The state just saved the financial system from itself. What is the point of privately owned banks if they need to be bailed out every decade?

The two extremes of economic policy, socialist and libertarian, agree on the answer: “not too much reason to have privately owned banks if they are gonna get bailed out all the time”. The two sides certainly do not see eye-to-eye on the solution. I’ll go through the socialist case below and the libertarian alternative in the next piece.

I have been writing about the Covid-19 financial turmoil.

The financial authorities see themselves as having, reluctantly, saved the financial system from itself in 2020, and they aim to do what they can to prevent a repeat. Then, as I concluded my last piece, what is the point of a privately owned financial system if we need the central banks to bail it out every decade?

Let me put that question into context.

The financial crisis in 2008, and the subsequent extensive bailouts of the private financial industry, fuelled a populist rage. The political discourse has not been as anti-capitalist since the 1970s, on both sides of the political spectrum.

And now, we have yet another crisis, Covid-19, where the state keeps the economy going — strong echoes of the demand policies of decades past.

And, more central to my narrative here, the state bailed out the financial system for the second time in a decade.

So what might be a socialist take on this?

The objective of the financial system is to connect savers with investors and to enable companies paying their bills and collecting revenue. All relatively simple. A dull utility function with little risk.

There is no reason why such a financial system should get itself in a state requiring a bailout every decade.

But, the reason we got the crisis in 2008 was because of all the neoliberal deregulations of the decades before. The unfortunate collapse of the Bretton Woods system in 1973 — caused by currency speculators — set in motion the forces of greed that culminated in the 2008 crisis.

The financial authorities promised us after 2008 that they would beef up regulations so there would be no repeat. In the words of Mark Carney, then Chairman of the Financial Stability Board and Governor of the Bank of England in 2017:

“Over the past decade, G20 financial reforms have fixed the faultlines that caused the global financial crisis”.

It didn’t quite work. The financial system needed a bailout only three years later.

The financial authorities already heavily control how financial institutions measure and manage risk, and those regulations would become even more intensive with Covid-19. They already reaffirmed their willingness to rescue the system when things go pear-shaped.

Why then would we agree to the private owners of the financial institutions being able to get all the benefits when they are already being told how to manage risk by the authorities, and on top of that enjoying bailouts when they fail?

The logical conclusion of what the financial authorities did in 2020 is not just to increase regulations, instead, take the financial institutions back to basis. Either convert them into safe and heavily regulated utilities or just nationalise them.

I think it is a horrible eventuality. Perhaps the reason is that I grew up in a country where the government owned all the banks and each of the three main political parties controlled their own bank and would only lend to party members. Businesses that did not pledge allegiance to a party were unable to operate.

That is a pretty universal experience, countries that today have state owned banks find them to be much more politicised and worse run than privately owned banks.

My LSE colleague, Vicente Cunat, did a fascinating study of the Spanish caixas, finding that there was a direct correlation between the amount of politication of their boards and bad performance.

Still, the logical conclusion of the lessons the financial authorities have drawn from Covid-19 is more state control. And since I don’t think crises will go away, (a topic for another post), either nationalisation or lobotomisation of the financial industry seems to be the logical asymptotic conclusion.

Don’t like that? Why not just take the laissez-faire approach and let the market decide as I’ll discuss in the next post.


Roadmap

Thanks

Several friends and colleagues have commented on this series. Robert Macrae and Nikola Tchouparov gave me excellent comments that significantly improved the pieces. We don’t always, or even usually, agree, and all opinions are mine alone.