“Bear [Stearns]
executives also believe the market for collateralised debt obligations, which
is dormant, will eventually come back, though the instruments will probably
have a new acronym to make them more palatable.”
- The Financial Times, 14th February 2008.
According to Wikipedia, Mary Mallon
(a.k.a. ‘Typhoid Mary’) managed to infect 47 people during the course of her
career as a cook. Three of them died of the disease. Between 1900 and 1907, she
infected two dozen people with typhoid fever. She worked in Mamaroneck, New
York for less than two weeks when residents began to succumb. She moved to
Manhattan in 1901 and members of the family where she was employed started to
develop fever and diarrhoea. The laundress died. She then went to work for a
lawyer and managed to infect seven out of a household of eight. In 1906 she
moved to Long Island. Within two weeks, six out of eleven household members
were hospitalized. She changed employment again and managed to infect three
more families. Her fame “is in part due to her vehement denial of her own role
in causing the disease, together with her refusal to cease working”.
Nobody, of
course, suggests that modern banks are virulent and destructive plague
carriers. They are a lot more dangerous than that. But there are more than a
few commonalities: carriers of typhoid, like the originators and redistributors
of securitised subprime mortgages, and other largely unpriceable repackaged
debts, “continue to excrete the bacteria in their faeces..”; and, as with poor
Mary Mallon, the sense of denial for their own responsibility is almost
palpable.
Imagine a world
without banks, suggests this
site. If there were no banks..
- Where would you go to borrow money ? (Banks no longer have a monopoly on supposed risk-taking, assuming they ever did, but the question forms a presumption that unlimited and indiscriminate access to credit is essential in a modern economy, rather than a sign of fiscal indiscipline and a general symptom of a dependency culture that perpetually postpones making tough decisions – like, for example, saving.)
- What would you then do with your savings ? (Invest them, perhaps, into either productive, wealth generative businesses that make things - rather than simply shuffling paper around in what amounts to financial legerdemain - or into comparatively safe ‘plain vanilla’ government or corporate securities, or perhaps even into the precious metals that represent ‘traditional real money as a store of value’ superior to the theoretically infinite and therefore ultimately worthless supply of fiat currency.)
- Would you be able to borrow / save as much as you need, when you need it, in a form that would be convenient for you ? (See responses to Questions 1 and 2. In the context of loans for property, there are still one or two holdouts known quaintly as ‘building societies’, but their own misadventures in SIVs, CDOs, Treasury assets, real estate loans, “fair value movements” and “hedge ineffectiveness” – a concept borrowed from Bear Stearns ? – suggests they are at least as capable of haemorrhaging capital as the best banks. And in our brave new web-enabled world, as Zopa now suggests, “People are better than Banks”.)
- What risks might you face as a saver / borrower ?
At least we are
now somewhat closer to appreciating the ironies inherent in Question 4. In a
world with banks, risks to savers include: a confidence-draining run
that threatens the loss of all savings beyond those guaranteed by a deposit
insurance scheme with almost no underlying assets; a growing pyramid of
unrestrained lending based on increasingly flimsy over-engineered financial
structures that nobody either within the banking system or outside it can seem
to understand or even price; a widespread infection of the credit markets that
triggers in turn a crisis of confidence between banking counterparties and
between banks and investors, culminating in a debt deflation and an economic
downturn of uncertain duration and severity. Thank goodness for the banks !
As somebody once
said during the internet boom or perhaps earlier, banking is necessary, but
banks aren’t. There is no shortage of businesses with substantial capital that
can perform broadly similar services, at least to those offered by so-called narrow
banks. Banks may enjoy a privileged position in terms of credit creation, but
money itself is completely fungible. One of the critical problems with our
fractional reserve banking system is that banking institutions are performing
so many more complex, risk-taking functions than merely accepting deposits and
making loans (or these days, not making loans). When confidence
in the system craters as a result of a tidal wave of credit infection and of doubts
about undisclosed losses trapped opaquely and perhaps dishonestly within it, the
system breaks down, and requires at the minimum substantial amounts of taxpayer
capital just to allow it to tick over.
One of the
loudest broadsides launched against the banks was by Martin Wolf of the FT back
in January:
“No industry has
a comparable talent for privatising gains and socialising losses.. Yet the
conflicts of interest created by large financial institutions are far harder to
manage than in any other industry:
First, these are
virtually the only businesses able to devastate entire economies; second, in no
other industry is uncertainty so pervasive; and, finally, in no other industry
is it as hard for outsiders to judge the quality of decision-making, at least
in the short run. This industry is, in consequence, exceptional in the extent
of both regulation and subsidisation. Yet this combination can hardly be deemed
a success. The present crisis in the world’s most sophisticated (sic) financial
system demonstrates that.. I now fear that the combination of the fragility of
the financial system with the huge rewards it generates for insiders will
destroy something even more important – the political legitimacy of the market
economy itself – across the globe.”
Mr. Wolf’s
Jeremiad was met in response by some rather self-serving special pleading from
anonymous investment bankers in the blogosphere, but otherwise by much ongoing
sympathy within the FT letters page (and here and elsewhere).
But why continue
grimly to focus on the rancid open sore that is the banking system in 2008 ?
The February 7th front page headline of the European Wall Street
Journal provides much of the answer:
“UK’s role as
finance hub is now economic burden.”
For what is the
UK if not the world’s largest offshore financial centre ? As the WSJ’s Alistair
MacDonald and Mark Whitehouse point out, “No large country is more dependent on
the movement of foreign money through its banks: some $2.4 trillion flowed in
and out of the UK in 2006, an amount equivalent to the country’s entire annual
economic output..” The WSJ also suggests that, rather ominously, “the financial sector accounts for more than
one-fifth of all UK jobs”. The comparable figure from the US, which treated
the world to the subprime debacle in the first place, is just 6%. And whatever damage a softening property
market and stalling investment banking business inflicts upon the economy may be reinforced by the
government’s on-the-hoof flip-flop policymaking-by-headline approach to
non-domiciles.
The Bank of
England’s February
Inflation Report was pulling few punches:
“The disruption
to global financial and credit markets continued. Current and expected policy
rates fell. Sterling depreciated substantially.. Consumer spending growth
appeared to soften and the climate for investment deteriorated. International
prospects worsened, especially in the United States.. the Committee’s central
projection is for output growth to slow markedly this year and then gradually start
to recover. The risks to growth are weighted to the downside.”
Even that
masterly use of central bankerly understatement gets the point across.
Annoyingly for the Bank, inflationary expectations are on the rise. Admittedly,
looking out further we can ignore the short term effects of higher energy, food
and import prices, because they will be offset by falling house prices, rising
unemployment and – theoretically at least – falling wages. But in the interim,
increasing fears of stagflation warrant heightened exposure, in a debt market
context, to inflation-protected debt and
nothing else. And as The
Business Ledger is probably correct to suggest, there is a growing danger
of a bubble forming in government bonds. The only economic backdrop that
justifiably supports 10 year UK government bond yields, for example, at or
around 4.5% - just 40 basis points higher than the year-on-year rise in the
Retail Price Index – is one of incipient Armageddon. The trouble with that
thesis is that incipient Armageddon, or for that matter merely a perpetuation
of the ongoing cretinocracy that is the banking sector, would argue for some
colossal government (i.e. taxpayer) support for that same ailing banking
sector. To put it politely, that would be diabolically negative for
conventional bondholders, though altogether less problematic for
inflation-protected investors. Absent tangible evidence of a recovery in
housing and consumer spending (other than a few days’ irrational exuberance on
the part of equity investors), a poor outcome for banks – and, in turn, quite
possibly for conventional Gilts, US Treasuries, et al – seems a feasible
outcome. Tragically and ironically, a rapid recovery in housing and
consumer spending might yet have exactly the same effect. Conventional
government bonds are starting to look dangerously overbought.
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