We commonly hear that the financial crisis arose because we took on too many debts and the banks took too many risks. But we see few explanations of the mechanics that allowed this to happen.
Words like ‘historically’ and ‘traditionally’ are applied to things that happened in the last 20 or 30 years. But a revealing comparison is only found with the previous period – roughly, the 1950s and 1960s, when no serious banking crises took place anywhere in the world. And at that time there was no formal regulation of British banks. How could this be?
When we compare the norms of banking in that era, the contrast is breathtaking. A couple of generations ago Northern Rock’s degree of dependence on other banks would have been inconceivable. Bankers themselves – legendary then for extreme caution – would have seen it as grossly irresponsible.
In 1969, high-street banks’ advances of loans and overdrafts were equivalent to 50 per cent of their deposits, and a textbook of the day pronounced that bankers regarded anything above 55 per cent as excessive.
Yet Northern Rock’s ratio of advances to deposits was over 330 per cent when it collapsed in 2007, and the British average now is 238per cent. To that we must add further interconnections through financial derivatives, which did not exist then.
And the domino effect of these interconnections brought banks down: Northern Rock and Lehman’s, and others in the 1970s and 1980s. Only this month, big French banks faced the same threat. This interbank business is massively destabilising.
It also explains the banks’ power: now if they don’t get their way, they can pull the whole economy down. In past crises, for example in 1890 and 1974, the authorities got other bankers to pool money and save a failing bank. Never before 2008 were they bailed out with public money.
A new report from the Green House thinktank [*] examines the changes that have occurred since the first policy of bank liberalisation by the Bank of England in 1971 and the more thoroughgoing process of the Thatcher government in the 1980s. It concludes with 13 recommendations for reforms to restore stability to finance.
The report starts with a list of 14 major differences in the ways that banking was done. Most if not all of them rendered banking safer than it is now.
Some of the differences cut across assumptions that are almost universally held today. For example, the banks and building societies operated cartels – which made the system safer, for example in removing competition to offer ever bigger mortgages based on ever bigger income multiples as a housing boom develops. The building societies’ cartel simply restricted access to mortgages when demand was high: this frustrated purchasers but reduced the inflation of house prices.
If we want banking to be safe again, we have to bring it back within similar bounds. In the 1980s, experts on bank regulation already warned that the banking system could collapse like a house of credit cards, because of the wholesale markets – whose value then was described as a ‘staggering’ US$2.1 trillion. Over-the-counter derivatives trading, much of it between banks, is now worth over $600 trillion.
In 2008, nobody could say that they had not been warned. The warnings were made over 20 years earlier, but they were ignored and then forgotten. This makes it far more difficult to restore a responsible banking system now, but it also makes the task all the more pressing.
[*] The Dog That Didn’t Bark: When banking crises did not occur and what we can learn from that. Download it at www.greenhousethinktank.org/page.php?pageid=recentpublications.