Reminder: Banks Only Make Money Because We Bail Them Out
Years after the 2008 financial crisis, America is still arguing over how to address Wall Street’s “too big to fail” problem. Here is another perspective, based on history: there is only one choice.
The “too big to fail” problem in a nutshell is that financial institutions grow so huge and powerful and interconnected that their collapse would devastate society in general, which means they will always be at least implicitly backstopped by public bailouts should they get themselves into a crisis. Which they do every couple decades or so! And so we have a society in which the financial sector’s gains are privatized (they go into bankers’ pockets) but the sectors losses, if they become catastrophic, are public (they come out of all of our pockets).
This is not good.
Everyone except bankers and their political minions knows the situation is not tenable. So after the 2008 crisis, nations around the world with large banking operations set out to figure out how best to make these institutions operate more safely. Most agreed that banks need to hold more money in reserve in case something goes wrong. America agrees, but our policies are considered more tepid than the response of other nations.
Yves Smith, who writes a very intelligent blog about how capitalism is fucked up, argues in Politico this week that America needs to look to Europe, which has been much tougher in its response to the crisis. Here is a very crucial bit of context from her story, which in a rational world would be informing our banking regulations: banks have proven themselves to be a regular systematic risk and blow up so frequently that virtually all of their profits are a mirage. Bolding ours:
In a 2010 speech, “The $100 Billion Question,” [Bank of England director of financial stability Andrew] Haldane concluded that the financial crisis of 2008-09 produced an output loss equivalent to $60 trillion to $200 trillion for the world economy. Assuming that a crisis occurs every 20 years, he said, overall that means that a poorly regulated financial sector does not add any net benefit to the economy—its repeated crises cost far more than Wall Street brings to overall economic growth. Haldane compared the speculative trading excesses of bankers to air pollution from the auto industry and wrote that “systemic risk is a noxious by-product” not unlike the damage to public health from carbon monoxide, lead and other toxins. In the auto sector, those problems were redressed through taxation and occasional prohibitions or restrictions on poisonous emissions. Why not take a similar approach to over-the-counter derivatives?
Haldane used a 2008 crisis cost of one times global GDP, the low end of his estimated range. That sounded large at the time but has proved to be about right. Haldane then tried the tax approach: make the big banks pay for the cost of the crisis over 20 years, which is about how often big busts occur in our deregulated world. The first-year charge alone would wipe out the banks. Or as Haldane colorfully put it: “Fully internalizing the output costs of financial crises would risk putting banks on the same trajectory as the dinosaurs, with the levy playing the role of the meteorite.” The implication was that barring banks from crisis-inducing behavior was the best remedy, regardless of the impact on profits, since banks could not begin to pay for the costs of financial meltdowns.
Banks don’t actually make money because they blow up so often! They only make money in the short term and are able to continue their insane book-and-bust cycle because their losses are socialized.
This is one of those not-secret and well-understood things that you would think would have been fixed as soon as it came to be understood. But nah.