Recently I was sitting in my economics lecture trying to figure out what to do about the banks so that we never have another financial crisis. After much thought, I came to the conclusion that banks are too important to be left to the bankers. The only way to avoid future financial crisis and massive bank bailouts is to nationalise the banks. Now I’m no out-and-out Communist driven by ideology alone. I don’t believe in one size fits all, in that everything should be privatised or nationalised, rather it depends upon the situation. Listen to my explanation with an open mind and you might find a certain logic in this seemingly drastic proposal.
The crucial point is that banks are central to the economy. If the banks are in trouble, the rest of the economy is in trouble. Whereas if an ordinary business fails, that is bad for the owners and employees, if a bank fails, the entire economy suffers. Our current crisis has been greatly exacerbated by the financial trouble. This is because every business of the economy is connected to the banks. Every business (and even every individual) has money saved and borrowed from the banks. If a bank gets in trouble it calls in its loans which can put all its clients into trouble. Or if a bank collapses businesses and individuals lose their savings, which means they spend less with a negative effect on the economy. Essentially trouble at the banks spreads out to the rest of the economy.
How do banks get into trouble? They are various ways, but they are essentially variants of the same way. Banks make money by receiving deposits and giving out a multiple (usually 10) of this in loans. This is fundamentally unstable as the usual bank can only cover 10% of its deposits (the riskier banks have an even lower percentage). Therefore banks are always walking a tightrope with the risk of collapse. This is a major problem with the way our economies are based. The core sector of the economy is also the most unstable part.
The logic of capitalism pushes banks down an unstable path. In order to make money, banks must lend money. The more they lend the more profit they make. However if they lend too much, they could over extend themselves and collapse. In fact bank collapses and financial crises are usually caused by banks over lending. Competition actually makes the situation worse. If a bank does not have lenient lending practices, it will lose business as their clients will go elsewhere. This is what happened in Ireland when the loose lending of Anglo Irish bank forced AIB and Bank Of Ireland to follow their lead. Left to their own devices banks inevitably drive themselves off a cliff.
Banks are entirely dependant on confidence. However this is incredibly unstable. Keynes rightly described this as being led by ‘animal spirits’. Confidence is driven more by emotion than logic. It swings wildly between irrational exuberance of the boom years to the chronic depression of the crash. Ideas like ‘this time is different’ ‘property will always rise in value’ become guiding principles. It is clear that basing the core sector of the economy on such illogical principles is a recipe for disaster. In this world, rumours and myths play a bigger role than facts and logic. In the world of a self-fulfilling prophecy, if enough people believe something than it becomes true. If people believe a bank is in trouble they will take their money out of it. Regardless of the actual state of the bank, it is now in trouble. The threat of a run on a bank can destroy a solid bank (and therefore the economy) even if it is based on a groundless rumour.
This is ridiculed in the novel The Jungle where a criminal is arrested in a shop beside a bank. A crowd gathers to watch the sight. As more people gather around they think the crowd is gathering outside the bank and fear a run on the bank and respond by taking their money out, which causes the bank to collapse. Although exaggerated, this story does hold the essence of the truth. That the core of the economy can be so unstable, so easy fail even if based on untrue rumours, should be a major concern. It is clearly a major problem that cannot be ignored.
Governments try to solve this problem by guaranteeing deposits. This is a commitment by the government to depositors that even if the bank fails customers will not lose their money (at least not up to a certain amount). The logic is that this way depositors will not fear a bank run and therefore bank runs will not happen (as confidence is a self-fulfilling prophecy). However this has many problems of its own. It leads to ‘moral hazard’ as banks are encouraged to take gambles knowing that if they go bust the government will bail them out. This becomes a case of heads they win, tails they don’t lose. The guarantees are hugely expensive (as recent times show) and lead to questions of why the taxpayers should pay for failed banks gambles. If the shareholders get to keep all the profits when times are good, then surely they should keep all the losses when times are bad.
While tighter regulation would undoubtedly be a step in the right direction, it wouldn’t be enough. Banks are constantly devising new ways to avoid and circumvent regulation. There will always be pressure to ease regulation by those who claim the market can solve all our problems (though ignoring the fact that the uncontrolled market lead to the current crisis). Regulation is good, but simply isn’t enough.
So far I have explained why banks are central to the economy, how unstable they are, how aiming to maximise profit is a major cause of this instability and why guarantees aren’t enough. The simple fact is that even if we get out of the current financial mess, under the current system it is only a matter of time until we get into another one. Nationalisation is the only answer. It removes the risk of moral hazard and ensures that taxpayers will enjoy the profits during the good times instead of just the losses during the bad times. With aims other than solely profit maximization it is more stable. There is also no fear that the bank may invent some new complicated mechanism to avoid regulation (a major cause of the financial crash in America). With the government’s reserves behind it there is no fear of a run on the bank. It can offer loans at a lower interest rate and focus on more community orientated investment. There would no longer be the obscene sight of the managers paying themselves outrageous salaries.
There would still be room for private banks, however they would not be supported in any way. If they got into trouble they would be on their own. The state bank would be the core of the economy, resolving the problem of placing “too big to fail” banks in unstable private hands. Just as schools and hospitals are too important to put in private hands, so too are banks. They are too important, too crucial to our economy to allow them to be taking large risks for extra profits.