Why Do We Keep Creating Banks?

I was thinking a bit about Taleb’s statement about the banking system: “Banks are not net profitable if you consider their entire history.” It’s a provocative statement, and probably true. Banks need bailouts over and over again.

But last night, I had a question. Let’s grant banks aren’t net profitable over their entire history, and even over relatively short periods of time (any 30 year period) without large bailouts.

If banks aren’t net profitable over their entire history, then why do people keep creating banks over and over again?

Are we really that gullible? Or is the value of being able to create credit so great we choose the bubbles created by credit over the lack of growth imposed by no credit?

It seems to me as though the intersection of Godley’s Theorem, Mosler’s Soft Currency economics, eternal optimism, and rent seeking collide to makes banks.

Steve Waldman had a series of posts about how it seems finance involves keeping the real level of risk hidden. And anyone who looks at banks can’t help but notice how many times they go back to the government for funds to remain solvent.

Public Banking points out the government is taking risk, so therefore should be compensated for that risk – and the government has done a good job at banking in some situations.

But if you think about how the Godley/Christ Theorem applies to the wider sectors, it’s pretty clear the world needs some expansion of credit that doesn’t really exist to force it to get out of bed and really get to work. Here is Godley’s statement once again, just to remind us:

It is thirty years since Carl Christ, of Johns Hopkins University, had the brilliant insight that should an economy ever reach stationary equilibrium, all stock variables as well as all flow variables would be constant; and that if all stock variables, including government debt, were constant, government receipts would have to equal government payments.

It would then follow that if the economy were moving toward stock-flow equilibrium and if taxes were levied as a proportion of income, the GDP of a (closed) economy would always be tracking, perhaps with a long lag, government outlays divided by the average tax rate – the very same concept that we call fiscal stance. Therefore, a necessary condition for the expansion of the economy, at least in the long term, is that the fiscal stance should rise: Government expenditure must rise relative to the average tax rate. If the tax rate were held constant, government expenditure would have to rise absolutely for output to grow; if government expenditure were held constant, the tax rate would have to fall.

As a thought experiement, move the world back to a gold standard where the government fiscal stance can’t rise, or to bad government scenario where people don’t trust the government enough to let the fiscal stance rise. You still have the same observation – somewhere, somehow, the fiscal stance of some sector must rise for the economy to grow.

So even though banks aren’t net profitable over time, they perform a massive service. Banks and bank credit allow for real living standards to grow while they expand credit. When the bubble collapses due to the lack of trust of the private credit, people are still better off than they were before the bubble.

This is something to keep in mind as we talk more about the sector balances, and horizontal money, and credit. The expansion of credit raises real living standards. It raises standards enough during the good times we end up ahead in the long run in real standards of living.

This is something I think the Austrians miss – credit does get the economy moving much, much faster. We should be asking what we can do to keep the economy moving this fast.

It’s also points out the Monetary Theory approach to banks is a bit stunted. Simply issuing more NFA won’t cause banks to go away, and it won’t necessarily make bank lending more stable.