Fixation with banking negates clear thinking

13 September 2011 | By Daniel Ben Ami

An elementary failure of logic means that the debate has failed to grasp the key challenges facing the British economy.
 
It has become widely accepted that the recession of 2008-09 was largely driven by problems in the financial sector. Therefore, so the argument goes, banking reform should substantially reduce the likelihood or impact of such crises arising in the future. This assumption is so pervasive that is it often thought there is no need to state it explicitly.

Such an approach fails to recognise the possibility that there could be a difference between the proximate cause of the recession and its underlying dynamic. Although the crisis  emerged in the financial sector, particularly banking, it was driven by more fundamental forces.

“The bubble that inflated in the run-up to 2008 did not emerge simply as the result of greedy, or at least careless, banks”

The bubble that inflated in the run-up to 2008 did not emerge simply as the result of greedy, or at least careless, banks. That is just a one-sided morality tale. The authorities on both sides of the Atlantic played a key role in creating it.

Action by the state helped to inflate the bubble in several ways. Low interest rates, high public spending and the liberalisation of lending rules all played a role. Bankers were certainly complicit in this arrangement, they were no innocent party, but the authorities played a central part too.

Politicians were not simply being foolish. They wanted to keep the economy ticking over but lacked the courage or insight to tackle its fundamental weaknesses. Their preferred solution was to muddle through by encouraging the extension of credit. (continues below)

It would have been far better if the authorities had been willing to tackle underlying economic weaknesses such as low levels of investment, research and innovation. Instead their alternative was to encourage credit expansion and bolster the financial sector.

When the bubble burst in 2008 both government and opposition moved quickly to heap the blame on “greedy bankers”. As a result a one-sided account of the crisis, with bankers as the evil party and politicians as innocent bystanders, has taken hold.

The outcome was incredibly successful for politicians in the short term, since it absolved them of responsibility, but bad for the rest of us. A new regulatory edifice is likely to be created which is at best irrelevant to the needs of the economy.

Indeed it arguably makes matters worse. In effect it validates the view that bad bankers were to blame for the crisis and leaves the economy’s key weaknesses unchallenged.

If the financial crisis was an expression of a deeper economic crisis it follows that regulation cannot solve the underlying problem. The new regulatory system will simply mean that the crisis expresses itself in a different way next time.

It is particularly ironic that the blinkered discussion of Vickers coincides with a eurozone debt crisis that threatens the integrity of the European banking system.
 
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^{Daniel Ben-Ami is a writer on economics and finance. His personal website can be found at www.danielbenami.com.}

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