Wednesday, September 15, 2010

Banking on your savings...

Blog mascot Steve Baker MP appears to be earning his salary...

There has been an awful lot of rubbish talked about banking over the last few years, including the idea that banks should be split into the nice, solid, reliable "High Street banks" and evil, risk-taking, "casino" banks.

Fair enough.

Except that the evidence simply doesn't bear out this analysis, as A Very British Dude points out very succinctly.
Nowhere did investment banking losses pull a retail bank down, or requrire one to take government bail-out money: let's look at the UK banking sector:
  • Lloyds TSB: Safe, solvent, straighthforward Retail bank, until it was persuaded to buy HBoS by Economic Jonah, Gordon Brown.

  • HBoS (Halifax, Bank of Scotland): mainly retail, Large Mortgage Business, which went belly-up and took Lloyds TSB with it too.
  • Royal Bank of Scotland, very small investment bank, Largest UK retail operation, big Corporate loan book, whose purchase of ING ABN Amro strained its balance sheet to breaking point. It's failure was hubris, not Investment banking.

  • HSBC: Universal Bank, large global retail and investment banking operations, now trading at the same shareprice it was before the crisis, and is still paying dividends.

  • Barclays: Large UK retail bank, overseas operations, buccaneering and ambitious investment bank, who were raised funds from private investors and just managed to keep out of Government hands.

  • Standard Chartered: International corporate and retail bank, mainly Asia and Africa - no problem at all.

  • Northern Rock: Ex Building society turned Mortgage and Retail, bailed out by a Labour government because they couldn't bear to see anyone make money and wanted to save jobs in key marginals.

  • Bradford & Bingley: See Northern Rock. Eventually bought by Spanish banking group, Santander.

Let's look at the evidence: Of the two "universal banks" listed in the UK, neither had to touch the UK taxpayer for money. HSBC was able to cope with the crash on it's own resources and Barclays was able to use its contacts from the investment bank to touch sovereign wealth investors, who have now been paid back. The banks which had got into trouble were either Mortgage banks without a large retail business from which the Mortgages were funded: Northern Rock and Bradford and Bingley, or they were banks who sailed close to the minimum Capital adequacy ratio like Royal Bank of Scotland. Or, like HBoS, Both.

So, the conventional wisdom simply isn't on the money.

However, that doesn't mean that there are not problems with the banking industry—there are. And one of the most fundamental wrongs is the fact that once you put your money in a bank, it no longer belongs to you.

No, really.

The Cobden Centre outlines the background.
The key case is Carr v Carr 1811 (reported in Merivale (541 n) 1815 – 17). A testator in making his bequest said “whatever debts might be due to him…at the time of his death”, the key question in this case being whether “a cash balance due to him on his banker’s account” passed by this bequest. The Master of the Rolls, Sir William Grant held that it did. He reasoned that it was not a depositum; a sealed bag of money could be, but this generally deposited money could not possibly have an ‘earmark’. Grant concluded on this point, “when money is paid into a banker’s, he always opens a debtor and creditor account with the payor. The banker employs the money himself, and is liable merely to answer the drafts of his customers to that amount.” For the legal scholars among you, Vaisey v Reynolds 1828 and Parker v Merchant 1843 both affirmed this position.

In Davaynes v Noble 1816 it was argued in front of Grant that a banker is a bailee rather than a debtor. Rejecting that argument, Grant said “money paid into a banker’s becomes immediately a part of his general assets; and he is merely a debtor for the amount.”

In Sims v Bond 1833 the Chief Justice of the Queens Bench Division affirmed in judgement “sums which are paid to the credit of a customer with a banker, though usually called deposits, are, in truth, loans by the customer to the banker.”

The House of Lords, then the highest court in the land, had its say on the matter in Foley v Hill and Others 1848, duly reported in the Clerk’s Reports, House of Lords 1847-66 (pages 28 and 36-7). In summary, the appellant in 1829 opened a bank account with the respondent bankers. Two further deposits we added in 1830 and in 1831 interest was still added. In 1838 the appellant brought proceedings against the respondent bankers seeking recovery of both the principle and interest. The counsel cleverly tried to argue that it was the duty of the respondent bankers to keep all the accounts up to date at all times and thus there was more to this relationship than that of debtor and creditor.

The Lord Chancellor Cottenham said the following in judgement
Money, when paid into a bank, ceases altogether to be the money of the principal; it is by then the money of the banker, who is bound to return an equivalent by paying a similar sum to that deposited with him when he is asked for it. The money paid into a banker’s is money known by the principal to be placed there for the purpose of being under the control of the banker; it is then the banker’s money; he is known to deal with it as his own; he makes what profit of it he can, which profit he retains to himself, paying back only the principal, according to the custom of bankers in some places, or the principal and a small rate of interest, according to the custom of bankers in other places. The money placed in custody of a banker is, to all intents and purposes, the money of the banker, to do with it as he pleases; he is guilty of no breach of trust in employing it; he is not answerable to the principal if he puts it into jeopardy, if he engages in a hazardous speculation; he is not bound to keep it or deal with it as the property of his principal; but he is, of course, answerable for the amount, because he has contracted, having received that money, to repay to the principal, when demanded, a sum equivalent to that paid into his hands.

That has been the subject of discussion in various cases, and that has been established to be the relative situation of banker and customer. That being established to be the relative situations of banker and customer, the banker is not an agent or factor, but he is a debtor.

Thus the settled position of the law is that when you deposit, the bank becomes the owner of the money deposited and you become a creditor to the bank.

This is, of course, not an entirely satisfactory state of affairs: what should happen is that when you deposit your money, you retain ownership. If one chose, one could loan the money to the bank (in return for a higher rate of interest, for instance) but it should be a choice by the customer.

Douglas Carswell: making a nuisance of himself—in a good way...

The increasingly busy Douglas Carswell, supported by this blog's mascot—the thoroughly excellent Steve Baker—is tabling a Ten Minute Bill that proposes precisely this. Douglas lays out the BIll's proposition succinctly on his own blog.
To be clear, this Bill does not stop banks from treating your deposit as a loan. You just have to make clear that you give them permission to do so. There would, in effect, be two types of bank account; one where it was made clear that you owned the money (and probably paid for banking services in fees), and one where the bank was free to lend on your money like they owned it.

And Steve Baker outlines the motivations and consequences in a Centre Right column, correctly pointing out that—whatever your opinion on the benefits or otherwise of fractional reserve banking—this is not only an attempt to stop the distortion of capitalism, but also an issue of property rights...
While banks maintain clear property rights in securities on deposit, the same cannot be said of monetary deposits. Thanks to a base of judicial decisions, when you deposit your money on demand at the bank, ready for immediate withdrawal without penalty, it is not your property, but the bank's. Banks can lend money held on demand and of course they do so.

This is fractional reserve banking and it may not be the good thing most bankers think it is.

Fractional reserves on demand deposits allow banks to extend credit in excess of real savings. That leads to the creation and destruction of fiduciary media: claims on money for which there is insufficient money to meet all claims. It is what makes bank runs possible. It means that, as the great economist Irving Fisher wrote in 1935,
our national circulating medium is now at the mercy of loan transactions of banks; and our thousands of checking banks are, in effect, so many irresponsible private mints.

As I explained in my maiden speech:
Unlike the situation in respect of any other commodity, in the case of money, price controls do not drive the product off the market. Artificially lowered interest rates increase the demand for credit, and decrease the supply of savings, but the legal privilege granted to banks means that they can meet demand by extending credit that is unbacked by real savings. There is a good argument to say that that causes the boom-and-bust cycle, the misdirection of resources in the capital structure of production, and over-consumption by consumers.

And since the money supply contracts when banks lend less, we find central banks injecting new money through QE, further distorting an economy already distended by excess credit expansion, in an attempt to cope with the anarchy of money creation and destruction caused by fractional reserve banking.

To repeat: demand deposits of money are not subject to the same principles of property and contract as any other commodity. Banks enjoy the legal privilege of open access to money which they are liable to return on demand. In concert with the central planning of interest rates and a range of government interventions, this is what is wrong with capitalism.

Whilst—as Brian at Samizdata points out—a Ten Minute Bill is unlikely to succeed in passing, it does show a fundamentally sensible way to approach this patent injustice, and deliver a more morally and economically sound banking and capitalist system.
Ten Minute Bills seldom pass. But they are a chance to fly a kite, put an idea on the map, run something up the flagpole, shoot a shot across the bows (see above) of some wicked and dangerous vessel or other, etc. etc., mix in further metaphors to taste. Were this particular kite actually to be nailed legally onto the map (which it will not be for the immediately foreseeable future) it would somewhat alter the legal relationship between banks and depositors.

Quite. But it is more than that...

Attendance for and voting on this Bill will show us just how determined Our New Coalition Overlords™ are to serve our interests. It is our money; and if the consequences of this Bill would be both to enshrine that in law and to provide more stability to the banking system—which they are—then a low attendance and votes against would show us that the Coalition care more for the comfort of the bankers than for the property rights of the people that they purport to represent.

We, the people, could sharpen our scythe blades—secure in the knowledge that this government is just another collection of corporatist scum who couldn't give a shit about property rights. And sharpening our scythes would be a worthy past-time because, if the above is the case, then we would be better killing the lot of them than enabling their apathy and wallet-books to undermine that which has made our economy and society successful...


Lord Blagger said...

In part you are right.

It is your money.

Hence my cheap solution is this. The first 50K of any account gets priority in a wind up. Cheap and cheerful. No up front cost.

A lot of this is Misean in nature. However, the problem here isn't with the economic approach. It's down to the old adage, I wouldn't start from here. You can't go from fractional reserve banking to asset backed without causing major damage in the process. You can do it gradually.

The gradual approach is to increase the capital requirements. Here, quite why the UK banks don't need to increase capital from the levels before, when the got into a mess is beyond me. Well not really, its an EU fix up to protect German banks.

However, the damage caused by the change is the lack of lending. Given politicians can't control your bowels when it comes to spending, people will be forced to lend to you. (A bit like the HMRC idea of taking tax direct from bank accounts. Try getting it back when they make a mistake. After all they've also passed a law saying you can't sue them for their mistakes. Along with their own tax haven laws exempting themselves)

There is another thing that can be done in the short term. The reason for the mess was no systemic risk monitoring by the regulator (Gordon).

Force all banks to publish a weekly (or daily) credit report. Then let people mash that up into who is weak and who is strong.

Anonymous said...

I recall that Paddington Bear was very cross that he didn't get the very same £1.00 back that he had banked. Should've known.

Roger Thornhill said...

Well, you have lent money to the bank, so it is not "your" money anymore, just that the bank will try and return it on demand. If you want "your money" to remain so, get a safe deposit box or a term deposit (which becomes a security, IIRC). What is wrong is the convenient misconception of "your money" to remain out there, and the banks are in no hurry to change that.

"Fractional reserves on demand deposits allow banks to extend credit in excess of real savings."

I am afraid this is a common error. What is "real savings"? When a bank lends money, that money either ends up back in another bank account and so is "real savings" again OR it is taken out as cash and remains taken out, in which case the bank, all things being equal, will hold off lending until it has recharged its reserves from net deposits of cash either over the counter or net interbank transfers of M0.

It will end in tears - again said...

To be fair both Barclays and HSBC would be insolvent if they didn't have the copper bottomed guarantee of a taxpayer bailout should anything go wrong.
The bank 'stress tests' that were recently carried out by the EU were a farce. Barclays declared £1Bn of toxic debt in other EU banks but has since admitted to having £8Bn in Italian toxic mortgage debt alone. How much more toxic debt is being hidden ?
As long as these banks can dump their rubbish assets for govt cash and recieve money at 0.5% while charging customers what they want then they will continue to prosper. And of course pay themselves big bonuses.
Taxpayers are mugs as we're just carrying the banks until the next collapse when there will be no more money to bail them out.
The banks know all this which is why they're filling their boots while they can.