Sunday, 18 November 2012
The basic premise of the Vickers report is flawed.
Vickers advocates separating retail from investment banking so as to prevent problems in the “socially useless” casino section of the banking industry damaging essential or “socially useful” banking activities. (The phrase “socially useless” is a quote from the head of the Financial Services Authority rather than a quote from Vickers.)
The Independent Commission on Banking report (aka the “Vickers” report) quite rightly wants to prevent banks exposing taxpayers to risk. They say “The risks inevitably associated with banking have to sit somewhere, and it should not be with taxpayers.” And again, “One of the key benefits of separation is that it would make it easier for the authorities to require creditors of failing retail banks, failing wholesale/investment banks, or both, if necessary, to bear losses, instead of the taxpayer.
Unfortunately, they then go on to advocate the inclusion behind their “ring fence” of activities which are not 100% safe, and which thus inevitably expose the taxpayer to risk. These include mortgages, loans to small businesses and possibly to large businesses.
So why the self-contradiction? The explanation is in this sentence where they say, “The economy would suffer if separation prevented retail deposits from financing household mortgages and some business investment.”
The flaw in that idea is that it assumes there is some sort of fixed amount of money available to an economy. I.e. they’re assuming that if money from retail deposits is not invested, then investment declines. That is not true. I.e. if restrictions are put on the way money is used, clearly the economy will “suffer” ALL ELSE EQUAL. But of course there is absolutely no reason why all else need be equal.
In particular, it is very easy to make up for the deflationary effect or “suffering” effect of placing a restriction on how money is used by increasing the country’s money supply. And the costs of doing that are ZERO.
In the words of Milton Friedman, “It need cost society essentially nothing in real resources to provide the individual with the current services of an additional dollar in cash balances.” That’s from Ch3 of his book “A Program for Monetary Stability”.
Having done that, every household and firm would then have a larger stock of money, and thus would NOT NEED to borrow so much. And as to households and firms with surplus cash, not doubt some would invest in interest or dividend earning investments, to which extent the total amount lent or invested would not decline. But possibly the total amount invested WOULD DECLINE somewhat. But so what? The important point is that full employment is still achievable, plus we would have dispensed with a totally unwarranted subsidy: the subsidy of banks.
In short there is choice between using a small amount of money in a dangerous fashion, and alternatively, creating more money, and employing it to set up a safer banking system. Likewise you can absorb a relatively small amount of time doing a car journey by exceeding the speed limit, or you can absorb more time and travel more safely.
In other words, the much vaunted “fence” should be placed between the two following activities. First, bank accounts which the state insures, but which are near 100% safe ANYWAY because the relevant money is just not invested, i.e. not put at risk. Second, there are interest earning or dividend earning forms of saving. But this is a COMMERCIAL activity, and while commercial activity is laudable, there is NO OBLIGATION on taxpayers to underwrite it.
That way it’s virtually impossible for banks to fail, plus there is no taxpayer subsidy worth talking about for banks. Of course, lenders and investors still stand to make substantial losses, but then they run that risk ANYWAY: stock markets crash from time to time. But as Mervyn King pointed out, the effects of stock market crashes are nowhere near as severe as the effects of a collapse of the banking system. Seems they aren’t as severe as the effect of a near collapse of the banking system which is staved off by billions grabbed from the taxpayer, if the last five years are any guide.