up their act in my opinion. And if that means that some of them fail and are replaced by other companies that give a better service, then good…..But my last paragraph was not aimed just at wholesale and investment banking, though it appears so from the layout. Retail banks also need to clean up their act or die trying.

28 Lee Griffin

You didn’t like the first part of this piece, so I’m not surprised you’ve reacted negatively to this one.

I did reply to comment 5, actually – see comment 15

I don’t “hate” banks, actually. They are necessary. But they should be subject to commercial discipline in my view, not propped up by government guarantees and funding, with regulators turning a blind eye to highly risky and even illegal practices.

“But they should be subject to commercial discipline in my view, not propped up by government guarantees and funding, with regulators turning a blind eye to highly risky and even illegal practices.”

So in the face of the crisis we had, what would you have done other than prop up the banks, and what evidence do you have that such measures would have provided a better situation than we are now in?

43 Richard W

You’re right. In fact that goes to the heart of the matter, really. The way people perceive money, credit, banking etc. isn’t what’s really going on.

Frances Coppola

” I don’t agree with you about nationalisation of banks. I would prefer to see investigation of solutions that don’t require yet more government money and preservation of megaliths to the detriment of smaller, more innovative businesses. ”

It seems to me that one of the best ways is through procedures to convert bondholders to equity holders when institutions get into trouble. Moreover, the bondholders would have an incentive to prevent the institution getting into trouble in the first place because they are going to take a capital hit in such a scenario. Unfortunately, those procedures did not exist in 2007/08. Hence, the Treasury injecting capital and the taxpayers being outraged.

The nature of banking means institutions are always going to get into trouble even with the best regulation. Bailouts of banks is nothing new. However, systems being in place where banks are responsible for bailing-out each other is clearly preferable to public money being used. Why would a bank wish to bailout a rival? Because banking crisis are rarely contained within one institution and quickly systemically spread to all. Therefore, if banks are accountable to each other they have an incentive to act to contain a systemic risk from escalating. Moreover, there would also be a crucial incentive to reduce risk within the system at all times.

“I am sure Andrew does know, but most people when you speak about ‘ electronically created ‘ think you are speaking about the paper medium of exchange that they have in their pocket.”

What a complete misdirection.

Aside from this “most people” nonsense (as if you can legitimately say you know what most people think on this issue), the problems being discussed here aren’t of people thinking the OP is talking about real physical money, it’s that people can’t work out why the OP thinks that when a bank lends money that it doesn’t go down on their accounts as a liability, or at least that those liabilities need to be managed and secured to keep the bank profitable over the long term.

Those questioning the OP on this idea of “creating money” are doing so because no money is created at all, except (somewhat ironically), if you’re being philosophical and abstract, physical money (or the as good as) in the short term out of the more abstract existence of money that you talk of.

46 Lee Griffin

I have written about this extensively – including in the original version of this post. However, in summary, I accept that much of what was done in 2008 was necessary because no plans were in place to manage the failure of one bank, let alone many. But that’s not where we are now. I support the work of the ICB in attempting to identify changes that will enable banks to fail safely, but in my view their draft report falls a long way short of what is required. It is my view that while the financial system remains dependent on sovereign financial support it will continue to be unstable.

Ideally I would like to see the dismantling of all forms of direct and indirect government support to financial institutions, but I accept that at present that is too severe – for example, we do need to have some deposit insurance for the moment, despite the moral hazard it creates for lenders. It requires a massive mindset shift for individual depositors to move away from believing that banks are a safe haven towards understanding that money lent to banks is at risk. What I do want accepted, though, is an understanding by government that its primary responsibility is to support PEOPLE, not prop up institutions.

“What I do want accepted, though, is an understanding by government that its primary responsibility is to support PEOPLE, not prop up institutions.”

Even when those institutions are supporting people? Are you truly that blind to the reasons why the banks were even propped up in the first place? We can take the Sally line that this is all a conservative plot to help bankers and screw the poor…or we can be a little bit more sensible and realise that a lot of the things you’re talking about are in place to help people and safeguard them from where institutions go wrong.

48 Richard W

Now that’s an idea that has some mileage. It would require far greater use of convertible capital – preference shares and contingent convertibles – than present Basel rules allow. But I like the idea of banks being accountable to each other.

51 Lee Griffin

Propping up failing institutions is not the only way of protecting people

53. What other ways are there that doesn’t require financial investment by the state? Even the idea you are happy back and forthing over with Richard W means that people will lose out if there is a true failure of the institution.

49 Lee Griffin

“Aside from this “most people” nonsense (as if you can legitimately say you know what most people think on this issue), the problems being discussed here aren’t of people thinking the OP is talking about real physical money, it’s that people can’t work out why the OP thinks that when a bank lends money that it doesn’t go down on their accounts as a liability, or at least that those liabilities need to be managed and secured to keep the bank profitable over the long term.”

Err, I didn’t say any such thing. I have no idea where you got that idea from. My whole point is that banks should be managing their assets and liabilities a whole lot better than they have been, and that if they don’t manage their assets and liabilities properly (including their off-balance sheet exposures) and go bust, let them. That has nothing to do with protecting people. Depositor insurance compensates people for losses arising from bank failure. Loans can be sold on. I think payments and access to current accounts must be maintained – this area needs more work and I think the ICB should be looking at this. But I really don’t think it’s necessary to prop up an insolvent and illiquid institution just to protect its customers.

54 Lee Griffin

That idea of Richard W’s would mean the state only getting involved if ALL banks fail. Even in the financial crisis we were nowhere near that, and despite all the scaremongering that’s going on around Eurozone debt I’m not convinced that the situation is that desperate.

49 Lee Griffin

“Those questioning the OP on this idea of “creating money” are doing so because no money is created at all, except (somewhat ironically), if you’re being philosophical and abstract, physical money (or the as good as) in the short term out of the more abstract existence of money that you talk of.”

If your definition of “money” is notes and coins, then you are correct, bank lending does not create new money – only the central bank can do that. But most “money” in circulation is not notes and coins, it is electronic account balances. And banks create new deposit account balances when they lend. Not many of those new deposit balances actually need to be covered by physical money – most financial transactions are not cash. But they are real money, they can be drawn from ATMs. And the bank has invented them. That’s how the credit creation process works.

10 Charles Wheeler

I have a lot of time for Bill Mitchell’s economic theories – and he is one of the few economists who does seem to understand how the credit creation process works. Steve Keen at Debtwatch is also very good on this: http://www.debtdeflation.com/blogs/2009/01/31/therovingcavaliersofcredit/

@48 Richard W:

The nature of banking means institutions are always going to get into trouble even with the best regulation. Bailouts of banks is nothing new.

Indeed. Banks are businesses and like other businesses it’s inevitable that from time to time one will go bust. Not only is it inevitable, it’s also probably necessary in an efficiently run economy to have some degree of creative destruction.

The problem is that when banks go bust, the state (and its citzens) are left to pick up the pieces. This shouldn’t happen.

I therefore propose that all banks should have to become either “safe banks” or “risky banks”: a safe bank would by law be limited to doing only safe things. To incentivise it to do so, its shareholders would not get limited liability. If a safe bank did go bust, its depositors would be guaranteed by the state.

A risky bank, OTOH, would have no such guarantee, indeed its customers would be required to agree that the government would not compensate them if things went tits up. Risky banks would also have much less regulation on what they could do, generally no more than others businesses.

The nature of banking means institutions are always going to get into trouble even with the best regulation. Bailouts of banks is nothing new. However, systems being in place where banks are responsible for bailing-out each other is clearly preferable to public money being used. Why would a bank wish to bailout a rival?

Another reason a bank might do this is because risky banks are, well, risky. So they might want to mutually guarantee each other to spread the risk. They’d be allowed not do so, and in that instance people might not want to be their customers. In the end the market would sort out what forms of bankrupcy protection are used.

“Both of you are wrong – there is a system and it has failed and only state control can gave it the period of stability it needs to be thoroughly reorganised because lets be clear – we need banks and we can’t afford failed banks – but we equally can’t afford that the market resolve this issue – because very obviously it cannot”

Interesting comment given that today we got the news that Icesave will be repaying the deposit guarantee systems of the UK and Holland.

And it was only a couple of days ago that Paul Krugman praised the Icelandic approach: liquidation of the failed banks, debt repudiation and devaluation.

Of course, my real problem with your desire to nationalise the banks lies here:

“because they did not deliver social objectives”

Your definition of “social objective” is a little odd, to say the least. And your plans for treatment of banks are flexible to say the least. When you wrote a report for the TUC about a Tobin Tax you were just frothing at the mouth with excitement about how much could be raised from taxing CHAPS transactions. It fell to me to have to explain that you had just, by doing so, entirely closed down the overnight interbank lending market. Then you denied that interbank lending went through CHAPS, it was SWIFT. At which point I showed you the BoE report that showed it was CHAPS and you started frothing about how I was closing down debate.

It’s all here:

http://www.guardian.co.uk/commentisfree/2009/nov/13/tuc-tax-bank-interbank-lending?commentpage=all#start-of-comments

My problem with your desire to restructure the banking system to provide “social objectives” is that you seem to have little idea about how the banking system currently works. Reforming what you don’t understand is a rather dangerous occupation for the rest of us.

Quantitative easing is not lending, it is asset purchase. And the new money it creates only goes to banks.

In the UK, QE was designed so that the assets purchased did not come from banks. The new money it created went to holders of those assets, meaning that they sold a bond and acquired a deposit (QE directly increased broad money). As a result of the BoE funding this expansion of its balance sheet, the banking sector naturally ended up with extra reserve balances (QE directly increased narrow money), but this a separate issue. Banks do not lend reserve balances to anyone but other banks.

@61 vimothy
Not sure it worked like that in the US, which has done far more QE, of course. And I’m not aware that there were any restrictions on banks selling their bond holdings to the BoE. However, it is true that many of the assets purchased would have come from institutional investors, among others. I’ve been a bit careless with my definitions, I think.

@59 Phil Hunt
There’s no such thing as a “safe bank”, except maybe a pure deposit-taker that charges fees for deposits and keeps the deposited money in a vault. The idea that there are “safe” banking activities is simply wrong. The “safest” form of “bank” lending is to governments, which is why Basel risk weightings for sovereign debt are zero – but look at the Eurozone. Mortgages too were always regarded as pretty “safe” – but look what happened to those. Three of the four banks that failed in the UK failed due to excessive risk-taking in traditional “safe” forms of lending – mortgages and commercial lending. And RBS failed mainly due to an idiotic acquisition.

Some investment activities are known to be high-risk, but that doesn’t make them unsafe. In my view a company that knowingly undertakes high-risk activities is more likely to manage them properly than one that thinks a risky activity – such as mortgage lending – can’t possibly go wrong. And any company that thinks it will be bailed out by the state if it all goes pear shaped is unlikely to bother to manage its risks properly at all. Which is what happened in the run up to the financial crisis.

Shareholders should be the first to take the financial hit when a bank folds. That didn’t happen in the 2008 crisis because the government stepped in.

The Asset Purchase Facility was designed so that the assets were bought from institutional investors with the idea that this would then increase the supply of broad money directly. Banks in any case are not big holders of gilts, for obvious reasons. Not sure of the exact construction of the Fed’s QE programme, but I believe you’re right to say that it differed in some respects from what we had in the UK.

@63: There’s no such thing as a “safe bank”, except maybe a pure deposit-taker that charges fees for deposits and keeps the deposited money in a vault. The idea that there are “safe” banking activities is simply wrong.

I think we may be talking at cross-purposes here. I don’t regard anything as completely, 100%, safe. But clearly some banking activities are safer than others.

Frances,

If your definition of “money” is notes and coins, then you are correct, bank lending does not create new money – only the central bank can do that. But most “money” in circulation is not notes and coins, it is electronic account balances. And banks create new deposit account balances when they lend. Not many of those new deposit balances actually need to be covered by physical money – most financial transactions are not cash. But they are real money, they can be drawn from ATMs. And the bank has invented them. That’s how the credit creation process works.

The bank has not “invented” those new deposit balances – no “new” money has been created. At some point their customer will want to withdraw or transfer that balance and the bank has to have the cash (I use the term to cover both physical and electronic balances) somewhere to cover it, which takes us to the earlier point about where banks source funds for lending.

Frances, further to Andrew’s point.

It’s true that the banking system as a whole creates credit.

However, an individual bank does not.

Think of it this way. If an individual bank can just whiestle up the money then a bank would have no funding requirements. Yet what we’re all worried about at present is that the banks won’t be able to cover their funding requirements.

We can’t actually have both, that banks don’t need funding and that we’re worried about where banks will get their funding.

The Mint is the only bit of Government that can create money. The notes and coins it makes comprise only 3% of the “money” in circulation.

The other 97% is created by spivs/banksters/hedge funds who take money they’ve either robbed from the real economy with usurious interest charges (e.g. ten times the rate they borrow at due to the UK governments guarantee) or been given for free from a bailout/QE operation (again taxpayer money).

For example, say SirGreedy of Limitlessevil shadow banking hedgefund gets his greedy mits on £1,000,000 from the real economy. He then borrows £30,000,000 from his friend Piers Bigend at RSWipe bank using the £1,000,000 as collateral.

He is able to borrow the £30,000,000 at a ridiculously low rate of interest as the money he is holding is 100% guaranteed by the UK Government. So he is likely to only to have to pay 1% or less interest on the loan (LIBOR or Euromarket rates).

SirGreedy takes the £30,000,000 and he might choose to gamble the money by speculating on food futures or shorting a European currency if he can persuade enough friends to join in on the pillaging. The UN recently pinned the blame for rising World food costs on bank speculation and it is undoubtedly the cause behind the food riots we are seeing in Africa and the Middle East.

But if SirGreedy is feeling cautious or has no friends a good safe bet is to buy a UK bond. It is 100% guaranteed by the UK Government and will pay him a return of 4%. He keeps this for a year and then sells it back to Bigend.

Sir Greedy repays his loan to Bigend (who makes £300,000K “profit”) for his bank RSWipe.

Sir Greedy takes home the 3% profit (£900K) he has made. He books it as a 90% profit on the £1,000,000 initial capital he had.

It’s now bonus time and both traders point to the hundreds of thousands pounds of profit they have made and its trebles all round and fat bonuses for both of them.

Notice there was no risk in any of these transactions as they are all underpinned by cast iron guarantees from the UK Government.

The UK taxpayer has lost £900K and gained nothing from the transactions.

In terms of inflation and effect on the real economy. £1,000,000 has disappeared from savers/house buyers somewhere and has reappeared as Government debt to the banks (£400K).

The £1,000,000 has turned into £1,400,000 causing inflation eventually.

In all likelihood it is very unlikely that exchanges would be this one sided. Much more likely that BigEnd will lend Sir Greedy £30M to play the game and Sir Greedy will in turn lend £30M to Bigend. This is why commentators refers to this as “interbank lending” or “Euromarket”.

Essentially its spivs both writing IOU’s for £30M on a napkin, swapping the napkins and magically creating profit for themselves by pillaging the UK taxpayer who as underwritten the whole deal.

Doesn’t look socially useful to me. Doesn’t look too intellectually demanding.

Why are we letting these people pay themselves salaries of 100s of time average wage for things that damage the well being of everyone else?”

@ 66, @ 67

@68 Sweetness & Light’s example is pretty good on how money creation works in the shadow banking sector – which is where much interbank lending comes from. Meanwhile ordinary bank lending – yes, Tim, by individual banks – creates credit balances that are not necessarily backed by reserves at the time they are created. “Fractional reserve banking” has always depended on timing differences – you don’t have the funds at the time but you hope to get them before the loan is drawn. If ordinary banks then draw on interbank funds to meet cash reserve requirements – which they do – new money is created in the real economy, not just in the shadow banking sector. Hence the huge growth in M2 as well as M3 in the run up to the financial crisis.

@65 Phil Hunt

It used to be the case that some activities were “clearly” safer than others. Unfortunately that is no longer the case. The “safest” forms of lending nearly brought down the international financial system – and it was precisely because they were thought of as “safe” that they became so risky. Mortgages of 125% the value of the house – as offered by both Halifax and Northern Rock – amount to gambling that the value of houses will continue to rise. If an investment banker takes an open punt like that we call it “speculation” and shout about “casino banking” putting depositors’ money at risk. But because it was retail lending it was “safe”, wasn’t it. Yeah, right.

I am amazed and appalled that anyone thinks that ringfencing together insured deposits with mortgage and other retail lending will make the banking system safer.