The big bank boondoggle*

The authors of the worst financial fiasco since the 1930s expect to make their resurrection a foregone conclusion. David Ransom suggests more sensible ways forward.
Hong Kong demonstrator asleep

Under the influence: a protester makes his feelings felt during demonstrationsin Hong Kong, October 2014. © Getty/Bloomberg/Brent Lewin

Brief though the episode was, between late 1968 and early 1970 I was a trainee banker. A class of callow youths (all white males) gathered in the City of London to be mentored by a retired manager out of Tierra del Fuego. We probed the elusive mysteries of double-entry book-keeping and fractional banking. Labelled ‘ambitious, but quiet and dignified’, I was dispatched to Montevideo in Uruguay.

A few months later the clerks there walked out on strike for decent pay. They were promptly ‘militarized’ – charged with desertion if they failed to return to work. A corpulent colonel occupied the manager’s office while troopers frogmarched a few captured clerks back to their desks. I made my escape, convinced that the key to successful banking lay hidden far too deep in the excruciating tedium of it all.

So I’m prejudiced. Never before or since have I experienced boredom as a physical pain. Whenever I hear of a banking culture built on cocaine, I am not shocked. It makes perfect sense to me for expensive rehab clinics to set up shop nearby. I know what it is to sit at a telex machine all day encoding the sale of illicit gold from the Amazon to a boilerplate company in Bermuda. I quite understand why bankers get injured by the repetitive strain of making money out of thin air. I too have felt their subliminal tendency to panic.

Though sometimes I marvel at their irrational exuberance, I would not say that bankers possess anything like a culture. Instead, I’d call it cod ideology, and in Uruguay I learned what it does in practice.

Within a couple of years, the rest of the country had been militarized as well. A place with a long progressive tradition began to imprison, torture, exile and disappear proportionately more of its own people than anywhere else on earth. The banks may not have been primarily responsible – the military blamed Tupamaro leftist guerrillas – but they were certainly the principal beneficiaries.

For this was the dawn of corporate globalization and deregulated financial markets. In an ailing Uruguayan economy, the spiralling private debts of the rich and their banks were transferred by military dictatorship to the Uruguayan people, who were thereby signed up to the ‘Third World’ debt (meaning banking) crisis.

Under the supervision of swivel-eyed generals and a Washington Consensus at the International Monetary Fund and World Bank, ‘structural adjustment’ across Latin America dictated the privatization of public assets and the export of basic commodities, fewer jobs and public services, lower wages, regressive taxation, the plundering of the natural environment, the suppression of human rights and anything that threatened to resemble a vibrant culture; a jumble of experimental measures slapped together in the name of saving democracy from itself and paying private banks for debts that were entirely their own.

The net result was that no-one except the rich could afford to buy anything, economies staggered to a halt and, in Uruguay, absolute poverty began to scar a society where once it had been almost unknown.

Zombie banks are kept alive by public subsidies and bailouts because it is too troublesome to close them down, even though they are worthless and do nothing useful

In this way I came to think of banks and financial markets as less interested in productive finance than in this cod ideology, soon to be styled ‘neoliberalism’ across much of the Majority World.

If, since 2008, the term has become more familiar to the Minority World, that’s because ‘austerity’ is also its progeny. Listen closely to prevailing financial wisdom today, particularly when applied to Greece, and you may hear ‘austerity’ mis-spoken as ‘structural adjustment’.

Neoliberalism has spread relentlessly, from free-trade agreements and the World Trade Organization, to the Transatlantic Trade and Investment Partnership (TTIP) and its sibling the Trans-Pacific Partnership (TPP), bearing the promise of fool’s gold – with carefree financial markets and banks in the lead.

Paradoxical as it may seem, financial meltdowns have been part of the process. By one estimate there were 147 banking crises worldwide between 1970 and 2011, ever more frequent and extreme as they headed for the Great Recession1, but always with the same desired result – public bailouts followed by some form of neoliberal ‘structural adjustment’.

The sheer scale of what the banks were really getting up to has not lost its capacity to astonish even me: money-laundering, sanctions-busting, tax evasion, insurance scams, pervasive ‘mis-selling’, interest- and exchange-rate manipulation, compulsive gambling, personal avarice and enrichment – the indictments of a ‘service’ that treats its customers as fodder have infested almost everything it does.

All of it certified by a cartel of credit-rating and audit corporations funded by the banks and overlooked by light-touch regulators who have been ‘captured’ by the banks. And all of it orchestrated by financial markets that have no firm foundation in anything other than ‘trust’ and ‘confidence’. It’s enough to cast doubt on the legendary instinct for self-preservation of capitalism itself.

A great deal of public anger has been directed at the way bank bosses have continued to reward themselves regardless. The bonus culture in finance is indeed a driver behind the growth of inequality and social injustice.

The further you want to clamber up the gradients of personal wealth, the more you need to be a banker or financier. If you reach the summit and the richest 0.1 per cent of the population, they outnumber both their fellow CEOs from the rest of the corporate club and the growing band of heirs to personal hoards put together.2

Carry on ballooning

But I think this can also be something of a distraction. What really matters is what keeps the giant boondoggle in play. We’re not talking magic here, however much neoliberalism defers to the ‘hidden hand’ of market forces.

It can’t be the banks’ usefulness to society. An increasing proportion of their lending – by now approaching 60 per cent – still clings to private property and mortgages.3 Lest we forget, this was what triggered the 2008 meltdown.

Property may be the easiest and most lucrative way for banks to securitize their activities and spin derivatives off into convoluted deals that never touch the real economy, but no-one claims that property is productive. Property bubbles may, for a few and for a while, generate more cash than can be earned from work. But for the rest, and particularly for the next generation, homes are made unaffordable.

When the 2007 credit crunch struck, the banks had no idea what anything was worth and stopped lending altogether, even to each other. They were, technically speaking, dead.

There is, however, a weird form of resurrection available only to them. They can be kept alive by public subsidies and bailouts because it is too troublesome to close them down, even though they are worthless and do nothing useful. Such banks are said to have first emerged when the Savings and Loans fiasco hit the US in 1987, and survived in Japan long after its own banking crisis in 1993. They came to be known as ‘zombie’ banks.4

Governor of the Bank of England, Mark Carney: quite relaxed about ballooning private debt.

REUTERS/Pool/Antony Devlin

And that, to my mind, describes accurately enough what all private banks have now become. You can tell from the frantic public efforts to prod them into some recognizable form of useful life. Forget all the unconditional bailouts and bribes. Trillions of dollars of free public money have been pumped into them by quantitative easing, in a last-ditch technical wheeze to get them lending productively. An exact equivalent would have been to drop ‘helicopter money’, or free cash, directly onto the heads of the population at large.

The result of pumping it in to the banks instead: bigger profits and bonuses, a bubble in the price of assets owned by the rich – chiefly property, of course – and abstruse disputes between economists as to whether it has made any difference to the real economy.

And so it goes on. ‘Systemic’ megabanks are said to be at once too big to fail and too cumbersome to function. Result: they get bigger and fewer, a monopolistic handful bestriding each national banking system, feeding from a public subsidy amounting to perhaps $300 billion every year in the euro area alone5 because financial markets choose to assume – all the more so since 2008 – they will be bailed out again, which means they borrow more cheaply and lend more riskily.

They must raise more of their own capital (the only money that is actually theirs) to reduce the risk of bailout. Result: entrenched evasion, bare minimum levels of capital and still no increase in productive lending.6 So they must be more tightly regulated. Result: fresh opportunities to play with the rules (‘arbitrage’), and shadow banking, which is scarcely regulated, proliferates. Any attempt to relate the size of bank bonuses to reason is futile.

Meanwhile, financial markets just keep on ballooning. Their assets (loans) in Britain have already grown to about four times the size of the country’s entire annual output. They are set to be 10 times the size by 2050. The Governor of the Bank of England is quite relaxed about this, advising that size (and, of course, lucrative business) is of less regulatory concern than safety.7

But what if government deficits were set to do the same? What makes private debts any less problematic than public ones? And who could bail this lot out?

In 2010 Andrew Haldane, then-Director of Financial Stability, now Chief Economist at the Bank of England, estimated that the crisis caused by the banks had cost between $60 and $200 trillion (thousand billion) in worldwide output and other losses.8

That’s quite some debt. Assuming a systemic crisis recurs on average every 20 years, Haldane calculated that banks should properly be charged in excess of $1.5 trillion every year in repayment – more than their entire market capitalization. But collecting this debt would, he confided, ‘risk putting the banks on the same trajectory as the dinosaurs’. So there were no plans to do so. Some debts, and those of the banks in particular, are evidently less worthy of collection than others.

Dinosaurs or zombies, take your pick. Why should we be transfixed by fossils or the living dead? At some point, we will come to our senses. Then the darkness of neoliberalism will disperse with the realization that some financial home truths have been staring us in the face all along.

Boom, bust and naked self-interest

Even the most cursory narrative of banking and financial crises makes it obvious that finance is a public utility, not private property. What is it that makes possible the endless bailing out of private banks, and therefore their continued existence, if not their automatic claim on public resources and tax revenues? Who with any say in the matter willingly hands over the power of taxation and economic policy to anything other than a halfway democratic government?

Is not the most profound and enduring objection to structural adjustment or austerity – even supposing that they actually work – that they violate this basic principle of democracy, ceding political power to naked self-interest? How did the leading exponents of tax evasion ever acquire the right to any political representation at all? Come to that, when was a bailout last subjected to democratic debate before it was an accomplished fact?

Private banks have also acquired a public licence, through the generation of credit, to create virtually all the money in circulation. This has given them quite disproportionate economic as well as political power.

One outcome has been exaggerated boom-and-bust economic cycles which societies struggle to counteract, having no effective means of doing so. No single measure is more likely to restore some sanity to finance than withdrawing from private banks their licence to print money.9

José Mujica sets a refreshing example at his home outside Montevideo.

Matilde Campodonico/AP/Press Association Images

This is within easy reach of long-established democratic prerogatives. So too is the withdrawal of deposit guarantees from anything other than retail, high-street banks, which are the only reason why most people need banks at all.

Other stipulations might usefully be added: that these banks should be mutuals serving only the interests of their customers; that they should be small and local, operating in communities they have learned to understand; that their priority must be to enhance resilience in the face of climate change, and to promote productive, sustainable employment. Self-styled democratic governments might even be prompted at long last to do their job.

They would be equally well-advised to place less reliance on regulation and more on what might actually work. For example, transaction taxes – on things like currency and commodity exchanges – have the simultaneously beneficial effect of restraining dangerous speculation and replenishing public funds.

They are also relatively difficult to evade. And they reflect more accurately what underpins all financial systems: taxation, surely best raised from the system itself. That argument goes uncontested, stalled only by the power of the banks. The European Union is still thinking about it.

There would then be a realistic prospect of returning the zombie megabanks to the grave from which they have so rashly been raised.

Let them survive, if they can, without a public prop that neoliberalism opposes for anything else. Let there be an end to the damage they can do, the blackmail they can threaten at every turn. With another meltdown more probable with the passing of every wasted year, we need to be forearmed as well as forewarned.

There is, after all, no greater folly than repeating the same mistake and expecting a different result.

In any event, showdowns between financial markets and democracy look set to intensify, especially in the rich world, which is now by far the largest debtor of all. To some extent, the impact of the Great Recession on ‘emerging’ economies has been mitigated because a degree of democracy and social justice has been asserting itself there.

Which takes me back to Uruguay, where I stayed for a while quite recently. For five years, until 1 March 2015, its elected president was José Mujica, a former Tupamaro guerrilla who was tortured by the military and spent 2 of his 13 prison years locked up inside some sort of horse trough.

As president, he continued growing chrysanthemums and living with his partner on her smallholding, stuck to his own relaxed style of dress and gave away 90 per cent of his presidential salary. Any adult Uruguayan who wishes to can now cultivate a couple of marijuana bushes in a back yard; anyone who is gay can marry; women have access to legal abortions. Finance, according to Mujica, is by no means the most precious gift of life.10

The country is not in chaos as a result of Mujica’s unconventional leadership. On the contrary, it has blossomed.

One balmy evening outside Montevideo, a young friend said to me: ‘I’m not particularly political, but I do feel that my views count.’ No-one had said anything like that to me for a very long while. Uruguay may not be Utopia – you can still get mugged. But, no question, there is dawn after the darkness.

Jargon buster

Reading about banks can be like wading through swamps of jargon. So here are some terms you might bump into, with simplified meanings attached. Bon voyage!

Asset: on a bank’s balance sheet, lending (eg loans to customers).

Balance sheet: statement of assets and liabilities.

Bankrupt: inability to pay bills.

Bond: tradable loan for a fixed period and rate of interest.

Capital: whatever is owned by the bank itself, primarily its ‘equity’ or shares.

The Chinese property bubble, as imagined on a construction site hoarding in Beijing.

WANG ZHAO/AFP/Getty Images

Capital ratio: capital as a proportion of assets.

Compound interest: added to ‘principal’ and charged on new total.

Derivative: a tradable ‘instrument’ depending for its value on the performance of something else – usually an ‘underlying asset’ such as a bond, currency or property.

Double-entry book-keeping: every transaction, except cash, recorded as a ‘credit’ to one account and a ‘debit’ to another. Beloved of chartered accountants.

Equity: usually shares conveying ownership and dividends.

Fire / Chinese Wall: formal separation between functions, such as retail and investment.

Fractional banking: creating credit by lending more than is held on deposit.

Hair cut: reduction in the repayment of a bond.

Hedge fund: investment fund aiming for high returns from aggressive trading strategies.

Illiquidity: assets not easily convertible into cash.

Insolvency: no cash or assets convertible into cash.

Investment bank: provides services for large companies and investors, including trading on financial markets, mergers, acquisitions and the like.

Junk bond: high risk of non-repayment, attracting high interest or ‘yield’.

Leverage: debt, usually measured as a proportion of capital.

Liability: on a bank’s balance sheet, borrowing (eg customer deposits).

Limited liability: risk to owners, usually shareholders, legally limited to the value of their shares.

Long: a ‘position’ in the market that depends for its profitability on a rise in the value of assets, like shares or currency, acquired by a trader.

Margin: difference between buying and selling price.

Money market: short-term borrowing and lending.

Moral hazard: reward for sin, likely to encourage a repeat.

Off-balance sheet: financing – such as a lease or ‘special purpose vehicle’ – that is not technically a debt and so is neither an asset nor a liability.

Option: entitlement to buy or sell an asset at a given price before a specified date.

Over-the-counter: transaction directly between individual traders.

Peer-to-peer (P2P): transaction directly between lender and borrower.

Private equity: funds injected into private companies by ‘specialized’ investors seeking high returns.

Quantitative easing: when interest rates are close to zero and can be reduced no further, central banks ‘print’ money electronically as another way of stimulating an economy.

Retail bank: sometimes known as ‘high street’ or ‘boring’, takes deposits from the general public.

Securitization: creating a tradable ‘security’ backed by the income from an asset like a mortgage or bond.

Short: a ‘position’ in the market that depends for its profitability on a fall in the value of assets, like shares or currency, acquired by a trader.

Swap: an exchange between traders designed to reduce interest rate or currency risk.

Systemic: A bank that’s considered so big that its failure would threaten the collapse of the global financial system.

Universal bank: combines retail and investment functions.

Venture capital: start-up funding for new companies.

  1. Cited in Martin Wolf, The Shifts and the Shocks, Penguin, London, 2014.

  2. Brian Bell and John Van Reenan, Bankers and Their Bonuses, London School of Economics Research Online, John Wiley and Son, London, 2013.

  3. The Economist, 31 January 2015.

  4. See, for example, Sheila Bair and Yalman Onaran, Zombie Banks, Bloomberg, 2011.

  5. IMF upper estimate cited in Peter Stalker, The Money Crisis, New Internationalist Publications, Oxford, 2015.

  6. Anat Admati and Martin Hellwig, The Bankers’ New Clothes, Princeton University Press, Princeton and Oxford, 2013.

  7. The Financial Times, 8 December 2014.

  8. Andrew G Haldane, The $100 Billion Question, Bank for International Settlements Review 40/2010.

  9. For a lucid account of this difficult topic (and many others raised here), see Peter Stalker, The Money Crisis, op cit.

  10. Mujica has been succeeded by his predecessor, Tabaré Vásquez, from the same ‘Broad Front’ progressive coalition. Uruguayan presidents are limited to one five-year term at any one time.