This weekend saw the second-biggest bank failure in US history. As the FT reported yesterday, US bank, First Republic was closed with the active involvement of US banking regulators and its $93.5bn deposits and most of its assets were sold to JPMorgan Chase. They got a $50 billion Federal loan to assist the deal.
The deal meant all depositors, including those above the $250,000 insurance limit, retained access to their money. That cost the Federal Deposit Insurance Corporation in the USA an estimated $13bn in support for this deal.
The third and largest bank failure in the USA in just over a month will likely have consequences.
The first is that JP Morgan is even bigger than ever. Under US competition law, this deal should not have been allowed. It makes JP Morgan far too big. But pragmatism overruled that. Too high to fail is now a fact. JP Morgan is never going to be allowed to go out of business.
Nor, in effect, was First Republic. Its shareholders might be wiped out, but the reality was that as far as its customers are concerned, the bank still functions. The pretence that continues that there is a private sector banking operation in the USA, and in countries like the UK, is now a farce. When depositors know that there is no risk to placing funds anywhere in financial markets because the state guarantees that they will not lose however bad the bank that they choose might be, the idea that there is a competitive market is well and truly over.
Another myth that is also finally shattered is the idea that banks are dependent on the capital markets for their funding. What is clear are two things. First, JP Morgan relied on a government loan to fund this deal. Second, First Republic (and now JP Morgan) relied on the explicit financial support of the government to run its despite taking operations, which support has now cost the US government $13 billion. Banks in the UK do exactly the same thing. Here the deposit guarantee is £85,000, but in reality (as we know from the experience of Northern Rock's failure), it is actually unlimited. To pretend that banks are anything more than an extension of the state now is quite ludicrous.
In that case, the question has to be asked as to why they are permitted to make so much money at cost to us all?
But, perhaps most important of all, the impact of this failure on US fiscal and monetary policy has to be considered. US inflation is falling, and the signs of recession are growing. For example, it has been noted that petrol and diesel consumption is now declining in the US, and not due to electric cars.
The Fed could react to a bank failure by increasing interest rates to supposedly supply banks with more margin.
They might also do this to make deposits more attractive when real interest rates are still negative.
And they may also do this to dampen demand, although doing so will undoubtedly reduce the amount of credit made available because that is exactly what the policy intention would be. Such a move would also increase the risk of debt default by bank borrowers and also reduce the income of banks as loan portfolios fall. Both increase the risk of further bank failures.
My suspicion is that the Fed will go for another slight rate rise despite the risks. I think that would be a big mistake, but the US generally requires the Fed to make a big mistake before its economic course is changed.
What would be better would be an acknowledgement of the fact that US banking is not what it claims to be. It is not a private sector activity. It does not behave as the private sector should. It uses public capital and the commodity it has to sell is provided costlessly to it by the state, as the $50 billion loan to JP Morgan was. Until these facts are acknowledged, the charade goes on, and decisions are taken on the wrong basis, threatening us all.
There needs to be a new awareness. That is that the government is ultimately responsible for all money creation. The banks are simply their agents. The wiring of the system has to reflect that fact. That is not how it is right now. And those who are profiting from the pretence are going to hold on to it for as long as possible. It's down to heterodox economists and those who really understand money to make clear that there are better choices to be made. Then one day those better choices might happen.
Thanks for reading this post.
You can share this post on social media of your choice by clicking these icons:
You can subscribe to this blog's daily email here.
And if you would like to support this blog you can, here:
Hear hear,
As Martin Wolf said many years ago, bankers are just civil servants implementing government monetary policy. They should as such be paid as civil servants not so called free market businessess, which they most patently are not.
Adair Turner added that most of what banks do is socially useless.
And Mervyn King said he couldn’t understand why top bankers weren’t hanging from lamp posts after the 2008 very costly global bank bailouts.
We really need to put the banks in their proper place in the economy.
That the supposed zealots of Private Enterprise, Competition and Libertarianism are once again being bailed out by governments is the grossest of offences against anything that might be considered fair and rational.
Wouldn’t something like a modern version of the Glass-Steagall acts be at least a beginning to dealing with this?
It’s amazing to me that the state role in money creation is in plain sight yet still remains widely misunderstood in the US and the UK.
If it were more understood, the chorus for asking for better public services and pay would hopefully have more heft whether in the states or here in the UK.
Katherina Pistor, ‘The Code of Capital’ (Ch.4, p.77) trenchantly explains the private sector fallacy of money: “The logic of a private economy is that you can sell only if you have a willing buyer, that is, a private buyer. If private buyers retreat, demand declines, and asset prices fall, investors who thought they had huge amounts of wealth at their fingertips might lose it in no time. To lock in past gains, investors will try to convert their private assets into state money, the only financial asset that is guaranteed to keep its nominal value”.
The Sovereign state issues credit that is also money. The private sector issues credit. It may often look like money, bot the test is a run: private capital then runs to the state; there is nowhere else to go. The state is the lender, dealer, issuer and guarantor of last resort. These are facts. Neoliberal monetarism is fudge.
Richard, We have now reached the point, at last that for anyone for whom neoliberalism is not literally a religion (which I am afraid seems to include most of the economics profession) it is now demonstrably clear that the domestic commercial banking sector is being subsidised by the state, and is not free enterprise, and not competitive; but a disguised monopoly which is privatising the public’s resources to make private monopoly profits. Now you know why living standards are falling, and now the public should know why they are permanently angry and butter. The Conservative/Labour neoliberal parliamentary Cartel is ultimately responsible for this state of affairs.
Mr Warren – I have for some time suspected that our politicians mostly agree with each other now about what the future direction of the country (and if you don’t, you are locked out) but I think that your description of it as a Neo-liberal ‘cartel’ is spot on.
A political cartel for sure.
Butter? Would there was butter: there is scarcely bread; but always butter for bankers, however much money they lose. The word, of course is ‘bitter’; the irony should not be lost.
We often hear that 97% of the money in circulation is created by commercial banks rather being of government issue.
I’m really not sure if everyone properly understands what this means. If it really meant what many others, at least in my opinion, think it means then they could never go bust!
However we know they can!
So what so you think they mean?
Richard, I have given up trying to understand what NeilW thinks about ‘money’; candidly, I am not sure even he knows.
Disappointingly, his comments reveal a lack of clarity
@ Richard,
You did actually pay me the compliment of saying I understood MMT even though you don’t think I express myself very clearly!
How about this for a better explanation of what money is?
“All money is created by crediting and debiting accounts. Money functions as a unit of account, medium of exchange, store of value, and record of debt. Every debt has a corresponding credit denominated in the unit of account of that jurisdiction, so that all debt is someone’s liability and is someone else’s asset, which nets to zero. Money is not only someone’s debt (a payable) but also someone else’s credit (a receivable), it is just as true to say that the world owns over 75 trillion in financial assets, expressed in USD, as it is to say that the world owes 75 trillion in financial liabilities.
If there were no credit-debt relationships, that is, if all financial liabilities were extinguished, then there would be no money, and exchange of goods and services would be reduced to barter”.
The “97% of money is created by private banks” argument is perfectly correct if their liabilities are included too. They should be, but is this fact generally appreciated?
That claim is interesting and I note you use double entry
But in that case you also have to accept that in your ‘creation narrative’ tax comes first
The 97% is bank credit. It looks like money, and transfers like money, until there is a run. The you find it drops rapidly down the hierarchy of money. State money is the guarantee and last resort. Bank credit isn’t.
Oh, and barter isn’t an alternative; barter is a single transaction, if it lubricates sustained economic activity there must be a ‘money’; whether a commodity, a sea shell or a cigarette. Money creates an economy, which is why economists are in such a mess with economic theory. Mehrling’s approach he calls ‘ the Money View’.
@ Richard,
Government creates a debt in the population by imposing a tax. Government spending into the economy follows then tax collection after that. This is the MMT view which I accept as being correct for a fiat currency issuing government. You seem to have a soft spot for Stephanie Kelton and she says the same thing.
A more usual ‘understanding’ (as I’m sure you’ll be aware) is that the government imposes a tax, then collects collects some money with which to spend. This is actually true for a non-fiat currency issuing government. It would have also been true in feudal times when the king imposed a tax on his barons, lords and nobles, to be paid in something tangible such as gold, silver or direct supplies. These nobles in turn would have levied a similar tax on those under them: vassals, knights and other ‘freemen’. At the bottom were serfs and peasants who paid a percentage of what they produced to those above them.
Whatever system of taxation we care to devise, the imposition of a tax has to come first. It simply isn’t possible any other way.
No
Not true
Government comes first
Exchange via debt comes next
Both happen well before tax
As far as I am aware, no society has ever been found in which barter is a significant contribution to economic activity except in situations where a money based economy has broken down. If the usual origin myth for money were true then you would expect to find barter economies at least mentioned in historical records but there are none.
There have been economies that function without money such as hunter-gatherer societies that relied on mutual aid and the Maya Empire the relied in a system of duties to supply storehouses that were owned in common.
The idea that money provides a “thin veil over barter”, as an academic economist once expressed it to me, is not only untrue of modern economies but seems to have never been true.
Barter was never significant in any recorded period
Debt has been
And money formalised that
This is why the claim that trax alone gives money value cannot be right
Sometimes, Richard it is simply necessary to concede, there is nothing to be done …..
Really?
I hadnt realised how big and important the latest bank failure was – it certainly hasnt hit the headlines that way.
It seems so clear – that indeed bankers are essentially civil servants – and ought to be rewarded that way.
It would be great to put a step by step series of ‘modest proposals’ to Starmer, Lib Dems and co , which would be common sense for the person in the street and gradually cut the banks , their profits, shareholder and executives down to size. So that ‘the wiring’ as Richard calls it, begins to reflect the non-competitive, public sector nature of the banking sector.
And all of this is before one considers the malign effects of the City on the wider economy and industry. It’s failure or rather refusal to support the investment that firms need to make in the people, infrastructure and R&D. Talk to SME’s about their struggles to get finance. Those water companies loading themselves with debt whilst paying large dividends and executive bonuses but utterly failing to make the investments needed. An extreme example of what is all too common in businesses, whose behaviour is shaped by pressures from the City to maximise profits and payouts regardless of consequences. Then the City’s role in tax evasion and money laundering. Its use of money creation to fuel the explosion in house prices.
It’s a long charge sheet. We await a party and leadership that are prepared to call them to account, and build the kind of financial services the wider economy and society need. Instead of the bloated parasite we currently have.
@ Richard,
“This is why the claim that tax alone gives money value cannot be right”
“In the first instance this tax is intended to control the inflation that would otherwise result
from excessive injections of money into the economy as a result of government spending ”
Your two statements above are somewhat contradictory. Tax is indeed required to control inflation. Too little tax means inflation will be too high. No tax at all would mean that inflation would potentially be infinite meaning that money would immediately lose all its value.
“Barter was never significant in any recorded period”
MMT economists often make the same point. Whenever an organised society emerges there always needs to be some entity, ie a government, to organise it. It doesn’t take them long to discover their ability to create a currency. Having said that there are still a few tribes in places like New Guinea and in the Amazon rainforest which exist independently of governments. It would be interesting to find out, rather than simply speculate, how their economies function and how important barter is in them.
That has been done Neil – barter is simply not the predecessor of money
And government exists without money
But that does not mean tax is imposed to create money
Nor does it mean the m money we have now has anything much to do with its pre-history
This is all getting tedious
I really think you need to read a bit more.
[…] Cross-posted from Tax Research UK […]