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Gov report: Actually, evil City traders DIDN'T cause the banking crash

Lending money to SMEs and giving people mortgages did

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So how do we solve the banking problem?

The narrative-writers' solution is to rein in the trading part of the banking industry and force them to concentrate on real loans to real economic activity - to break up the banks, perhaps, or to have regional banking again.

The further left one goes, the more insistence you'll find that politicians, or maybe trade union leaders too, should be part of banks' senior management so that the 'wider interests of society' are considered.

And then there's that financial transactions tax - the Robin Hood Tax - which will curb the excessive trading once and for all. (I'll leave it to another day perhaps to explain why that's so wrong-headed in itself.)

Where this fails is in the original analysis. As above, HBOS didn't go bust as a result of any of that trading or market speculation stuff. They didn't really do any of it to begin with, so that couldn't be the cause. They just lent money to too many people who couldn't pay it back. It was, as the report itself says, a traditional bank collapse - nowt whatsoever to do with the bright new world of speculation.

RBS went bust because it bought ABN Amro for too much money. No other reason at all. Northern Rock didn't gamble or speculate; it just issued mortgages. Northern Rock in particular suffered a bank run, something which banks have been subject to since 13th century Italy (or 30 secs after Ur's foundation, take your pick).

They didn't have the money to pay back all their depositors because, as in It's a Wonderful Life (plot synopsis, relevant part is a quarter of the way down), the money isn't in the bank. They gave it to the man down the street to buy his house with, and he hasn't finished paying them back yet.

Dunfermline Building Society didn't even have the lust for profit from shareholders to blame. It went bust lending too much to commercial property projects.

As to having regional banks with the politicos on board, have a look at the Spanish cajas. They were actually owned by charitable foundations, so greed wasn't part of it. They also didn't do any of those neoliberal market things like trade stocks or bonds or swaps or futures. They just made loans to people who wanted to buy houses or run businesses.

And they had politicos on their boards, indeed there often was a revolving door between high office in politics and high office in banking management. It's interesting to note that every single one of Spain's cajas has gone bust as a result of supposedly taking society's wider interests into account.

That something went wrong in banking is obviously true. But it is important to note what actually did go wrong. Only then can a reasonable and effective solution be found.

The bits of the banking system that went titsup did so for the traditional reasons that banks go titsup. They lent too much money to people who couldn't pay it back. Or in the RBS case, suffered an overdose of the auction winners' curse. It simply wasn't to do with the trading culture or speculation. This is why attempting to change the trading culture and speculation won't provide a solution.

What will provide something of a solution is to insist that banks must hold more capital against their loan books, something that's already been put in place under the Basel III rules. Unfortunately that has a side effect: the banks can therefore lend less money. As everybody can see now, banks don't want to lend money to anyone at present.

That just brings us to the great truth at the heart of the subject of economics. There are no solutions; there are only trade-offs. You can have a robust banking system where it's difficult to get a loan, or you can have easy money and a banking system that periodically goes titsup.

Your choice, but the choice does have to be made. ®

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