Banking and the Financial Crisis

Although only the government can truly ‘create’ money, banks can increase the money supply by making loans to the customers. These loans of course at the same time create an equal and opposite amount of debt. Lending in the right amounts can be a good thing for the economy, as it enables people and businesses to invest, but if done too much it creates so much debt that eventually the economy collapses under the weight of it, which is what happened in 2008.

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An explosion in the money supply, as a result of irresponsible lending by the banks, was the main cause of the financial crisis.
Picture © Nadia Isakova

Now the problem is that banks generally want to do lots of lending, because every time they make a loan they can charge interest on it. In the short term this is good for them, as more interest means more profits means bigger bonuses. In the long term however this can be disastrous for the economy, but bankers generally don’t care about this, as by then they’ve got their bonuses and it’s the taxpayer who has to pick up the pieces (via a policy of Austerity). So it’s down to the regulator (in our case the Bank of England) to limit the lending and ensure the banks don’t lend too much and leave us all in the lurch. Unfortunately the Bank of England completely failed in this respect, which is why we got into the mess we are in now. To give an idea of how out-of-control things got, in the run-up to the Financial Crisis only 3% of the money in circulation was government-created coins and banknotes, while the other 97% of the money in circulation was in the form of loans created by the banks.

Now there is one other crucial point here. When the banks got into trouble the government could simply have let them go bankrupt, which wouldn’t therefore have necessitated a bailout and the subsequent huge cost to the taxpayer. However in recent years banks had been allowed to mix their high-risk investment banking operations (so called ‘casino’ banking) with their lower-risk retail banking operations (current accounts, mortgages etc). So when the high-risk stuff went wrong, it looked like it was going to drag everything else down with it as well, and possibly the entire economy. Thus the government had no option but to intervene (at an estimated cost to the taxpayer of £456bn, which it is estimated has now risen to £1.3 trillion.)

The run on Northern Rock was the first indication that liberalisation of the banking system had gone too far.
Picture © Alex Gunningham

However it wasn’t always this way. For many years banks were forced to keep their retail and investment banking operations separate, specifically to stop something like this happening. (This policy was strongly enforced after the great crash of 1929, and the subsequent Great Depression). However banks were always lobbying for greater freedom of operation, and in 1986 Margaret Thatcher instigated the so-called ‘Big Bang’, which served to deregulate financial markets and give banks much more freedom to do what they wanted. This in turn led to the mixing up of retail banking and investment banking operations, the ultimate result of which was the crash of 2008.

Since 2008 the government has initiated a review of banking practices, and has attempted to go back to the time when the two types of banking operations were kept separate, with greater restrictions on how much money banks can lend. However the banks have lobbied hard against this, and it now looks like the recommendations are going to be heavily watered down. Why are the banks lobbying? Because once again they want the freedom to lend lots of money so they can make more profits for themselves, safe in the knowledge that if everything comes crashing down again it won’t be them that have to pay for it, but the general public by even greater Austerity. As long has the financial sector has the government in its grip by a combination of Lobbying and Party Funding, there is little we can do stop this cycle of impoverishment of the masses to feed the greed of the banking sector.

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