Credit where it’s due

You would be hard pressed to find anyone who thought economics and politics were not related, yet too often we don’t discuss them as such. Instead ‘the economy’ is referred to as a separate entity that we are all subjected to.

This is apparent in the way the Credit CrunchTM is debated. By constantly waiting for the ‘storm clouds to blow over’ or praying for a ‘V-shaped recovery’, we end up missing out how people go about shaping the recession as they survive, drown and profit from the situation.

It has emerged that over a million Britons are using credit card loans to pay for rent and mortgages. It is a vulgar development. Banks were bailed out with taxpayers money, and interest-rates were reduced to a whisker over zero by the Bank of England. This gave banks a favourable environment to lend cheaply in and, in theory, start a consumption-fuelled recovery. Instead they have used the money to swell their balance sheets and, as is shown here, have profited from the lower interest-rates by deliberately failing to pass on the decrease to their customers.

Now these same banks can use more lucrative credit card loans to squeeze poor people further and, when people are unable to repay their loans, use the harsher conditions of credit card lending to ramp-up charges and repayment rates. Alongside this, there are the significant penalty fees that banks command ($20.5 billion in the US, I can’t find UK data) through credit cards.

It is a political and economic (political economy, you could say) scandal that it can happen and shows, once again, how fruitful stronger unions in the financial sector would be for the majority of savers and borrowers.

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7 thoughts on “Credit where it’s due

  1. After day one of my ‘introduction to economics part 2’ course, and particularly having missed part 1, I’m in no position to comment on economics. But, while I essentially agree it’s awful, I wasn’t sure about one point. I thought we wanted (indeed, were forcing the nationalised) banks to increase the amount on their balance sheets, because it was the lack of money on their balance sheets that partly created the problem in the first place? Isn’t it good to have banks that are a bit more solvent? Obviously it’s very very bad to have people paying mortgages by credit card though. hm.

    I have committed to writing one post a week about my economics course, to ensure I actually learn something. Comments will be extremely welcome, just to warn you in advance.

  2. Agreed, a less stretched reserve ratio (the amount of money you have in your vaults compared to the amount you’ve lent out -typically 10-20%) would be welcome. But it’s not an end in itself. A healthier balance between assets and liabilities should only mean, as you say, that a bank is less likely to become insolvent.

    Yet it’s utterly pointless, from a progressive standpoint, to swell the assets of banks with taxpayers’ money if they use it as a risk-free way to exploit the public. I would rather a bank goes insolvent and the government protects savers directly, than the government rescues a bank who uses the donations to wring further cash out of the public.

    The crisis was more about ‘securitisation’ which basically means selling an IOU (a loan) on to a third party, thereby converting a liability into an asset, and taking a loan off the balance sheets. This maintains the reserve ratio, which emphasises the point that reforming banks – rather than swelling their balance sheets to allow them to continue where they left off – is what matters.

  3. Interesting post. It strikes me that the intention of the policy was always that banks could make risk free money off the tax payer and customer, provided that a little more of it was held.

    As for whether the government should protect savers or banks that is a good question. I think the reasons for opting for banks are two fold. Firstly, the logistical nightmare of how to reimburse customers after a bank goes down. As we saw with Icesave, people took months to get their money back and this uncertainty caused problems. Imagine if a major UK bank went down and 5 million people had all their assets frozen for a few months, what government would want to be responsible for that.

    Secondly, the banking system is seen as a good in its own right. The fact that it normally makes money and pays (some) taxes is beneficial. If it were to collapse entirely it would mean a significant loss of future revenue.

    Another interesting point is whether the banks are overstepping the mark in how profitable they are making themselves and acting like a cartel, possibly even at government instruction, to replenish their balance sheet at the expense of those indebted to their credit cards.

    It has long been a feature of the UK banking system that instead of charging for accounts retail banks make money from charges, usually on the less well off, to cover the administrative costs. From the original post it seems the recapitalisation may follow this approach too. Doesn’t seem very fair.

    Course sounds interesting be sure to share your wisdom

  4. A public bank that seeks to give its funders (ie savers) greater protection and invests in public infrastructure could have been a way of protecting savers rather than private bankers. I don’t know how difficult that is logistically. I doubt it would be impossible, given that it was common in the social-democratic days. If you can recapitalise private banks instantly with taxpayers’ money, it can’t be all that unreasonable. That would also allow monetary policy, like reducing the interest-rate, to actually be passed on to consumers rather than gifting private banks a bigger profit margin as currently happens.

    I don’t think reform of banking requires the concept of concept of banking to collapse. Banking could work for more progressive ends if it were reformed, but in its current state, I don’t think it’s good in its own right.

    It is an interesting point about free current accounts resulting in fee-based cost recovery. There was a decent article in the Telegraph about it, which I can’t seem to find. Banks recover their costs through interest payments though (among other things), the fleecing of poor people isn’t to “cover the administrative costs”, it’s too make tonnes of cash through exploitation. I don’t think it should be termed otherwise.

    The data isn’t yet available apparently, but research soon to be published shows that the risk-adjusted interest rates charged to individuals is more than to businesses, which shows a fairly straightforward method of exploitation.

  5. Doting Dutta,

    Your comment about a public bank investing in infrastructure reminds me of a chap called Dieter Helm who is a regulation economis. He sees teh national debt as divided into three segments:
    Public debt
    Individual debt
    Infrastructural debt (the delayed but necessary infrastructural improvements)

    He had the idea which you will find on the “Policy Exchange” website in a number of articles, that the government should get out of the recession notthrough borrowing to consume but by implementing policies that encouraged indivduals to save and then investing those savings into infrastructural improvement.

    This sounds like a similar idea to the public bank concept but may be a little easier for a post socialist world to swallow. Either way – the citizenry of the country would be investing in their own infrastructure. However, the income stream brought about through ownership of natural monopolies such as the electricity grid’s transmission infrastructure would be diverted back to the bank in the form of interest repayments tby the owner of the infrastructure to the national bank which lent it the money. The national bank would then be taxed accordingly and some of therefore, some of the public funds invested wuld be transfered back to the taxpayer.

    Dieter Helm views this as a means of overcoming the dry-up in capital markets that has made the cost of borrowing prohibitively expensive for the necessary improvements to the UK’s infrastructure.

    Errrrrrr.. kinda relevant i reckon. Doesn’t discount the idea of the public bank in the slightest. However, it seems play to the same tune as your idea.

  6. This sounds grand. I can’t find anything on the Policy Exchange website, but if I get you here, the government sets up a specific ‘infrastructure bank’ and then encourages the population to save in it? That would be fine I guess, but infrastructure requires a big upfront investment and would a new bank have the finances to do that? If not they would end up borrowing on the money and capital markets and end up wasting money which they would not have to if it came from a fully fledged public bank. Or how does it work?

    However, to counter what I’ve said (but pick up on a theme I talked about elsewhere), I think the left is guilty of misreading ‘public’ as ‘progressive’ (in much the same way the right does). The state is only as progressive as its citizens can demand it to be, which, as we’ve seen with the nationalised UK banks, is not very much. If, however, UK citizens withheld their savings until the policies changed (ie a union of savings) they would find themselves much more empowered.

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