Wednesday, 15 June 2016

Barclays Bank’s fake capital.

In 2008, Barclays came up with a great idea for improving its capital ratio: create a few billion pounds out of thin air and lend it to an Arab sheikh (Sheikh Mansour) on condition he used the money to buy newly issued shares in the bank.

According to a Science Direct paper by Prof Richard Werner entitled “How do banks create money…”, that trick was illegal, “But regulators were willing to overlook this”, as Werner put it. And apparently the justification for that illegality was (to quote Werner again) that “This certainly was cheaper for the UK tax payer than using tax money.”  OK, let’s run thru this.

In the recent recession, stimulus was needed, plus it was clear that banks needed to be made safer, e.g. by increasing their capital ratios. But there is a possible conflict there.

If increasing bank capital ratios (as per the Modigliani Miller theory) has no effect on the cost of funding banks, then there isn't too much of a problem. That is, banks can simply be ordered to raise their capital ratios, plus stimulus can be implemented.

That stimulus does not cost taxpayers anything. Reason is, to over simplify a bit, that in the case of helicopter drops (one form of stimulus), the state simply prints money and spends it (and/or cuts taxes). There is no need to rob taxpayers of a single penny. Or as Milton Friedman put it, “It need cost society essentially nothing in real resources to provide the individual with the current services of an additional dollar in cash balances.”

Of course stimulus can take various forms other than helicopter money (HM), but actually fiscal and monetary stimulus combined come to much the same thing as HM, as others have pointed out. That is, under traditional fiscal stimulus, government borrows £X and spends it and/or cuts taxes, and it gives £X of bonds to those it has borrowed from. The central bank then prints money and buys back at least some of those bonds so as to make sure interest rates don’t rise. Or maybe the central bank prints money and buys back ALL OF those bonds, which is pretty much what has happened under QE in recent years. The latter scenario nets out to the same thing as HM.

So let’s assume that stimulus takes the form of HM (a policy which is actually advocated by some, e.g. this lot)

What if Modigliani Miller is not valid?

An alternative possibility is that MM is NOT VALID, i.e. that increased bank capital ratios do in fact raise bank funding costs. In that case, raising those ratios will indeed cut lending which will be deflationary, but that deflationary effect is easily countered with more HM. So again, there is no cost to the taxpayer, and thus no excuse for dodgy loans to sheiks.

Yet another possibility is that MM is not valid, but government is determined not to let lending by banks decline. That of course is a totally illogical stance: after all if the cost of funding banks (or growing apples) rises, then it’s reasonable to expect a fall in bank lending (or apple sales). Indeed, it was blindingly obvious in 2008 that banks had over-extended themselves, i.e. loaned out too much, thus a CONTRACTION in total bank lending would have made very good sense.

As to what REASON government might have for insisting that bank lending should not fall, the possibilities aren’t too hard to fathom. One is that politicians are beholden to bankster / criminals for funding political parties. Another is that because bankers wear smart suits, drive smart cars and have nice houses in the country, politicians conclude that bankers must know what they’re talking about. Thus when bankers say banks cannot be allowed to shrink, else civilisation as we know it will come to an end, politicians jump to attention and do what bankers want.

Taxpayers subsidize banks.

Yet another possibility is that MM is not valid, government is determined not to let the size of the bank industry shrink, and decides to deal with that by some sort of taxpayer funded subsidy for the process of increasing bank capital. That’s the ONLY circumstance in which the “Sheikh Mansour” trick would save taxpayers’ money. But for reasons given above, refusing to let the size of the bank industry shrink makes no sense whatever.


This is nonsense from start to finish, unless I’ve missed something.


  1. Are you saying Werner is talking nonsense?

    1. I’m a big fan of Werner’s, but I think that sentence: “This certainly was cheaper for the UK tax payer than using tax money” is iffy. If my above argument is correct, the only circumstance in which that’s true is where government implements an artificial and unjustified pro-bank stance. And we’ve had enough of bail-outs for banks and other forms of featherbedding for banks I think.

  2. He is not condoning it by saying that,only being pragmantic.If the state had had to bail out Barclays it would have cost the taxpayer.The fact that they did something underhand meant they avoided being nationalised.Like it or noe it was a benefit to the taxpayer!But no one would recommend such an illegal action.


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