In Parts 1, 2, and 3 of this series I examined the role of banks in creating 95% of money; the ratio of reserves they should be required to hold to cover ‘bad loans’ (which has recently been lowered); the proposed Miliband bank market share cap; and the Carswell two-type bank despositor system proposal.

In this final part we shall go to back to the basics of the problems these proposals have sought to answer.

It is now widely accepted that ‘normal banks’, by the creation of credit/money in the form of loans and mortgages, contribute to the ‘boom and bust cycle’ which Gordon Brown spectacularly failed to end as he had promised. The creation of credit enables economic growth, but when that credit is given too freely also leads debts that cannot be repayed. As such, it is the high street banks that create this credit bubble that leads to bad investment and subsequent ‘busts’. The role of the banks and their customers is therefore crucial in the entire economy of any nation.

The crux of the problem lies in the decisions made by ordinary banks about whether to give any single person a loan of some kind; is the investment wise or will go it bad? The point is to examine the factors that induce banks to create credit unwisely and leads to credit bubbles.

Naturally it doesn’t help that banks have become largely divorced from their customers. When making a loan or giving a mortgage, they rarely look at an individual’s real circumstances or character; they consider only the ‘bottom line’ line numbers, and in good times, incentivise those who sell credit with bonuses. It would be wiser to save to the bonus for when the debt is payed; eggs might not hatch.

In general, the trend to ‘global’ or ‘bottom line’ banking has divorced banks from some of the realities that are likely to effect whether their investments are good or bad. They have lost personal contact with their customers. To this extent, a break up of the larger banks and easing of the rules for entry to the market, creating more competition, may encourage more detailed attention to individual cases – what used to be called ‘customer service’! {For a case study on the problems of setting up a new bank, we recommend the Channel 4 three part series Bank of Dave – ed.}

One factor that encourages banks to think that credit creation is less risky, is Government sponsored ‘guarantees’ such as the current ‘Help to Buy’ scheme. Many warned that this may lead to a ‘property bubble’ and with house prices predicted to rise 8% this year and wages rise only 1.25%, the would be buyers cannot long keep up with the prices. The insanity of this scheme is that it has clearly been documented as having directly lead to US sub prime housing collapse.

The banks willingness to fund this growing bubble is due to their (not unfounded) belief that when the bubble bursts their losses will be guaranteed by the tax payer – even if it means depositor confiscation as occurred in Cyprus. Governments simply need to be made to understand that governing a country does not include acting as the public’s fund managers in property and financial speculation. If the British Government were an investment management company it would be bankrupt many times over. Government – you’re no good at it! Stop!

Another thing the Government does that encourages over leveraging by banks, is to ‘guarantee’ depositors accounts up to £85,000. Contrary to popular belief, this does not benefit the depositor as the money in their account does not belong to them. Rather, it guarantees the bank, and encourages them to create credit or make loans and investments that otherwise they may be less inclined to do. It encourages the creation of debt that is more likely to go bad.

The other large factor that contributes to overdue bank scrambles for ‘liquidity’ is the lack of transparency about individual banks leverage ratios. For the sake of their depositors and shareholders – and so that they and the market can correct rapidly – surely these ratios should be made clear and public at regular intervals? This would encourage the banks to be more prudent in the role as credit creators, as depositors and shareholders could more easily assess the status of their risks.

Finally, let us mention ‘herd psychology’. When everything is seen to be going well (whether it really is or not), everyone wants to jump in. Keynesian ‘animal instincts’ take the form of a kind mass euphoria. Right up until Lehman’s collapsed, ‘experts’ in fine offices with pretty secretaries were saying “Buy! Buy now!”. Of all the schools of economic thought, only the Austrian economists predicted the deluge. Even the Central Banks were caught off guard. Given the role the Central Banks have in artificially suppressing interest rates, thereby encouraging the creation of excess of credit and bad debt, should we not also, as many free market reformers in the US now do, examine the need for a Central Bank at all?

Governments not only oblige the nation as a whole to take on ever more debt (£96bn last year), but by their guarantees and use of ‘independent’ central banks they encourage banks to create ever more personal debt for individuals. It is clearly unsustainable. Some now think it is too late to save the system as it is; that 2007-8 was but a foretaste of what is to come. Let us hope they are wrong, but if they are right let us not make the same mistake of bailing out bankrupt banks again, but use the opportunity to change the system.

*Peter Schiff was right video; https://www.youtube.com/watch?v=Z0YTY5TWtmU

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