How much does a person need a bank? Or to put it another way: Which banks do people need? For 30 years, the financial world has been moving from one crisis to the next – at the expense of governments and taxpayers. This article shows what a new and fairer form of financial trading looks like.
Understand why banks need more regulation, not more freedom
“What is a break-in into a bank against founding a bank,” Bertolt Brecht asked one of the protagonists in his Threepenny Opera. The poet thus criticized the asocial excesses of the financial sector more than 90 years ago. This sentence is more relevant today than ever. Since the great financial crisis of 2007/08 at the latest, many people have lost confidence in the banks. Suddenly it doesn’t seem so ridiculous any more if someone stores his savings under the mattress – at least nobody can gamble there.
But how could such a catastrophic crisis have come about? When politics gave up its control over the banks 30 years ago, it was said that free financial markets would regulate themselves and thus create prosperity for all. This article explains why exactly the opposite has happened and why crises are virtually inevitable in a financial world without rules. They also show how such mistakes can be avoided in the future.
In this article you will also find out,
– how disproportionate salaries are in the banking sector,
– how a financial bubble is created, and
– what speculative banks have to do with the fact that the Internet is now dominated by a few giants.
Since politics has intervened less in banking transactions, the global financial world has been shaken time and again by crises
If we take a closer look at the course and consequences of the last major financial crisis in 2007/08, we get the impression that banks and stock exchanges can do what they want. Where does this too much freedom come from?
In the 1970s and 1980s, heads of state such as Jimmy Carter and Ronald Reagan in the US and Margaret Thatcher in the UK bowed to pressure from the financial markets and began to deregulate them. This meant that politics increasingly withdrew from these markets and triggered a radical change in the financial world. For example, banks were now able to grant loans without strict conditions. At the same time, they invented numerous products to speculate on the stock market. The best-known example of this is interest rate derivatives.
Another milestone was the abolition of the separation of commercial and investment banks in 1999 by the then US President Bill Clinton. Thus also completely normal banks were allowed to speculate on the stock exchange. The amount of money circulating on the financial markets grew immeasurably. Small and medium-sized banks began to juggle values corresponding to Germany’s annual gross domestic product.
At the same time, bankers’ salaries and bonuses rose to lofty heights. In the last three decades alone, the average salary of a banker has risen by around 70%. This hardly corresponds to the real increase in bankers’ performance.
What about the deregulation of the banks?
The world outside the banking sector did not feel much of the deregulation of banks – except for regularly recurring crises. Deregulation enabled speculation on a completely new scale. Huge investments were made worldwide, which were no longer based on real values. This phenomenon is called the financial bubble – which will burst at some point. The crisis of 2007/08 emerged from such a financial bubble. It shook the global financial world and has cost taxpayers millions all over the world to date.
The banks had apparently not learnt anything from the crisis that shook the world economy at the end of the 1990s. At that time, the Asian crisis caused threatening turbulence on the financial markets. The bubble was created by too much money being pumped by banks into South and East Asian countries such as Thailand, Indonesia and South Korea. As a result, companies in these countries did not automatically become more productive.
Nevertheless, they hired people on a large scale and invested the funds of foreign donors. But when they withdrew their money, the whole house of cards suddenly collapsed and the whole world economy began to spin.
Even experienced bankers are guided by their emotions and make momentous wrong decisions
The decisions that lead to the creation of financial bubbles, among other things, are made by experienced bankers. Actually, they should have learned from the past and be able to assess the consequences of their actions. But the reality is different. Especially the protagonists of the financial markets are too often guided by their gut feeling.
This is no wonder when we consider how closely the global financial world is networked and how many factors influence it. Even the most stable stock can lose value rapidly if, for example, an earthquake in Nepal destroys large inventories. Because it is impossible to predict the development of a share, many bankers and investors simply follow their gut feeling.
A simple example illustrates where this can lead: If, for example, many investors invest in a stock X, other investors find out about it and participate in the investment. The value of this stock shoots up long before the company in question can even meet expectations. Since the hoped-for profits initially fail to materialize, many investors sell their shares again. These sales cause the value of the stock to fall. And now the big disaster breaks out: Bankers follow the herd instinct in a blunt manner and try in panic to get rid of their shares, if necessary even below value, so that they do not completely lose their stakes. The share falls and falls. Welcome to the daily madness of the financial world.
This is exactly how major financial crises arise:
Investors see a problem and react panically by withdrawing all investments – which in turn exacerbates the problem.
The dotcom bubble after the turn of the millennium also followed this pattern. Back then, investors began to invest large sums in small garage companies in the hope of finding the next Google or Amazon. When it became clear that many companies were unable to meet the excessive profit expectations, an unprecedented fall in the share price occurred. Investors lost enormous sums. In Germany, these new markets closed completely.
The financial markets are jointly responsible for the unequal distribution of income and the indebtedness of states
But let’s not just look at the crises. Didn’t the deregulated financial markets nevertheless boost the global economy? The answer is clearly no.
The politicians who liberalised the global financial markets in the 1970s and 1980s promised the dawn of a new era. This era is now here – an era of negative headlines, bankruptcies and billions in losses that always end up absorbing taxpayers.
The basic idea of liberalised financial markets is clear: successful companies should be rewarded with investments, while unprofitable companies should be encouraged to increase their profitability through restructuring. In this way, the financial markets should have a positive influence on the economy. Instead, they themselves have become trouble spots. One crisis follows another, bankers are hopelessly overwhelmed and banks must be rescued.
In addition, there are the massive collateral damages that every financial crisis brings with it. Since the dotcom crisis, for example, banks have been very reluctant to invest in smaller IT companies. This is one of the reasons why the Internet is now dominated by a few giants and new companies hardly have a chance.
Could it get worse?
Even more serious is the negative trend that is triggering financial crises in less stable countries. Emerging markets are particularly often affected. By suddenly withdrawing their money on a massive scale, international investors are also plunging solid companies into chaos for no reason, and the governments of the countries affected are having to sweep up the pieces.
In addition, the liberalisation of the financial markets is one of the reasons why the asset gap is widening and many countries are heavily indebted. In the 1990s, bankers and managers were paid similarly to the middle class. Since then, however, their income has multiplied, while most people’s salaries have risen moderately at best. On the other hand, during the financial crises many states have to take on horrendous debts to save ailing banks, service their loans and import important goods from other countries.
The fiscal policies of recent decades have cost millions of people their jobs and plunged countries into bankruptcy. It’s time to get out. But what could it look like?
A reform of the financial market should be carried out with caution
One thing is clear: a reform of the financial market must be carried out with caution. Withdrawing confidence and state support from banks overnight can have just as devastating consequences as the current financial chaos.
This happened, for example, in Greece during the last financial crisis. When the country was hit by the crisis, politicians called the banks unreliable. As a result, many private customers and investors lost confidence in the banks and panicked and withdrew all their money. However, this made the banks even more unstable and the crisis spread. To this day, Greek banks are suffering a dramatic loss of confidence.
Such a spiral of crisis must in any case be prevented in the event of a reorientation of the financial markets. So how must governments proceed?
The best model for a regulated and successful financial world can be found in the period after the Second World War. At that time, the economy was relatively stable and the banking business did not caprile the existence of thousands of companies and individuals.
During this time, bankers were paid the same as other employees with similar qualifications and their business was known as boring banking. This was the time when the financial business provided a small but solid part of the economic performance. In the USA, it fluctuated between 0.6 and 0.9%.
At the time, banks were not speculating on government bonds and risky securities and concentrated instead on their actual tasks. You can find out what these consist of in the next section.
Banks must find their way back to their roots
So there was a time when banks had nothing in common with casinos – except that both were about money. And that’s exactly where we should go back to.
Banks should concentrate again on their traditional tasks. In the past they were quite manageable. Their core business was to manage their investors’ money on the one hand and to provide loans for real projects on the other. This was particularly important for start-ups of smaller companies, so that they could get into business at all.
This type of credit must therefore be maintained, because such bonds can be used to generate real value in the economy. On the other hand, banks must stop lending to each other and thus creating unreal asset masses that can only be used for speculation.
Banks make countless such financial transfers on a daily basis. Billions of dollars, euros and yen are constantly moving around the globe without ever creating real value. A good reform would therefore be a financial transaction tax, in which each transaction would be subject to a minimum tax of about 0.1%. This would reduce speculative trading but not lending to real companies.
John Maynard Keynes first considered such a financial transaction tax in the USA after the great economic crisis of the 1930s. Today she is mostly associated with the American economist James Tobin. Although many countries, including Germany, are in favour of such a tax, it has not yet been introduced.
What about trading stocks?
Trading in shares should also be limited. As we have seen, not only small investors, but also professional investors are always uncritically infected by the enthusiasm for a share. They invest a lot of money in order to then panically sell off the same share again, for example because it does not live up to its promise of profit. Enormous price fluctuations are the result.
Above all, however, the business with government bonds should be more closely controlled. After all, this is not just about individual companies. Investors can drive entire states into crisis by selling off their bonds on a massive scale, e.g. if they disagree with their policies. The security of such investments therefore fluctuates extremely, which further destabilizes countries like Greece.
By regulating the financial world more strictly, we can save a lot of money and use it for climate protection
There is another error in the system of the current financial world. Some banks speculate with enormous risks. If their calculations work out, some people become very rich. If, however, the bank gambles itself away and gets into a roll itself as a result, it is happy to be saved – by the taxpayer. Not only is this unfair, it also contradicts the logic of the market.
It is obvious that banks should take more responsibility for their own rescue in the future. That would be easy to achieve. Financial institutions would simply have to be obliged to increase their equity ratio. If a bank had to deposit a certain amount of equity capital in proportion to its financial transactions as collateral, the number of transactions without real countervalue would quickly decrease.
Before the 2007/08 crisis, many banks had only around 2% equity, which was far too little to save themselves in the event of a crisis. In Germany alone, taxpayers therefore had to raise around 200 billion euros to help the exuberant bankers who had miscalculated so catastrophically.
It is not difficult to consider where this money would be better invested. Take climate change, one of the most pressing problems of our time. Saving the climate costs an enormous amount of money and often enough these costs prevent effective action. However, if banks had to be saved less frequently with taxpayers’ money, money would be available to put it into the really important things, such as the production of wind and solar energy.
A nice idea: The famous glass towers of the financial stronghold Frankfurt am Main would one day no longer accommodate bankers with disproportionate salaries, but solar energy and electric car companies that bring a real improvement to the world – instead of just promising it.
Summary
Through wild speculation and excessive trade in credit, banks have created global crises and ruined states. This must stop. The radical exit from financial madness must be dared and the banks returned to their roots.
Other interesting articles about wealth can be found HERE
If you want to learn more about the banking system, have a look at The Evolution of Banking Over Time
The information in this article is based on the content of the book “Wie viel Bank braucht ein Mensch” by Thomas Fricke. Thomas Fricke is a well-known German business journalist. From 2002 to 2012 he was Chief Economist of the Financial Times Deutschland. Since 2007 Fricke has headed the Internet portal Wirtschaftswunder and since 2009 he has also been Chief Economist at the business media of Gruner+Jahr.