Martin Wolf, chief economics commentator at the Financial Times said:
“If we were not so familiar with banking we would surely treat it as fraudulent.”
So where’s the fraud? Well it’s so glaringly obvious that no one ever sees it. That’s known as “not seeing the wood for the trees”. Anyway, the fraud is as follows.
Banks . . .
First, accept deposits.
Second, they promise to return to depositors (and others, e.g. bond-holders) the exact sum deposited (maybe plus interest and maybe less bank charges).
Third, they lend on that money to borrowers in ways that are not 100% safe.
Spotted the fraud? No?
Well the fraud lies in the fact that borrowers may not repay their loans, in which event, depositors just cannot be repaid. That’s no different to me taking money off you for safekeeping, investing the money on the stock market, and then when the value of those investments falls, I tell you you can’t have all your money back. That’s fraudulent, isn't it?
In fact it’s a MATHEMATICAL CERTAINTY that at some point in the life of any bank that it will make a series of poor loans, or it will have bad luck with its loans, and won’t be able to repay depositors.
And that “failure to repay” has happened over, and over, and over, and over, and over again ever since Roman times. It’s amazing that the dummies that make up the human race haven’t noticed the inherent flaw, or rather the blatantly fraudulent element in the basic promise that banks make to depositors.
So how do we dispose of that fraud while letting banks continue with the various perfectly LEGITIMATE things they do? Well it’s easy: just ban the above promise.
In other words if a depositor wants their money lending on or investing with a view to earning interest, then their bank can give them a STAKE IN the relevant investments or loans. Even better, depositors could SPECIFY what they want their money to be used for (e.g. safe mortgages, or at the other extreme dodgy South American gold mines). But banks shouldn’t be allowed to promise to return a SPECIFIC SUM OF MONEY to the depositor.
On the other hand, if the depositor DOES WANT a specific sum of money back, then the bank should DO NOTHING with the relevant money apart from lodge it in a 100% safe manner. Nothing fraudulent there is there?
And same should apply to shadow banks or any other entity involved in accepting deposits or borrowing from bond-holders and then lending on or investing the relevant sums.
That way banks CANNOT SUDDENLY COLLAPSE, though there is nothing to stop them declining slowly. Thus banks don’t need to be subsidised. And remember that wherever there is a subsidy, there is a misallocation of resources, unless some very good reason can be given for the subsidy. I.e. wherever there is a subsidy, GDP is lower than it would otherwise be (unless there is a very good reason for the subsidy).
Unfortunately the above would be a very fundamental change to our banking system. And 95% of the population (lefties included) do not like fundamental changes. That is 95% of the population prefer what they’re used to, however deplorable it is, e.g. slavery. It saves them having to think.
Or as Edmund Burke put it, “Custom reconciles us to everything”.
And replacing bank collapses with variable equity values has big advantages, as Mergyn King, former governor of the Bank of England pointed out. As he said in his “Bagehot to Basel” speech:
“We saw in 1987 and again in the early 2000s, that a sharp fall in equity values did not cause the same damage as did the banking crisis. Equity markets provide a natural safety valve, and when they suffer sharp falls, economic policy can respond. But when the banking system failed in September 2008, not even massive injections of both liquidity and capital by the state could prevent a devastating collapse of confidence and output around the world.”