Nationalizing the Banks – Response to Reader Criticism

Thank you for your carefully considered argument in rebuttal of my (conceptual) proposal to nationalize the banking industry.

Perhaps you will think less ill of me if we can agree on precisely what has been occupying my thoughts – because it appears to me that you are making some unfounded assumptions regarding what I am actually proposing for consideration.

First, we need to agree on the difference between “debt” related risk and “equity” related risk.

It is my contention that Banking activity should be confined to debt related risk.

Secondly, “lending” from a lender’s perspective, should be a fairly vanilla transaction. There are two criteria for consideration:

• What is the so-called discounted asset coverage ratio? (This represents the security that the borrower offers to the lender to protect the lender against loss of capital. For example, if you want to buy house, I will lend you up to (say) 80% of the value of the house and you have to put up 20% of your own money. If I lend you (say) 110% of the purchase price I am taking an equity related risk that the price if your house will rise.)
• What is the fixed charge coverage ratio? (This is the ratio of borrower’s’ cash flow to commitments such as tax, interest and capital repayments; and represents the security to the lender that he/she will in fact receive the interest on borrowings and also receive the capital repayment installments as promised. For example, your fixed charge coverage ratio should be greater than 1.2X. If your fixed charge coverage ratio is less than 1 then I am taking an equity related risk that your cash flow income will rise.).

The above are formulae which require a “box ticking” type approach which anyone could manage – whether it be government or private enterprise. The problem is that private enterprise has failed in its duty to carry out this task responsibly – and not for the first time.

What has happened – over and over again in the history of banking – is that banks start off by borrowing money at one price (interest rate) and lending at a higher price. The spread or margin represents their gross profit which is used to offset expenses and provide a (typically handsome) net profit. They also lend the same one dollar up to twelve times to various borrowers on the argument that not all lenders will want their money back at the same time. This allows them to create money “out of thin air” and this is a very significant privilege which carries with it enormous responsibility to act with due care towards society in general.

The 1929 stock market crash was caused partially by the fact that banks had strayed from their primary purpose of lending. They became greedy and started to “lend” to higher and higher risk propositions. Eventually, they became involved in equity type risks. In 1933, the Glass Stiegel Act was passed – specifically to ensure that “never again” will banks be allowed to be involved in BOTH low risk lending AND (equivalent to) high risk equity investment.

Lending should have low associated risks and low associated returns; and investing should have high risks and compensatory high returns. Governments should absolutely NOT be involved in high risk investing because it requires sophisticated commercial expertise which governments typically do not possess. On this you and I can agree, but we should also agree that this should most certainly also not be a banking activity.

By extension, therefore, because of the high associated risks of equity investing, Private Enterprise banks should also not become involved in equity investing or equivalent risk lending activities. History shows that the economy ALWAYS lands up as a basket case because of private enterprise banker greed when they stray from pure lending. Think about the current situation:

• We now no longer earn any interest on short term cheque accounts. Why? Why should banks have access to my hard earned money at no financial benefit to me?
• When I deposit my money into an interest bearing account, I can’t get access to it for 72 hours – ostensibly to allow time for cheque clearance and notwithstanding the sophisticated computerized clearing systems. But this gives the bank free access to my money for 72 hours – which they are able to on-lend immediately at a profit. Why should this be allowed? I am not the only client of my bank. Multiply what they do to me by a couple of million people and they have access to massive amounts of money for 72 hours without any cost to them. Why should this be allowed?
• We now pay bank fees. We pay the banks a fee to allow us to deposit our money with them. Why? Banks earn billions of dollars in “fees” and we just accept that. Why? Banks should be able to cover their costs out of the profit margin from lending. For example, the very notion that a Service Station should charge me a premium on what they pay for gasoline and also charge me a fee for giving me access to their bowser is just plain ridiculous.
• CEO’s of banks earn outrageous salaries and bonuses. Why? If all that banks were supposed to be doing is ticking boxes, why are bank CEOs paid so handsomely?

The reason the banks give for charging fees is that they now have very sophisticated infrastructures and high overheads. But why do they need such sophisticated infrastructures? The process of borrowing and on-lending is a simple one. The reason banks have become so sophisticated is that they have expanded their activities into areas which have nothing whatever to do with borrowing and lending. For example, they are involved in derivatives trading – forward “insurance” cover for currency movements, interest rate movements and commodity price movements. Why? They don’t typically do this because it benefits the client. They do it because it benefits them. They also typically trade as PRINCIPALS in the markets for these products and the traders are instructed to try to maximize profits from trading in currencies, commodities and interest rate contracts. Banks nowadays have significant trading departments. Why? And why should I be charged fees to fund this outrageously irresponsible activity (from a lending risk perspective)?

In 1999, the banking lobby maneuvered to get the Glass Stiegel Act repealed. Why? Because it didn’t suit them to be barred from BOTH lending AND investing. What happened? Well, arguably, they ran amuck. They became equity investors in Stockbrokers and Insurance Companies and Investment Banks and Equity Investment portfolio managers and Venture Capital investors and Hedge Fund Investors. These activities represented MASSIVE conflicts of interests. Banks are supposed to operate under licenses. Not just anyone can open a bank. You need a license; and the reason you need a license is that a bank typically borrows one dollar and lends that same dollar to twelve different clients on the argument that not every lender will want its money back at the same time. That is privilege enough!! Banks do not need to diversify (stray) beyond such activities. The banks abused the privilege – and not for the first time. Banks have abused this privilege over and over again in the course of history. They become greedy and lust after power – and so their activities expand to encompass non lending activities.

By suggesting that the “banking” industry be nationalized I am suggesting that “lending” for wealth creation activity should be nationalized and that private enterprise organizations should not be allowed to borrow money to on-lend.

This will not impact in the slightest on equity risk activities and if any organization wishes to raise money by way of equity (as opposed to borrowing) for the purpose of high risk lending such as consumer loans and equity type transactions then that will be just fine. But the key here is that no private sector organization should be allowed to create money out of thin air by borrowing one dollar and lending twelve (or any other multiple) dollars against that one dollar. That “privilege” puts too much power into hands of people who, over the centuries have demonstrated time and again that they can’t be trusted.

Because you are a Christian, I am sure you will agree that the Bible’s admonitions regarding borrowing and lending should be heeded. As a general principle, the Bible recognizes the enormous power that the lender has over the borrower, and the enormous responsibility that accompanies this power. Arguably, that responsible behaviour has been starkly absent in recent years. The banks have abused the privileges once too often. The way to address this problem is not to pass another Glass Stiegel type Act. The way to solve this problem is to take away the cookie jar from the fat and overindulged child – once and for all time.

I stand by my contention that “lust for financial power” is typically a male oriented activity and is driven by testosterone. Harvard University has recently published the results of research which substantially support this contention. Rest assured that I fully agree with the argument that Private Enterprise and Free Markets are absolutely essential to allowing equal opportunity to everyone to earn a superior return for an above average risk and by applying above average capabilities – but that risk should be an entrepreneurial risk which relates to wealth building activity. Banks absolutely should not be involved in entrepreneurial activities and neither should governments. That’s why banking should not have any overtones of entrepreneurial risk, and that’s why governments should be quite capable of performing a box ticking banking function in the greater interests of society. In short, the money supply of any country should be under the total control of the Central Government. Thomas Jefferson clearly understood this when he helped draft the United States Constitution.

In closing, please understand that this “suggestion” to nationalize the banks is by way of stimulating discussion. My views represent the views of one individual. I do not seriously expect anyone to just accept any “brainstorming” type idea at face value. But I do think that it can do no harm to explore and discuss every creative idea that is tossed out there in the current economic environment. What we are facing is a threat of “extinction” of the financial system. That is an extremely serious threat.