Yesterday, the Governor of the Bank of England suggested that the banks have slowly returned to their bad habits – but why should that have happened?
Just over two years ago, senior bankers were standing around in draughty Treasury corridors willing to sacrifice anything for Government help in order to avoid the prospect of a banking meltdown.
Yet now, all seems well on Planet Bank.
J K Galbraith said “the financial memory is brief”. The fact that even now, those living in broken economies are piling into the stock markets and making speculative investments reinforces his view.
Investors fall into only two groups. Firstly, we have those who believe that markets will rise for ever – at least for as long as they are investing. Secondly, we have the more experienced group which thinks that it can ride the “ups” and climb out just before prices begin to dip. What they don’t seem to realise is that they are all as vulnerable as each other.
By rights, stock markets should have crashed by now. All that has held them at reasonably healthy levels is the abstract money that has been generated by central banks. No doubt the central banks imagine that they are doing their governments a favour but once again, they appear to have forgotten one immutable fact: investment euphoria (which on this occasion, they have helped to create) is always followed by a crash.
The trials and tribulations of 2008 have largely been long- forgotten. Speculators, traders and fund managers are riding the tiger once again with no obvious plan to dismount. They have returned to that state of false-euphoria which may well be generating “winnings” today but tomorrow will inevitably herald the collapse.
Those who really do manage to avoid the fall will do so more by luck than by judgement.
Regrettably, those who are making money and experiencing all that goes with it believe that they deserve their new-found riches. Their bosses tell them that they deserve their rewards – as if it is they who are creating the wealth. That belief spawns another very dangerous banker “syndrome”:
It is a super-assurance which carries an ominous presumption of invincibility. (Other sufferers are some hospial consultants and many politicians)
It is that belief – that blinkered uber-vanity which grips them in an ever-faster spinning vortex of blind euphoria.
When economist Roger Babson forecast the Crash of 1929, he was vilified because he was encroaching on the speculative madness which had gripped a nation. He had said that there would be a 60 to 80 point drop in the Dow and that many would lose their jobs and money and that there would be a depression. At the time, everyone was investing. The majority borrowed the money to invest because they believed that they could not lose.
Fast-forward to 1986 ; the time of leveraged buy-outs, merger and acquisition mania and Gekko-style corporate raids. Once again, euphoria came to rule the world. That year, J K Galbraith himself was asked by the New York Times to write a piece on this “new” phenomenon. He recognised the investment euphoria symptoms and predicted a stock market crash. The New York Times declined to publish but The Atlantic printed Galbraith’s article in early 1987.
Black Monday was on October 19th 1987.
Currently, we are in the midst of yet another one of those speculative episodes but this time it is mired in the economic fallout created by bailed-out bank debt. Plus we have that added “Chaos Theory” element provided by disruptions in the Middle East, various sovereign debt crises, commodity inflation and propped-up currencies…and yet…The Investment Euphoria is alive, smiling and in extremely good health.
Some may say that the investment banking fraternity has lost touch with harsh economic reality. The economy is outside their bubble.
The world’s indices are highish but still don’t seem to be in quite the right place. Speculators appear to be making money as stock markets rise and fall daily like a tart’s knickers.
There are some outsiders who have a sense of foreboding because bankers’ and politicians’ policies appear to be doing no more than postponing an inescapable economic destiny.
Investment bankers, fund managers and speculators count their profits and bonuses as speculative euphoria grips them. The downside is that whereas past amateur investors would pile into the equity markets out of greed, the modern version has taken to buying equities out of necessity.
The returns that private investors can obtain from the retail banks are so low that inflation is now eroding their money. One of the few places available to them nowadays which can produce a reasonable return is the Stock Exchange.
So how will the end-game pan-out?
That depends on the will of Central Banks such as the American Fed and the UK’s Bank of England. Their current status has deteriorated to that of the mildly interested but totally impotent but anxious observer. That suits the banks. They’re filling their pockets before the shutters come crashing down – and who can blame them?
Meanwhile, the central banks should prevent retail banks from investing OUR money in anything vaguely risky – i.e. allow only a very small percentage to be invested in equities.
If legislation decreed that Retail Banks should invest say 90% of their (our) money in Fixed interest or Gilts and a maximum of 10% in Equities, we could breathe a collective sigh of relief.
So what if the banks are pulling-in returns of 10%+ on their investments? We don’t care – all that we need is a return that beats inflation. Currently, the banks cannot even manage that – inspite of the super-human skills that they claim of their investment experts. (You know, the experts who are SO good that they have to be bribed to remain in place though the medium of the 7-figure bonus but can only leave the bank saver with a net-return of less that 1% p.a. on their savings)
Banking itself should be a very simple process.
The Retail Bank is a box into which we put money and the bank pays us a small return for the privilege. If we need a loan, and the bank believes that we ‘ll be able to pay it back, it lends us the money and we pay the bank a small return for the privilege.
But it doesn’t quite happen like that.
Instead, we have a monster which pays us a negligible amount for the use of our money and should we need the bank’s help, we are ripped-off with eye-watering repayments and outrageous interest rates. Plus, the banking “industry” is the only commercial activity which can sell you something (a loan) and then at any time in the future, increase the price.
Can you imagine buying a bunch of bananas from a greengrocer who then contacts you to say ” Have you finished those bananas yet? No? Well, the price has just gone up on the uneaten ones. In fact, we’re going to charge you more for the ones you’ve already eaten.”
The other self-pertetuated myth is that banks “create wealth”. They do not create wealth – they simply redistribute it.
However, the function of an Investment Bank – the one which does play with equities, is to help industry and commerce to create wealth. The Investment Bank is supposed to do that by raising money. Instead, it has evolved (some say “mutated”) into an organisation whose raison d’etre has become profit creation – for itself and its shareholders.
Bankers and politicians are confusing external wealth-creation (for others) with profit creation (for themselves).
Think about it. The banks don’t actually make anything -they merely redistribute it. Imagine an economy which consisted of nothing but banks – it would not work because no-one would be producing anything.
Banks cannot function without a steady money supply which is generated outside the banking system.
Mervyn King is right – until there is a major re-think of the banking system and it returns to carrying out those simple functions which augment an economy rather than leech funds away from it – we’re heading for another major fall.
Forget all that dramatic nonsense about “breaking up” the banks – it’s a straightforward accounting exercise with a “firewall” between the Investment and the Retail Bank.
What the banks need is a fundamental rethink of their function as well as another major reminder of their own fallibility.
I have a feeling that the lesson will manifest itself sooner than many “experts” believe.