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Let bad banks fail

I was invited to Ireland this week to join a debate at the University College Cork's Philosophical Debating Society.  The Debate was entitled: This House Believes That We Should Let Banks Go To the Wall, as in banks should die if they are failing.

This is well illustrated by the poster advertising the debate:
Bankerdebate1_copy

Viva le revolution!

I offered to take either side of the debate, as I can argue my way out of a paper bag, and they gave me the proposal: banks should fail, let them die! this house believes banks should go to the wall.

I've already mentioned this debate once,
and was impressed to find a dynamic group of students and locals ready for a
lively discussion about banks and whether governments should prop them
up or not.

My rival was Ciaran Hancock, Business Affairs Correspondent with the Irish and UK Times, who opposed the motion.

I don't have time to report the whole debate so I'm just going to present my one-sided view. 

Before I do so, please bear in mind that I could quite easily have argued either corner, so these views are not necessarily my own.

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Ladies and gentlemen

The problem with our world today is that the banks have over-leveraged and the implosion of credit they created is now our monster to tame. For each euro a bank owned, they generated ten or even a hundred euro’s of debt. That debt mountain has to be eroded before the good times can roll again.

The real question therefore, is should that debt mountain be vanquished today or in years to come?

If your answer is for years to come, then support the government’s actions and pump cash into the ailing system of finance.  Give this debt mountain to the next generation, as in your kids.

On the other hand, if your answer is that we should swallow our medicine now in order to get over this headache, then we should allow the banks to go to the wall.  At least we can then move on with a clean sheet for the future.

I vote for the latter choice because it will make us fitter for the future, rather than having a long-term pain in the rear.

All of this started back in 2002.  Back then, the leverage of credit was nowhere near as horrendous as it is today.  Since then, in the five years that followed, derivatives markets created around $20 trillion of false credit – money that did not exist.  This was being generated in the USA and across Europe through Credit Derivatives,and it created a housing bubble and world of money that was non-sustainable, non-believable and non-existent.

The fall of Lehman Brothers in 2008 ended that rollercoaster ride forever, and the consequent hard landing means that we now have to pay back that $20 trillion-plus of credit.

That is the size of this correction, in fact it could be even greater, and this is why banks should be allowed to go to the wall.

Banks should be allowed to go to the wall because the defenders of free market economics supported and promoted the efficient operation of markets. They actively defended the use of Credit Default Swaps, Collateralised Debt Obligations and other free market tools.  They claimed these were just examples of the free markets at work. They cheerfully endorsed the self-regulation of the financial markets on the basis that only the fittest survive.

So why are they not supporting, promoting, cheering, endorsing and defending free market economics today?

In a free markets world, those that have fail are supposed to do just that: fail. The banks that are not the fittest should not survive. They should be allowed to go to the wall.

Why won’t we let these banks fail therefore?

Because they are ‘too big to fail’, ‘too integral to our economy’ or ‘too important for society'?

No.

Banks are not allowed to fail because politicians would lose their jobs and, as a consequence, our societies might run to anarchy.

If we were all allowed to lose our money on deposit and businesses were suddenly unable to process payments or gain access to capital, our economies would crash, unemployment would rise and riots would ensue.

We have seen this in Greece recently, and every day there is picketing outside the Parliament of Iceland to show the anger and hurt their country is feeling.

This is the reality of letting banks fail and this would be the reality here in Ireland, across Europe and most countries impacted by this crisis.

But politicians losing their offices, bankers losing their jobs and society facing levels of unemployment and disruption is exactly what we have to face up to, if we are to get over this glitch.

Let me put it another way, if we do not swallow this pain today then we are just postponing it for tomorrow. By not letting banks fail, we are placing the burden of their debt and our gluttony on our children and our children’s children.

There is the rub.

So we should take our medicine today and be done with it, rather than living on our greed and letting our children and grandchildren pay for it.

And even if we do not let banks fail, we do not solve the problem. We just exacerbate it.

By not letting banks fail, governments are pumping tens of billions of dollars into a system that is broken. This system is not fixable, or appears not to be. After all, the US and European governments sank over a trillion dollars into the system in October and it is still broken. These governments came back with a further multi-trillion dollar package just this month, and it is still broken.

All that the government’s actions have achieved is to realign the balance sheet of the banks and line the bankster’s pockets. This purely demonstrates therefore that providing liquidity from government coffers does not work.

What about nationalising the bank’s then?

Well, that does not work either.

By nationalising the banks all you achieve is inefficiency and imbalance.  You cannot have a system where some banks are government owned and some are not. So do we nationalise all of them, including the healthy banks, just because some rotten apples have poisoned the barrely?  That is not fair.

Equally, by nationalising a few, that is also not fair.

The ones that are nationalised become lazy and complacent, and they will continually be beaten by the ones that are not. Furthermore, by nationalising institutions where neither the institutions themselves nor the government wants to nationalise them, we create an worse situation.

No, let bad banks fail and be done with it.

And what would happen if we did let banks go to the wall?

What would be the worst scenario?

Riots, anarchy, revolution, civil war?

Possibly … but only if we let all the banks fail, including the good ones.  Equally,there are alternatives.

For example Joseph Stiglitz, the Nobel Prize winning economist, believes that banks should be allowed to fail.  The way he would do it is to have the government guarantee and secure all depositors' monies, along with the current bank operations, buildings and branches.

The government then wipes out their balance sheet debts by declaring the banks bankrupt and, through the same process, they then create new banks that are healthy.

When the new banks prove to be robust, they are then returned to the private sector with a clean bill of health.

This approach has some merit, as it focuses upon creating good banks.  After all, who wants to create ‘bad banks’? Who wants a ‘toxic bank’? What is the point of that?

Let the bad banks fail.

And let us not forget that we are not saying let all banks fail. Just the ones that are broken.

There are still healthy banks out there and, in the rules of free market economics, these banks should be allowed to be more powerful and competitive at the expense of the ones that are ailing and weak.

Let the fittest survive and let the weakest go to the wall.

Equally, in a world where technology is a critical component, there are many new ways of gaining access to finance anyway, with several new financial providers in play.

In the UK, we have seen several new banks being launched by local governments, the Post Office, Metro Bank and more. We have also seen new providers such as Zopa, Wonga, SmartyPig and the Barter Network, to name but a few.

There are healthy banks and alternative banks therefore who can prop up our system. 

Result?

If the ailing and weak
banks that over-leveraged cannot cover their capital, then let them fail.

Others will be left standing who are efficient and appropriate. This is how free market economics works, and I wonder why the free market economists and politicians don't get this.

In conclusion, the real reason we won’t let bad banks fail is because politicians are too fearful of losing their jobs and society is too concerned about losing the good times.

But here is the core of the reason banks should be allowed to go to the wall because if we don’t lose jobs and the good times now, then someone will lose them later. And that someone is you, your children and your children’s children.

All we are doing is deferring the issue through stimulus packages to saddle future generations with debts and taxes.  Equally, as George Osborne the UK's Shadow Chancellor recently stated, we have allowed the capitalisation of the profits through the socialisation of the losses. Banksters enjoyed the freedom of the city in the good times whilst giving us all the hurt for the bad times.

This is wrong.

So let the systems fail, the bad banks go to the wall, the cleansing of the system and its cancerous over-leveraged poison, and create a new world order that works far better than the broken one of today.

Thank you.

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My opponent then presented some thoughts about how government guarantees meant that we were not deferring taxes to future generations; how 30,000 bankers on the dole queues would not be right; that AIB and other banks had announced lending was coming back to SMEs and more; that the government could not do the job the banks do; that 100,000 people would be laid off in Ireland this year with unemployment rising to 12% of the population; that growth was down 6% this year and was only getting worse; and so on.

His bottom-line was that we could not let the banks go to the wall, as all of this would just get worse and that was untenable.

We then had a long debate with the audience of students and Corkonians (no, people from Cork are not called Corkers) with comments such as the fact that Anglo-Irish Bank is a disgrace which fuelled and protected property developers and no-one else; that the government's guarantees have purely underwritten foreign business loans; that the world today is characterised by insecurity and doubt and that we need security and certainty for an economy to work; that banks fulfil a role that State does not and cannot, after all where else do business start-ups have to go other than a bank for capital; that If banks fail, we fail as a society and that our property becomes their property and we all go to the wall; and more.

Finally, we came to conclusions.

I’ve already outlined most of what was said but, in my concluding remarks, I did say that the issue we face today is the deleveraging of our over leverage.

When Lehman Brothers collapsed, over $550 billion was withdrawn from the US banking system in hours.  This would have led to the collapse of America within a day if action had not been taken. That incident created the fear, uncertainty and doubt (FUD) we face today, and that if we do not let more bad banks fail, we can never get back to certainty and security.

The fact that every $1 billion in losses at Lehman could equate to $20 billion or more of losses on Credit Default Swaps created the FUD.  No-one knew where or with whom these losses would occur and, with $400 billion of losses, that meant the world expected up to $10 trillion of exposure.

That was, and is, the issue.

This has resulted in the strangulation of credit and access to capital, which is why Ireland is now paying €3.50 for every €100 to insure its sovereign debt, compared with only €0.10 for every €100 just a year ago.

This is unsustainable when you have public sector debt in Ireland expected to rise by €15 billion this year alone, to €70 billion overall, and 220% of the country’s annual economic output pledged to the banking system.

That is why bad banks should go to the wall.

There will still be good banks, there will still be new banks, but bad banks need to go to the wall.

We then had a vote and the motion was carried … by about one vote.

Godirectlytowall_copy

Banks should be allowed to go to the wall.

Even with all of this emotion and reasoned argument, students and Corkonians were still split about whether banks should be allowed to fail.

But then, with lots of money in savings for the pensioners in the room and a debating society full of budding lawyers (yes, that’s the core group of graduates in a debating room), it’s not surprising the motion was only just carried.

After all, who wants to see a bank fail when they are either providing your current or future income?

Oh yes, and it wouldn't surprise me if I come back sometime soon and argue why banks should not be allowed to go to the wall, just for the fun of it.

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By the way, if you have ten minutes, this interview with Joseph Stiglitz expanding his plan for failed banks (recorded last Wednesday) is worth watching:

About Chris M Skinner

Chris M Skinner
Chris Skinner is best known as an independent commentator on the financial markets through his blog, the Finanser.com, as author of the bestselling book Digital Bank, and Chair of the European networking forum the Financial Services Club. He has been voted one of the most influential people in banking by The Financial Brand (as well as one of the best blogs), a FinTech Titan (Next Bank), one of the Fintech Leaders you need to follow (City AM, Deluxe and Jax Finance), as well as one of the Top 40 most influential people in financial technology by the Wall Street Journal’s Financial News. To learn more click here...

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