Monday, 20 January 2014

Why Rob Banks?

The recent blather-fest over bankers' bonuses avoided the key question, which is: why do banks make so much money? The American bank robber Willie Sutton, when asked why he robbed them, is supposed to have said "because that's where the money is". The phrase was a journalist's invention, and often misattributed to John Dillinger, but it gave rise to Sutton's Law, which is a variant on the time-honoured principle: consider the obvious. Ed Miliband has proposed that the big five banks be ever-so-slightly broken up to encourage competition, but this will not obviously lead to the banking sector becoming less profitable, so it does not address the key issue - unless you think the issue is the superior magical properties of the number seven.

Banks make too much money. We know this because they pay such high sums in salaries and bonuses (it really is that obvious). Retail banking is not highly profitable, but investment banking and involvement in wider financial services makes the sector profitable overall, albeit more risky. One argument against large bonuses is that these are profits that are being skimmed off by employees to the detriment of shareholders - i.e. the principal-agent problem - however it is clear that enough "owners" are beneficiaries (or are disempowered through intermediaries) to prevent this changing. As the old saying has it, "the best way to rob a bank is to own one". The state bailout of banks in 2009 has meant that future profitability (i.e. at the level of management profits) can now be taken for granted, hence we should not be surprised that the bonus habit has not been kicked. If you ever had any doubts about banking being a one-way bet, you shouldn't now.

The reason banks are so profitable is not that they constitute a cartel (Miliband's implicit criticism), or even that they have a monopoly over money (the argument of those who prefer gold or Bitcoins, whose own behaviour disproves the monopoly claim), but that most of us have a bank account, which wasn't the case as recently as 30 years ago. The rise of financial services profitability reflects the growth in household savings and debt, which is "obvious" when you consider that the broad role of banks and building societies is to convert savings into loans. While we fret about rising debt (legitimately, as so much has been converted into unproductive assets such as property), and the iniquities of rising inequality (exacerbated by the class bias of banking), we ignore the growth in overall social wealth. Bank profits (and thus the divvy of bonuses) are an economic rent on society as a whole.

The way to change this is to limit the scope of commercial banks (the investment/retail ringfence is a red herring as the key issue is profit not practice). This means re-establishing the role of mutuals, cooperatives and not-for-profit savings banks (not the pseudo-mutuals we have today, which are intimately bound up in the banking industry). Again, to state the obvious, the tide of change since the 1980s - of demutualisation, extinction of savings banks, and diversification and mergers - has fuelled the growth in bank profitability, providing access to mortgages and household savings for leverage. Re-engineering the banking sector is hardly a novel proposition, though it's too often justified by questionable claims that it would lead to more business investment (the evidence points to a lack of demand for investment capital rather than a lack of supply), or by the romanticising of mutuals and nostalgia for Captain Mainwaring. I would offer two other reasons for considering it.

The first is that we need to decouple property debt from property prices at some point. The current strategy of insufficient home building, out-of-reach mortgages, and rising private rents cannot go on indefinitely. Whether you think this will be resolved by a bonfire of planning regulations (the market) or by renewed council house building (the state), the consequence must be a drop in the real price of property (i.e nominal prices growing at a slower rate than inflation). A gradual adjustment can be absorbed, but for the duration (two or three decades) it will mean lower profits as mortgages lose their attraction as an asset class (at the macroeconomic level, this just means that funds go elsewhere, ideally into more productive investments - it will also kill equity release, which means consumer demand will fall, though the reduction in mortgage repayments should partly offset this, while more productive investment should lead to rising real wages). Mutuals could accommodate this as their fundamental model is to recycle repayments into new loans. Falling real prices means that the repayments on historic loans can fund proportionately more new loans (conversely, during eras of rising real prices, mutuals must borrow more wholesale funds or limit loan supply - hence the evolution of mortgage-backed securities).

The second reason is technology. Miliband's vision of two new banks on the high street misses the point, even if it is just a rhetorical trope. In the future, there will be many fewer bank branches (they have halved in number since 1990 as online and phone banking have grown), and that is no bad thing. The traditional UK retail model is based on free banking subsidised by higher lending fees (e.g. punitive overdraft charges), upselling (mortgages and insurance) and mis-selling (PPI etc). A not-for-profit, nationalised utility bank, funded by the taxpayer, could support a branch network (merged with post offices in some areas), and so free-up the commercial banks to move to a combination of online-only and a smaller number of specialised business lending branches. This would also allow the commercial banks to divest themselves of "basic" accounts and low-value customers, so reverting to their traditional "well off" market, where service fees would be more acceptable. The nationalised bank should also own the inter-bank payments system (and rebuild it from the ground up) and provide cash-in facilities for traders, wherever they bank. It could also provide self-financing (i.e. zero profit) personal loans to those deemed unattractive by the commercial banks, thus under-cutting the extortionate payday lenders.

Of course, we already have a nationalised bank in the UK, in the form of RBS, and have even created a holding company for mortgages in the form of Northern Rock Asset Management (the bit left after Branson walked off with the branches), so the basis of a utility bank is already in place. What isn't present is the political will to take the next step, which suggests both a reluctance to cross the City and a refusal to even think about the housing crisis beyond subsidising the existing, dysfunctional model. Instead we are offered palliatives such as "easier switching", new "challenger" brands, and "Help to Buy", not to mention Wonga and its ilk.

Willie Sutton was jailed repeatedly and broke out of prison three times. He was eventually paroled in 1969, aged 68, when he was physically incapable of any more robberies. It is estimated that he stole over $2 million (roughly ten times that in modern prices) during his criminal career. When asked, he replied: "Why did I rob banks? Because I enjoyed it. I loved it. I was more alive when I was inside a bank, robbing it, than at any other time in my life. I enjoyed everything about it so much that one or two weeks later I'd be out looking for the next job. But to me the money was the chips, that's all". Why do bankers pay themselves stratospheric bonuses? Not just because they love the money. They love the status, the buzz, the disapproving glares from the rest of us schmucks. So long as we let them, they will keep on doing it.

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