News across the global financial system has been a worry this week. The collapse of the SVB in California was followed by worries about Credit Suisse, one of Europe’s largest banks, whose share price plunged after its largest shareholder couldn’t provide it a loan. That triggered a plunge in Asian stocks and a rush for the safety of gold because, hey, ‘thuh markit’ has the same behaviour as startled reef-fish. The bank was eventually given a loan by the Swiss central bank (‘lender of last resort’).
If all this gives you the impression that global banking systems are a house of cards built by investors (shareholders) for their gain, who don’t care about the Ma-and-Pa everyday people who put their money into it – well, you’re right. The system is known as ‘fractional reserve banking’. Banks borrow money and on-lend at profit. A proportion of the borrowed money, typically, is also reinvested in bonds at long-term, which is fine – except when interest rates rise. At that point, bonds typically lose value and a bank can scrabble to find money. Banks also don’t keep depositor money in labelled shoeboxes in the vault. Money not on-lent is profitless to them. So they keep as little cash on hand as possible – hence the term ‘fractional reserve’.
The problem is keeping enough liquid funds on hand to meet daily demands, while maximising profits. In part the level is defined by regulation, in part by business decisions by bank directors. The problem is that if costs rise (as they do when interest rates go up) and then enough people suddenly demand their money – NOW – well, there’s no polite way to say it. The bank’s fucked. That’s what happened to SVB, reportedly fuelled via Twitter.
The system also hasn’t changed much since the global financial crisis of 2007-10. Back then the world was facing a financial collapse likely to provoke a generation-long global depression that would make the Great Depression of the 1930s look like a kiddie game. The ‘stimulus’ packages issued by governments stopped that, but also merely kicked the can down the road. Some gossamer-thin safety nets were thrown up, and the system roared on, pouring wealth into the pockets of the rich – much of it through the ‘money markets’ in which money, itself, is traded as a commodity.
This is not good news for everyday people who use banks because they have to, and who are increasingly struggling to make ends meet. Since the GFC some nations have introduced deposit insurance up to certain levels, but they’re usually minimal. Anybody with more money than the insurance covers will lose it if their bank collapses. And sure, US President Joe Biden has made good on the SVB issue for all its depositors. But that’s not a guarantee that every nation will do the same.
Nor does every country have a systemic guarantee of depositor funds. That’s certainly the case here in New Zealand where, currently, the method for – er – ‘securing’ depositor money is called ‘Open Bank Resolution’ (OBR). It works like this. Imagine that a New Zealand bank collapses, leaving hundreds of thousands of everyday Kiwis unable to access their money or be paid by employers. Normally the receivers would step in and, after about a decade, pay out whatever they can recover from the failed institution.
Under OBR, however, the Reserve Bank sends a statutory manager in to run the failed institution, money is found to prop it up, and it reopens next day for business. So where does the money to prop it up come from? Why, the depositors. People who entrusted their life savings to the bank suddenly find that a proportion of their money is taken to keep the institution running.
The Reserve Bank of New Zealand explanation is here: https://www.rbnz.govt.nz/regulation-and-supervision/oversight-of-banks/standards-and-requirements-for-banks/open-bank-resolution Note the graphic. The spin is about as subtle as a brick. Now, I was working there at the time, in the very comms department that developed that graphic, and objected to it then. But of course nobody listened to my suggestion that no spin on OBR would alter the fact that it was a fast way to have pitchfork-wielding mobs turn up at the doors. Besides which, OBR is a classic example of socialising the losses while privatising the gains. At basic philosophical level it’s morally bankrupt (as it were).
But apparently I was wrong because people, being rational operators (the technical term), will be happy that a proportion of their savings have been taken away. I mean, they still have a bit left as opposed to zero – who could complain?
Well, quite. I don’t think this is how people actually behave – I think that someone confronted with an OBR ‘haircut’ (the technical term for the failed bank helping itself to depositors money) will take the attitude that they’ve just been subjected to summary highway robbery. This is because people aren’t rational operators – people, in reality, think emotionally. And yes, the point has been shown scientifically. There is also growing evidence that such emotional response can be transmitted by social media.
Of course, in the neo-liberal version of capitalism, everybody is treated as if they rationally know the risks and make perfect judgements. If you put your money in an institution you take the risk that it might fail. If it fails – well, you chose to put your money there. Except that in the real world most people focus not on their investment portfolio, but on the next grocery bill. Money in the bank is there because they need somewhere to hold money they’ve struggled to collect, so they can have a home and don’t starve. And the current financial setup requires banks – most money, indeed, isn’t even tangible: it’s numbers defined by electron flows.
If the bank then fails and the money’s gone, they’re stuffed. It’s for this reason that all but two governments in the OECD have introduced deposit insurance schemes. One of the two is New Zealand. It’s been talked about – the Minister of Finance of the day, Bill English, spent years from about 2009 having what he called ‘chew sessions’ with Reserve Bank and The Treasury officials over it. The Reserve Bank kept putting a spanner in the works. Why? Among other things, apparently a deposit guarantee removes incentives on bank directors to be sensible, thus rendering ‘thuh markit’ imperfect (it removes allegedly ‘moral’ pressures to behave responsibly). Besides, any such scheme could be a liability on the taxpayer. (Well quite. So tell me again why it’s wrong for governments elected by the public to use public money to help the public?)
None of these arguments considered that problem of angry depositors armed with pitchforks. As it happens, a system is being brought in later this year, but New Zealand is very late to the party and – taking the exchange rate into account – the value covered is just 37 percent of the equivalent Australian protection scheme. It’s a poor compromise.
Copyright © Matthew Wright 2023
3 thoughts on “Do we face a new global financial crisis?”
Since we are required to have a bank account for receiving payment by most employers and businesses. Therefore some of us are actually not choosing to have our money in banks but cannot have another choice. The fact that when you deposit money electronically that deposit is not usually immediately available to withdraw (as it was when you used to deposit cash). They ‘play the market’ with it to gain some profit from it, then release it to you after a time frame of their choosing. It’s probably a good thing for them, as should the institution fail, you won’t be able to get the funds to buy the pitchfork required to form the mob to complain. Perhaps we should be buying shares in pitchfork production companies for the future? Paying with electronic transfer of course.
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That lack of actual choice is the problem, as opposed to the theoretical claims of economic theory, which is based on the assumption that all human behaviours are a product of logically rational choice. It’s why underground cash economies have emerged. The idea that theory trumps reality was worse in the 1990s – today’s economists are a LOT more soundly based. Unfortunately the New Zealand banking system, including its regulatory framework, is a product of 1980s-1990s thinking. It’s had a few layers added on of late, but none of them have fixed the fundamental structure which is a hard-baked expression of purist neo-liberalism. It’s not alone – NZ merely reflected how the world has gone in general. It’s akin to an egg balanced on its head, while everybody watches and issues commentaries every time it wobbles. The three ‘pillars’ on which the system is based, incidentally, are (a) self discipline (ie: the financial institution controls itself, hands-off by everybody else), (b) market discipline (‘market forces’ will destroy any entity that’s out of line, thus only the fittest of them survive, yay for social Darwinism); and (c) regulatory discipline. Of these, only (c) has any practical power and consists of a gossamer-thin skein of rules that mostly are designed to force banks to ‘disclose’ what they are doing and to waft a slightly dampened bus-ticket in the direction of any bank that doesn’t comply. The Reserve Bank has some real powers that it can enforce if needed but hasn’t really used them. The NZ prudential regulatory system has been reviewed various times by the IMF and other bodies and is broadly consistent with the general global approach to such things. Therein, of course, is the problem; and the fact that ‘self discipline’ was shown to be a crock by the GFC, 15 years ago, should have set some alarm bells ringing. Things changed globally, but the systemic fundamentals that led to this outcome didn’t.
Aside from this, what worries me particularly is the general assumption the entire neo-liberal economic model – which basically frames the way the globalised world operates just now – defines ‘all of capitalism’, whereas in fact the neo-liberal model is merely one aspect of this much broader system. It replaced, for example, a liberal-democratic capitalist model which worked well in its time. The time for liberal-democratic capitalism is long over. But the relentless cracks appearing in the neo-liberal system indicate that its time, also, is past – we need a new VERSION of capitalism. What worries me is that the whole philosophy will be thrown out when the hard-coded inequities built into the overall neo-liberal model finally prompt the poor to pick up their pitchforks.
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Ugh…this post made me shiver. One of my very first jobs after uni. was at Barclays Bank…in the Short Term Money Market. I was only a lowly clerical assistant, but I saw first hand how the cowboys did their deals. To them it was just a commodity to be traded [read gambled].
I hope New Zealand comes up with a guarantee system /before/ anything awful happens, again. 😦
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