Make Banking Honest?

Jeremy Warner has a column in the The Telegraph entitled “Banking can be made honest – but not fail-safe.”  You can probably guess the one option he does NOT recommend…but I am getting ahead of myself.

He uses the calamity around the Hewlett-Packard / Autonomy deal as the example of dishonest banking:

Last year, Hewlett-Packard, the world’s largest PC manufacturer, coughed up a humongous $11.1 billion to buy the British software company Autonomy. Even at the time, HP was widely thought to have overpaid horribly, but by quite how much only became apparent this week, when the firm wrote off more than three quarters of the purchase price. In the process, HP claimed that it had been deliberately sold a pup – the books had been wilfully cooked, it alleged, to make profits seem higher than they really were.

Right off the bat, he sends his readers down the path of one of the least contentious practices in banking – facilitation of mergers and acquisitions.  Behind such a transaction is a buyer and a seller, each able to utilize whatever resources and advisors deemed necessary to ascertain a fair value of the target opportunity.

On one extreme, perhaps HP just plain overpaid.  On the other extreme, the seller committed some form of fraud in representing the company (I make no such suggestion, only using the example pointed to by Warner to make the point).  In either case, the resolution of this event belongs to the parties at hand, and if necessary a third party judge or arbitrator.

Trillions in mortgage fraud, trillions in front-door and back-door bailouts (none of which are attributable to M&A activity, I suspect); yet Warner looks for dishonesty anywhere other than the obvious.

Does Warner use this example to throw his readers off of the scent of the real problem?  Perhaps.  Then, to add insult to injury, he goes looking in all the wrong places for solutions.  He summarizes the objectives of global government discussions regarding reform:

There are two basic aims behind the international reform effort. One is to ensure that banks can be made safe to fail and therefore don’t have to be bailed out by taxpayers. The second is to stop the perceived excesses of the credit cycle by preventing investment bankers from using ordinary, insured deposits for reckless, casino banking activities.

He then goes through a list of reasons why banking really should not be burdened further with regulation, and in any case, he rightly sees that further government regulation likely will not bring about a solution:

The bottom line is that it is virtually impossible to legislate for completely safe banking. Nor would you really want to. For all the undoubted traumas of the credit cycle, fractional reserve banking has delivered phenomenal economic progress over the past 200 years. To have decent levels of growth, it may be necessary to let finance do roughly what it wants.

Make banking more robust by all means, but in the end the sort of relationship banking we all want to see – honest, responsible and with the customers’ interests firmly back in the saddle – will come not from lawmakers, but from banks themselves. To judge by the scandal of Autonomy, there’s a long way to go.

So, the solution is to create better bankers – perfect the human species, if you will.  If only all men were honest.

There is one problem, and only one problem, with modern banking.  It is a monopoly / cartel system, allowed by government law and backed by central banks.  The banks could never achieve such high levels of leverage without this government created backstop.  They would never grow too-big-to-fail, as they could never see this leverage in a free-market.

Fractional reserves in some form would certainly continue, but the regulation brought on by the market would ensure that failure would occur well before any one bank became so large as to become a systematic risk.  Ludwig von Mises certainly saw it this way:

But even if the 100 per cent reserve plan were to be adopted on the basis of the unadulterated gold standard, it would not entirely remove the drawbacks inherent in every kind of government interference with banking. What is needed to prevent any further credit expansion is to place the banking business under the general rules of commercial and civil laws compelling every individual and firm to fulfill all obligations in full compliance with the terms of the contract.

But, some people may ask, what about a cartel of the commercial banks? Could not the banks collude for the sake of a boundless expansion of their issuance of fiduciary media? The objection is preposterous. As long as the public is not, by government interference, deprived of the right of withdrawing its deposits, no bank can risk its own good will by collusion with banks whose good will is not so high as its own.

Free banking is the only method available for the prevention of the dangers inherent in credit expansion. It would, it is true, not hinder a slow credit expansion, kept within very narrow limits, on the part of cautious banks which provide the public with all information required about their financial status. But under free banking it would have been impossible for credit expansion with all its inevitable consequences to have developed into a regular - one is tempted to say normal - feature of the economic system. Only free banking would have rendered the market economy secure against crises and depressions.

Don’t expect Warner or any other mainstream writer to come out forcefully in favor if the one single proposal that would achieve the “two basic aims” identified above:

• Ensure that banks can be made safe to fail and therefore don’t have to be bailed out by taxpayers.
• Stop the perceived excesses of the credit cycle by preventing investment bankers from using ordinary, insured deposits for reckless, casino banking activities.

End the monopoly.  End government support in all forms.  End the government enabled cartel of central banking.

End the Fed.