More than Banking Needs to Change

ISIS Press Release 06/05/09

Banking for bankers and corporations

The events of the past year have led to many hard questions being asked about our financial system and ‘free market economy’. Commentators are finally starting to challenge the assumption on which so much has depended, that the market is always right - the invisible hand will guide the economy to make the most effective use of resources – and if there is ever a deviation from this optimal state, the market will correct itself. That is why the bankers and their allies insist governments must not interfere with the operation of the market. In practice, however, it means that all important decisions are taken by the people who run the banks and the big corporations.

This is a very convenient theory for bankers, whose telephone number salaries are one of the things we are not to interfere with. But the theory is simply wrong.

To be sure, the market is generally able to correct small disturbances from the optimum. If there are too few pizza restaurants to satisfy the demand, more will open; if there are too many then some will go out of business. As a result, we should end up with about the right number. For that sort of thing, the market generally works a lot better than having some bureaucrat in charge.

Unfortunately, how a complex nonlinear system reacts to small perturbations is not in general a good indicator of how it will react to large ones, and that is certainly the case with economies. Markets frequently go to extremes and show no signs of returning to normal on their own, in complete contradiction of what the theory predicts. As George Soros points out [1], in recent years alone governments have had to intervene in the international banking crisis in 1982, the bankruptcy of Continental Illinois in 1984, the emerging markets crisis of 1997, the failure of Long Term Capital Management in 1998, and more besides, including of course the current credit crunch. The same bankers who demand free rein when times are good are quick to run to the government for help when their excesses get them into trouble.

The first priority of governments is clearly to get the economy moving again and people back into work. Now that the myth of the market has been so obviously demolished, however, they should ignore what Soros calls the “market fundamentalists” and put in place measures designed to stop it going wrong in the first place. To a large extent, this would mean simply bringing back rules that were abolished in the 1980s and 1990s, when the neo-liberals dominated economics both in theory and in practice.

Light touch regulation failed to protect savings and pensions

It is now argued that there should be strict regulations governing what banks can do. They would not be obliged by law to comply, but those that did not could not expect to be bailed out by the taxpayer if they ran into trouble. We would also include a rule that because of the extra risk, pension funds and public bodies should not be permitted to invest in banks that have not signed up to the code. If we cannot prevent some people gambling, at least we can stop them doing it with our money.

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