Friday, 19 July 2013

More Lanchester on banks

John Lanchester is back on the subject of banks again in the London Review of Books.

The short review: worth a read, of course, but don't forget to take it with the customary generous pinch of salt.

The long review: after the jump break.

A lot of it sounds right but there are some parts of the argument that clearly don't hold together. Two examples.

(1) Do we want banks with more or fewer assets? Bank loans are bank assets. (When a bank lends money to someone, it creates a claim for repayment of the principal together with interest, which is an asset. Quite how much of an asset it is depends on the ability of that claim to be realised.) So, if we want banks to lend money (as Lanchester suggests) we will need them to create more of these assets. On the other hand, if the sheer size of bank assets is disturbing (as he also suggests) then don't we want to encourage banks to make money in other ways - just like Barclays, which does "stuff other than lend to us, principally because, from the point of view of a bank trying to make a lot of money as quickly as it can, we’re not all that exciting" - i.e. shrink their lending? It all just sounds a bit 'I wouldn't start from here'-ish.

(2) The split between retail and investment banking. As Lanchester says, it would have made no difference to Lehmans or to HBOS. It would have made no difference to Northern Rock either. So why do we need it? The return of this idea is puzzling.

Next, the law is not as straightforward as he suggests. Is section 3 of the Fraud Act 2006 the nice easy answer to the PPI farago? Judge for yourself.

"3 Fraud by failing to disclose information
A person is in breach of this section if he—
(a) dishonestly fails to disclose to another person information which he is under a legal duty to disclose, and
(b) intends, by failing to disclose the information—
(i) to make a gain for himself or another, or
(ii) to cause loss to another or to expose another to a risk of loss."

The key words for present purposes are "dishonestly" and "under a legal duty to disclose". You're allowed to make an innocent mistake; and you don't have to tell everyone everything all the time or face going to prison - or else how would anyone have the time to sell anything? (Ever sold a house with a view to making a gain? Did you tell them about the dodgy light switch in the spare room? Don't worry, you're not going to prison.) The laws concerning what has to be disclosed in selling insurance are extensive and complicated. But as the links in my previous post showed, the banks generally complied with them. All those brochures and leaflets are produced for a reason: it's in the small print somewhere, if you can be bothered to read it.

Perhaps of most significance is his big point. What is the danger from banks? "UK bank assets are 492 per cent of GDP. In plain English, our banks are five times bigger than our entire economy." Wrong. Bank assets are five times bigger than the amount of output generated by the economy in a single year. That's quite different. (Go to the BBC for an explanation of GDP.) The amount Britain produces in a year is not the same as its total economy any more than your annual income is the same as your wealth and total earning potential. The ONS estimates that the net wealth of the UK in 2011 was £6.8 trillion. GDP for 2010 was about £1.4 billion. Note the billions and trillions - they matter.

You could say I am being too pedantic. Or I'm inventing a stock/flow confusion where none exists. Or what does it matter anyway?

It matters for this reason. It is part of Lanchester's argument that if banks go wrong then we can't afford to bail them out. Clearly that is worrying if true. But it is not true. Bank assets are stocks, not flows. UK wealth is a stock, not a flow. We can afford to bail them out, as long as we use wealth not income.

Now, I accept Lanchester's point that it would be painful and we would rather not have to do it. But that isn't surprising. If all the assets of the entire banking sector of one of the wealthiest countries in the world suddenly became worthless, that would be painful. It would be painful if those assets were 100% of GDP or 500%. And bear in mind that it would probably only happen in awful circumstances that would be causing a huge amount of pain quite independently of its effect on banks.

But what you can afford is a matter of degree and a matter of political will. Let's take another example, the position of northern and southern European countries in the ongoing euro difficulties. Tyler Cowen gave us this parable (altered for the English reader):

"Put reason aside, how would you *feel*?

You meet an employed professional with a £300,000 house, £100,000 in the bank, a nice car, a few (illiquid) Renaissance paintings, and very nice shoes. His name is Fabio.

He is £60,000 in debt, which is about equal to his yearly income. His bank has upped his mortgage rate so he has to pay off that debt at a faster pace than expected, which means he must restrict his consumption.

He threatens to mistreat his longstanding girlfriend Angela, unless she works harder to maintain his previous level of consumption. Angela refuses to help much, citing a false economic theory in defence of her position.

Fabio’s brother relentlessly attacks Angela’s false theory. His cousin in Naples claims that Angela is obliged to help because she has benefited from being in the relationship.

One of the points being made here is that all this talk about Greek (or Spanish or Italian or what have you) debt levels being very high ignores the fact that these places have plenty of wealth. The question is: are they prepared to dip into that wealth (instead of restricting their consumption) in order to satisfy obligations incurred by their governments? The answer appears to be: not really.

(This also leads into one of the points to consider when hearing the argument that we don't need to worry about the UK's high public debt because we have had much higher public debts in the past, for example after World War II. That's right. But ask yourself this: were the people of Britain prepared to dip into their wealth and/or restrict their consumption to pay for the war? Of course. Only a knob says we should have done a deal with Hitler to save the Empire, for example. But are the people of Britain prepared to make similar sacrifices to maintain the high levels of welfare spending achieved during the boom years of the 1990s? I'm not so sure.)

So, on the bits of his article I can test - the law, the numbers - Lanchester is not quite right. Is he right on the other bits? The cultural side of things seems right (my own experience of working for banks is that it is incredibly hard for them to gather together the sort of information you would expect - Lanchester's experience with the dollar cheque is not unique), but I can't be sure.

I think it is important that he is right. As I set out above, we can afford to have our banks - if we want to. Whether we want to is a political and social question, and opinion formers such as Lanchester play a role in deciding. If people read Lanchester and think "there you go, he explained it all in detail, with numbers and charts and chapter and verse on the law, and all these banks are about to explode and all the bankers should be locked up now" then they've formed an opinion which is only loosely based on the true costs and benefits of our banking system.

Out of the crooked timber of humanity no straight thing was ever made. That goes for liberal review periodicals as much as it does for banks. 

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