Alan Kohler: Banking is a paradox at the heart of capitalism
Banking is a confidence trick, but preserving the trick has meant that banks have become arms of the state, writes Alan Kohler.
Banking is the confidence trick that lies at the heart of capitalism, but preserving the trick has meant that banks have become arms of the state.
The banking crisis gripping the US and Europe is the inevitable result of the past 12 months of rate hikes – it (almost) always happens.
UBS is now the monopoly bank in Switzerland after its shotgun marriage with Credit Suisse, with the Swiss National Bank holding the gun and actually firing it at bondholders, who lose everything. But now UBS is also, in effect, an extension of the Swiss government.
Would Australia’s smaller banks even exist without the government guarantee for deposits up to $250,000? Unlikely. Some of the big ones would probably struggle, too.
The maturity transformation that banks do (that is, they borrow short and lend long) underpins the capitalist society, especially now.
Finance rules the world
It’s where the capital in capitalism comes from. Not all of it, of course: The rest – the equity – comes from saving for retirement, rich people trying to get richer and just plain speculators, but that’s another confidence trick altogether.
In the past few decades, the economy has been financialised, that is, finance has come to rule the world.
At first it was agriculture that ruled, then manufacturing – first textiles, then cars – and then computers and the internet.
Now it’s banking, because in the past 15 years after the GFC and the pandemic central banks cut interest rates to zero and flooded the banking system with cheap cash, which bankers have turned into long-term loans for great personal reward.
It has been the greatest executive money-making machine since Silicon Valley.
And as a result, global debt now stands at more than 300 per cent of GDP, triple what it was in 1970.
But central banks are now taking instead of giving – the machine is in reverse.
The way banking works is both simple and precarious – you have your salary paid into a bank because you have confidence that when you tap your card at the supermarket or the cafe it will beep obediently because the bank is paying for your groceries or your coffee.
But the bank hasn’t put your wages aside for you. It has lent the money to someone for 25 years so they can buy a house, and the whole thing only works because you and the others with wages going into the bank don’t ask for it all at once.
It only works if you and everybody else believes the bank will have it when you ask for it; that is, it’s only true if you believe it’s true. That’s the trick – banks can only be trusted as long as they are trusted.
When confidence breaks down
Occasionally the confidence breaks down as it is doing now, usually because depositors get worried that a bank’s assets (loans, bonds and properties) have lost value so they are worth less than the liabilities (deposits), which is a solvency problem, so they ask for their money back all at once. That creates a “bank run”, or a liquidity problem.
Governments regulate to preserve the illusion that your money is always available and then clean up when there’s a run.
The Great Depression happened because in 1930 there was none of the latter, and 9000 US banks failed, so after the horse bolted, then US president Franklin D. Roosevelt shut the gate in 1933 by creating the Federal Deposit Insurance Corporation (FDIC) to guarantee deposits up to $US2500. By 2010, it had become $250,000.
(In Australia only three small banks actually failed, even though unemployment reached 32 per cent, so there was thought to be no need for an FDIC).
The Great Recession of 2008 happened because US authorities were worried about moral hazard – which is where people take too much risk because they think they’ll be protected from its consequences – and they let Lehman Brothers go broke to teach them, and everyone, a lesson. Big mistake.
A week later there was a run on Washington Mutual, America’s largest savings and loan association; it went bust, and that is still the largest bank failure in history ($US307 billion).
Australia, meanwhile, created the Financial Claims Scheme to guarantee deposits up to $250,000, the park bench on which the banks now rest.
Now, in 2023, the US has had its second biggest bank failure ever – Silicon Valley Bank ($US209 billion) – and suddenly all deposits are guaranteed. Moral hazard? No worries – everyone’s money is fully protected, except those who bought shares or bonds. Depositors only.
Silicon Valley Bank (SVB) was a classic case of a solvency problem turning into a liquidity one. For some reason it owned a lot of government bonds, which lost value when interest rates went up, so the flighty Silicon Valley start-ups who had their money in the bank got worried and took it out.
Ironically, that led to bond rates going down again and the value of the assets going up – because of the liquidity crisis it caused! But by then it was too late.
Arms of the state
In Switzerland, Credit Suisse has been struggling with profitability for years but the SVB collapse brought the problems to a head. And so its competitor UBS must buy Credit Suisse for not very much, with a big government loan, and a government guarantee that it won’t lose on the deal.
Maturity transformation – that is, normal banking – has become so essential to the operation of society that the privately-owned banks that do it are now essentially arms of the state.
Australia’s smaller banks now rely more than ever on the deposit guarantee. The big four are valued at $394 billion (even more than eight nuclear submarines) so they won’t be nationalised, but they are too big to fail.
Anything that can’t be allowed to fail is not a part of the free-market capitalism founded by Adam Smith, or the “creative destruction” preached by Joseph Schumpeter or even the neoliberalism of Milton Friedman.
And that’s the great paradox of the free market: The banks that lie at its heart are not free, or in the market. They are government contractors.
Alan Kohler is founder of Eureka Report and finance presenter on ABC News. He writes twice a week for The New Daily