Don’t be conned by the ‘profits’ we’ve made on our stakes in the banks

I didn’t want to write about the banks today. Really, I didn’t.

But I can’t sit back and calmly read all this drivel in the papers about how the decision to bail them out has been ‘vindicated’ by the fact that they’ve managed to post something resembling a profit, without at least raising a few objections.

We might be seeing a profit on the direct ‘investment’ we pumped into the likes of Lloyds Banking Group and Northern Rock. But how could we not? After we bought the banks, we created the most bank-friendly economic environment you could possibly dream of.

Interest rates were slashed to near zero. The Bank of England bought all the gilts that anyone could throw at them. The economy was turned into a profit-making machine just for the banks.

Let’s illustrate this using a business that we’re all a bit more comfortable with, just to hammer the point home.

Let’s say that, rather than the banks, the taxpayer had been forced to buy a chunk of a high street fashion chain – Next or Marks & Spencer perhaps. Then say we scrapped VAT on clothing, and trebled it on food and heating. We then used the money raised from the food and heating tax (which of course, would hit the most vulnerable in our society) to introduce a government subsidy on clothing imports.

Then, when the fashion chains reported massive growth in profits as their costs plunge, we all cheer and pat ourselves on the back for being so clever as to invest in them. And all the management award themselves big bonuses for steering so well through the recession.

That sort of bail-out would cause a revolution. But the indirect costs of the banking bail-out have been no less severe. Money has been taken from savers in order to fund the repayments of those heavily in debt. And that’s been done so that banks don’t have to face up to the consequences of their poor judgement leading up to the credit crisis.

Now we could argue until the cows come home about how the bail-out itself was pulled off. But that’s in the past. The point is that now, we don’t seem to be getting very far with making sure it doesn’t happen again. Governments are caught between panicking over the state of banks’ balance sheets and then fretting over whether they are lending enough – two utterly opposing concerns.

If we decide that banks are too important to fail, and so must be government backed, then like it or not, we have to separate out the vital part of banking and turn it into something safe, dull and heavily regulated. John Kay wrote a great chapter in the recent LSE publication, ‘The Future of Finance‘ [pdf], which explains this move to ‘narrow banking’ in more detail.

If we decide instead that banks can be left to stand entirely on their own two feet, then we need to work out a way in which they can go bust without endangering the entire financial system.

I don’t see either of those two things happening. All I see is the main players in what should by now be a discredited system, arguing for business and bonuses as usual. And that’s a big problem. Not because I have anything against people earning large sums of money, or that I have anything against bankers particularly. It’s because if we don’t sort this out, we’ll end up with another crisis like 2008.

As Kay puts it: “The financial services industry is now the most powerful political force in Britain and the US. If anyone doubted that, the last two years have demonstrated it. The industry has extracted subsidies and guarantees of extraordinary magnitude from the taxpayer without substantial conditions or significant reform.

“But the central problems that give rise to the crisis have not been addressed, far less resolved. It is therefore inevitable that crisis will recur. Not, obviously, in the particular form seen in the New Economy boom and bust, or the credit explosion and credit crunch, but in some other, not yet identified, area of the financial services sector.”

And the more the press just focus on the great ‘return’ we taxpayers can look forward to from our ‘investment’ in the broken banks, the easier it becomes to make the case for the status quo. That would be very bad news for us all.