Are Our Banks Still Too Big To Fail?

[Readers please note I will come back to the post-truth part 2 after this series, I got distracted onto the subject of the banking crisis and related stuff this week.]

[First in a 2 part series on a subject no-one knows much about – economics]

THE MIRACLE BEFORE THE STORM

There was a time when I kept my head down, shuffling along with the other commuters, then jammed in like a dead sardine on a tube train as I made my way to my 9-5 office job. I did sometimes wonder what went on inside those giant soulless steel and glass office blocks towering all around me, that seemed to grow ever taller. I did sometimes wonder why the UK seemed to be so obsessed with finance in London while the rest of the country dwindled. The former industrial powerhouse of the Midlands and North was now a depressed area where state welfare seemed to be the main source of a great many people’s incomes. Mrs. Thatcher seemed to have transformed the country for the better overall, there were no longer 3 day weeks, endless strikes and power cuts at least. Somehow however unless you were a banker, or a stockbroker, or a property magnate, or a lawyer perhaps, you had this painful feeling that you were being screwed. What did all these now-venerated occupations have in common? Well they were essentially non-productive in the sense that they did not produce anything useful or even tangible.

I had begun to notice that the more money I earned, that more of those extra earnings seemed to disappear in deductions that mysteriously occurred on my pay cheque. The little terraced house I thought I was going to be able to afford next year, when I got that pay increase I was promised for my hard work, had mysteriously acquired another £20,000 in “value” and was as far beyond my reach as ever. I was striving it seemed, to little avail. I began to take an interest in economics, hoping to solve this riddle of my futile existence. I read the newspaper columns and talked to my friends and colleagues. Some people were confident that there would soon be a house price crash. “House prices can’t just keep on rising forever” they said, “it doesn’t make sense!”. We (the little people) were all hoping for this – the thing that the “economists” were most afraid of, a house price crash – so that we could finally afford to buy a house.

Pundits in the media debated what was being called Gordon Brown’s “miracle economy”, and Prime Minister Tony Blair (of the Labour party) lauded his sidekick at no.11 “the best chancellor for 100 years.”:

http://news.bbc.co.uk/2/hi/programmes/panorama/4243108.stm

Quote:

Stephanie finds, as she travels the country, that it is spending and borrowing that has filled the gap – thanks to cheap money and cheap Asian imports.

How can you run an economy on “spending and borrowing” I wondered, is this really the best we’ve done for 100 years? Where on earth was all this “cheap money” coming from? Was this a miracle or a mirage? My experience of money was that it was very expensive, the concept of “cheap” money was quite alien to me.

That eminent banker Fred Goodwin, the CEO of the Royal Bank of Scotland, became Sir Fred Goodwin, his knighthood awarded for “services to banking”. Us mere mortals could only gaze up in awe at the towering giants of the banking world, who loomed above us like demi-gods, flying to and fro between the financial capitals of the world in their private jets, dealing in billions.

THE STORM – THE BANKING CRISIS OF 2008

Then came the banking crisis of 2008/9 and finally my nagging doubts about what was really going on, had turned to downright alarm. Was that basket that the UK had been putting all its eggs into, the financial sector, in fact just a giant house of cards that was about to tumble down? Fortunately Gordon Brown (of the Labour party), now the Prime Minister, was on hand to sort out the mess, he stepped up to the dispatch box in the House of Commons and casually revealed that he had saved the world. British politics had produced a real saviour to rival any of those fictitious Marvel comic-book super-heroes.

However before long my nagging doubts began to return. Had Gordon Brown really saved the world or merely “kicked the can down the road”? We were being told that the banks were too big to be allowed to fail, and so the PM had bailed the banks out, adding a large lump of extra debt to our national debt. The national debt had shot up from 35.5% of GDP in April 2008 to 65.5% of GDP by the time Labour were voted out in May 2010, and during the so-called “austerity” period that followed, where the Coalition and Conservatives were in power, the debt has continued to grow (it now stands at 83.9% (depending on who you ask)), although it is has stopped rising so quickly now (figures from the ONS):

https://www.ons.gov.uk/economy/governmentpublicsectorandtaxes/publicsectorfinance/timeseries/hf6x

By the way the UK national debt total is now apparently:

£1,801,375,860,000

In case you got lost among all those digits – that’s quite a lot. To put it in context its very roughly £75,000 per taxpayer by my calculations. That’s what it was a couple of days ago anyway, according to:

http://www.nationaldebtclock.co.uk/

although the Daily Telegraph seems to think its a bit lower than that:

http://www.telegraph.co.uk/business/2016/02/19/how-large-is-the-uks-national-debt-and-why-does-it-matter/

At last house prices had indeed crashed somewhat but it wasn’t long before they started to rise again, albeit in a more shaky manner, as demonstrated by this graph:

http://www.economicshelp.org/blog/5709/housing/market/

Sir Fred (aka “Fred the Shred”), the man who more than anybody in the UK had come to be associated with the banking crisis, was reduced back to merely plain old Fred again, losing his knighthood in 2012. It seems he was also not a banker, if this is accurate:

https://www.theguardian.com/business/2011/mar/10/fred-goodwin-superinjunction-banking

The Labour front benches were in some confusion about how Fred had ever come to be knighted in the first place (it was something about charity was it Harriet, not “services to banking”?), to the amusement of the other parties:

WHAT CAUSED THE CRASH?

So, Fred the Shred was taken down a peg or two (maybe that wasn’t enough pegs), but what had caused the crash? As the 2008 crisis unfolded we had learned about all the hair-raising goings on that had led to the crisis, such as these convoluted things called “collateralized debt obligations” (CDOs) which we were told (if I remember right) were “parcels” containing lots of little bits of debt, including dodgy “sub-prime” mortgage debts.

http://www.investopedia.com/terms/c/cdo.asp

Other complicated sounding thingies like “credit default swaps” also were mentioned, you can find out what they are all about here (good luck with that):

http://www.investopedia.com/terms/c/creditdefaultswap.asp

We were told banks were lending to each other in a bizarre spider’s web of interconnections. Why?? Why were banks lending to each other? The point of banks is to lend to individual people and businesses, not to EACH OTHER, surely?? This system is also known as Fictional Reserve Banking – where banks lend to each other to somehow (I don’t know how) create the impression that they have reserves. I am of course making this all up, or am I? Judge for yourself:

https://en.wikipedia.org/wiki/Interbank_lending_market

Quote:

Low transaction volume in this market was a major contributing factor to the financial crisis of 2007.

Am I alone here or does this sound patently absurd? Low levels of inter-bank lending was a major cause of the financial crisis?

IS THIS STUFF STILL GOING ON?

Enough of reminiscing about all this, let us turn our minds to where we are at now, and where we are heading. What has changed at the banks exactly?  Perhaps some of the worst excesses have receded, but I wonder – is inter bank lending still going on, it appears that it is:

http://www.thisismoney.co.uk/money/markets/article-1645325/LIBOR-Latest-inter-bank-lending-rate-charts.html

Who on earth is lending to our government now that interest rates are set at the ridiculously low rate of 0.25% (I fear the answer is the banks)? Is lending to the government really a safe thing to do with your hard earned savings? Would you lend money to Gordon Brown for example, if he was just a person?

According to this article, some sub-prime lending is back (although at a high interest rate):

http://www.thisismoney.co.uk/money/mortgageshome/article-2385347/Magellan-offers-8-55-mortgage-loans-tainted-credit-records.html

In this article the BBC asks why anyone would lend money at a negative interest rate (negative interest rates are now a thing apparently). Generosity perhaps? Philanthropy? I don’t know, here is the BBC’s view:

http://www.bbc.com/news/business-32284393

I can’t help looking at all this stuff without thinking its just not possible for a real human being to know what’s going on in the financial sector any more. It wasn’t back in the run up to the financial crisis, and I really believe that it still isn’t. That worries me. To give us some idea of how complicated its got – apparently whizz kids in the financial “industry” have created mind-boggling computer programs that automatically make speculative transactions, this led to a new type of thingy called a “flash crash” in 2010:

http://news.sky.com/story/flash-crash-for-pound-to-118-is-surrounded-in-mystery-10608056

Wow, that’s flashy!! Did those whizz kids get their Ferraris repo’d I wonder?

ARE WE HEADING FOR ANOTHER CRISIS?

I don’t want to start a panic, a run on the banks, but I am continuing to wonder – are the banks still too big to fail? Has anything really changed in the banking sector? As I walk down the high street in my little town, I see the same big names that were there before – HSBC, Natwest, RBS etc., and the big building societies as well.

The government has guaranteed deposits of up to £75,000 but does this just make us lazy and not bother to look for alternatives to the high street banks, and not question THEIR credit worthiness? The very fact that big banks are “too big to fail” i.e. will be bailed out by the govt., surely makes us more inclined to bank with those very banks, giving them an unfair competitive advantage and making them lazy? This is always the problem with govt. interventions of course, the unintended consequences.

https://www.fscs.org.uk/what-we-cover/products/banks-building-societies/

If the banks are still “too big to fail”, and we have another crisis, what will happen? Will the govt. bail the banks out again and add even more to the national debt? Is a bailout actually a sort of reward for failure, where does all the bailout money actually go, is there any oversight? Of course the heads of the failed organizations are usually at least replaced, but many of the employees and the organization itself are often not, so the organization still survives – RBS is still with us for example.

The Guardian takes a look at Steve Eisman’s view on the likelihood of another crash (Steve Eisman got rich quick by predicting the last crisis and shorting stocks):

https://www.theguardian.com/money/2016/nov/19/big-short-financial-crash-steve-eisman-italy-banks-risk

Although he is focused on Italian banks in particular, I can’t help wondering if a crisis in the Eurozone could easily cause major problems for our financial sector, what with all this inter-bank lending going on, not to mention the basic economic impact such a crisis would have on the UK. Also, do our banks and pension funds own government bonds issued by other countries I wonder? Perhaps we should be reassured by Eisman’s view of our banks today:

I’m not really worried about England’s banks,” says Eisman. “They are in better shape than most in Europe.

This article talks knowingly about “stress tests” but I have to wonder if anyone just tried blowing really hard at the house of cards to see if it would fall down. After every crisis these people emerge who were unknown before the crisis, and shot to fame for predicting the crisis. I think we need to be careful not to assume they didn’t just get lucky. There still seem to be quite a few dubious things going on as far as I can see, from my limited knowledge.

COULD WE AVOID ANOTHER CRISIS?

The “Austrian” school think we should return to the gold standard, might not be a bad idea:

https://mises.org/about-mises/what-austrian-economics

A guy called George Selgin thinks that we could avoid future banking crises, he has published some of his ideas here:

https://www.alt-m.org/

New forms of currency have emerged – we have recently seen the emergence of Bitcoin and the Totnes pound:

https://en.wikipedia.org/wiki/Totnes_pound

I’m not sure if these will help the situation or not.

I wonder if the very phrase “too big to fail” is a misleading one. Could we make our big banks smaller without damaging their competitiveness in the global economy? Is the question the wrong one to be asking in any case, should we instead be asking if our govt. has grown too big to function sensibly? We have come to rely on our govt. to sort out any problems that come up, but does the govt. just make even bigger problems more likely in the longer run when it does “sort” our problems out in the present?

No-one wants to lose all their savings so its comforting to know the govt. has guaranteed our savings, but without such a guarantee we would be more cautious – we would spread the risk probably by splitting our savings across different banks for example. We might also be more likely to try other forms of investment to spread the risk still further. There are interesting new alternatives out there such as peer-to-peer lending sites for both personal loans and business loans now. We put all our money in the big banks but I have heard from businesses that these same banks are reluctant to lend (no doubt partly because the interest rates are so low). Is this state regulated and state supported (on a crutch) banking sector more of a hindrance to economic prosperity now? Is the relationship between governments and banks something like a marriage gone wrong where both partners are too afraid of what might happen if they split up? I am increasingly inclined to think so myself. The more I think about politics the more I think we need a smaller, less interventionist state. Maybe its not so much more regulation that we need, but rather a lot less regulation and interference.

WHAT DO YOU THINK?

I don’t know the answers to all these huge questions, but I have a nagging feeling that the questions probably need to be asked in order to forestall another worse crisis in the future. There is also the question of course – could we get our money back at some point for the last bailout or will our grandchildren still be paying for the mistakes of the bankers and politicians? What do you think about it all? Please add your by comments below (please try to make your explanations intelligible to the non-banker especially if you are an industry insider).

In the next episode I will take a highly in-expert look into the phenomenon of “Quantitative Easing”.

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