Ever since the financial crisis, there has been an onslaught of people who think we need to scrap the entire financial system and start over. The main source of angst has been private banks. Basically, people think banks lent too much money and leveraged up the financial system and then we got a financial crisis. This isn't necessarily wrong, but that's not really how banks work. Let me explain.
A bank is a lot like your water company. The water company supplies water through the pipes into your home and you can turn on the spigot whenever you please. Water flows as you need it and stops as you don't need it. This is a good thing as it allows us to use water on-demand and to meet our specific needs. Banks operate in much the same way - they supply credit to the economy and when we need it we can tap into it. If the economy needs more liquidity, there is an elastic money supply that can expand to take advantage of those new opportunities. (Read, the Basics of Banking).
Now, the financial crisis was an unusual beast. The majority of loans being issued were relatively low risk loans. The problem was that all of the loans were tied to an asset (housing) that was assumed to be fairly low risk. And just like the water company doesn't decide how much water you put in the bathtub, the banks don't decide how much home prices get bid up (and down). So as consumers irrationally bid up home prices, the risks of the tub overflowing were growing.
The strange thing about the financial crisis is that when the tub overflowed (i.e., house prices collapsed), very few people blamed the homeowners who bid those prices up (i.e., the people who filled up the bathtub in the first place).¹ But make no mistake, this was the crux of the problem. Blaming banks for rising asset prices is like blaming your credit card company when you pay $20,000 for a $1,000 iPhone.
Importantly, banks are private competitive entities that compete for our credit. If I have an income and good credit, then I can shop around to access the cheapest line of credit available to finance future needs as opposed to having to access my current liquidity (which I might be able to put to a better use elsewhere). This elastic money supply makes our economy much more dynamic than it otherwise would be.
There's a downside to private competitive banks - they must try to manage their risks so that they are also maximizing profits. In general, when times are good, they take more risk (because their risk analysis looks better since everyone's balance sheet looks better), and when times are bad, they take less risk (because their risk analysis looks worse since everyone's balance sheet looks worse). Banking tends to be procyclical in much the same way that stock market booms are procyclical (or that water usage is procyclical).
So banks lend more during good times (sometimes exacerbating the boom) and lend less during bad times (sometimes exacerbating the bust). This procyclical tendency is just part of the economy's natural ebb and flow. We can reduce the size of the booms and busts via better regulations and better knowledge, but it's unlikely that we can eliminate it.
This brings me to this weekend's vote in Switzerland on the Vollgeld Proposal. I touched briefly on this after my recent visit to Switzerland, but the basic gist is that the angst against private banks is so bad in Switzerland that their direct democracy raised enough votes to potentially end private banking and fully reserve the banking system with what they perceive as a "sovereign money" system. In essence, the control of the money supply would return to the government.
This is silly for several reasons:
The bottom line is that the Vollgeld Proposal doesn't solve the problem that the Swiss people think it will. If they fully reserve the banking system, then the Swiss National Bank will be forced to issue more reserves to back all new loans. And if they centralize the issuance of loans, then government bureaucrats will suddenly control all new issuance of credit.
Personally, I think this proposal is supported by people with a hammer who view everything as a nail. Hammering the banking system into submission won't fix the actual problem. Instead, the Swiss people should advocate for better and smarter regulations that restrict how banks manage their risks and reduce the systemic risk they pose to the rest of the economy in the case that we decide to overfill our bathtubs.²
¹ - I am by no means trying to absolve the banks from any blame in the crisis. Yes, they definitely made too many loans to low credit borrowers. And they definitely leveraged loans into securitized products that made the crisis bigger than it should have been. But the key point here is that the kill mechanism in the financial crisis was house prices and the blame for booming house prices is widespread.
² - Not gonna lie. A warm overflowing bath sounds pretty nice right about now.
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