The Great Banking Lie

The Great Banking Lie

Neither one of them could believe their eyes.

I sat in a comfortable armchair in the office of the newly appointed deputy minister of finance of a large African country. He sat across from me on a silk-upholstered divan. Next to him was a consultant seconded to the government by one of the country’s largest banks. He could barely contain his contempt.

I certainly didn’t look like the managing director of a financial company. My faded jeans had holes at the knees. I was wearing a T-shirt stained with the ochre-colored soil from the building site. My work boots were caked with the stuff.

“I think you’ll find that this is in everyone’s best interests, including your clients,” said the banker. “Members,” I corrected him. “We aren’t a bank.” Icy stare.

Maybe my distrust of the financial sector originated on that day long ago … but everything that’s happened since has reinforced it. And it’s had a profound impact on the way I approach my work at The Sovereign Society.

The banker in the deputy minister’s office was trying to convince me to accept an arrangement that would have forced my nonprofit housing company to hand over management of our loan portfolio to a commercial bank. He’d convinced his friends in the government that this would help protect the investment it was about to make in my company.

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I flatly refused. Amongst other things, I simply wasn’t prepared to see 10 to 15% of our hard-earned capital eaten up by bank fees and administrative overheads. That was the main reason we’d started our housing finance outfit in the first place — to ensure that the maximum possible went to build houses for the country’s urban poor … not into the pockets of middlemen.

Finance as Progress … and Parasite

The sort of arrangement the African banker sought is pretty common. Inserting themselves into private arrangements between others is a great way for financial institutions to reap fees. Try, for example, to do anything significant in this country without a bank account. You won’t get very far. Indeed, banks are built into the framework of our financial lives from start (college loans) to finish (401(k)s and IRAs).

That isn’t always how the financial sector has operated in the modern economy. Banks emerged to provide a place for people and businesses to save. They lent out those savings to those who needed them, profiting mainly from interest. This “intermediation” function was absolutely essential to the emergence of the modern industrial economy in every free market society.

But starting in the 1980s, the financial sectors of the major world economies began to pursue other lines of business. Starting then, the role of the capital markets and the banking sector in funding new investments began to decrease. Most of the money in the system is being used for lending and speculation against existing assets such as housing, stocks and bonds. The intermediation of savings for productive investment in business — the textbook description of the financial sector — constitutes only a minor share of banking today.

The change is profound. The U.S. financial sector represented around 4% of the U.S. economy in 1980. It’s now double that. Despite currently taking around 25% of all corporate profits, it creates a mere 4% of all jobs. Most of that growth and profit has taken the form of increasingly exotic financial engineering and skyrocketing fees.

As abundant research has shown, when the financial sector gets bigger than about 4.5% of the economy, it begins to act as a drag on growth, increasing income and wealth inequality exponentially. The big finance houses no longer profit by contributing an essential service to the economy. Instead, they operate elaborate debt systems that channel ever-increasing amounts from ordinary households and businesses to themselves. Their profits become our loss.

Instead of contributing to balanced growth through investment in productive capacity, the finance sector becomes a zero-sum game between financial wealth holders and the rest of society.

Ted, Are You a Leftist?

Occasionally, I get letters accusing me of being a closet leftist for my criticisms of America’s bloated financial and corporate sectors. Those criticisms reflect the combination of a logical fallacy, some serious propaganda … and misunderstanding of conservatism.

The logical fallacy is that if a business is huge and profitable, it must be efficient and a net contributor to economic welfare. If a senior executive earns millions annually, it must be because that is what that person contributes to their firm’s profitability. It’s rooted in the assumption that firms and individuals within them get rich by market competition as opposed to extracting economic rent.

And it’s backed up by the most sophisticated propaganda system the world has ever known, which constantly reinforces this idea. Most of the major business journals in the U.S. — quite unlike the U.K.’s venerable The Economist — do everything they can to create the impression that our state of economic affairs is natural and just.

What Are We Trying to Conserve?

As a system of thought and action, conservatism asserts that we should be skeptical toward change, since we shortsighted humans can never safely predict the outcome of our interventions.

The problem is that the structure of the U.S. economy is the result of dramatic interventions that changed the fundamental rules of the game for the financial and corporate sectors — interventions driven largely by lobbying from those within them.

Today’s financial sector is nothing at all like the one that financed waves of U.S. industrialization in the second half of the 19th century and from 1945 to 1970. Modern executives behave radically differently compared to their predecessors. Both have undergone a revolution.

True conservatism is about more than defending the status quo as it stands at any given moment. Instead, it’s about trying to understand the arrangements that have brought about prosperity in the past and working to restore them if necessary … even through dramatic interventions.

So when it comes to the U.S. financial sector, call me a Conservative.

Kind regards,
The Great Banking Lie
Ted Bauman
Editor, The Bauman Letter