Banking And Economics

The recent government bailout of banks in 2008 proved to be a disappointment on several

levels even though many banking institutions were saved from financial collapse. First and foremost, the overall economy in most countries continues to suffer. Second, small businesses in particular are having difficulty obtaining normal levels of commercial financing help from banks despite the fact that one of the primary purposes of a bank bailout was to restore normalcy to small business lending. Third, many banks have resumed investment activities that include the financial derivatives which precipitated the most recent banking crisis.

There seems to be a widespread assumption that healthy banks will lead to a productive economy. This supposed relationship between banking and economics is probably flawed but has nevertheless served as the basis for several government bailouts. Banks do have a powerful lobbying presence that has perpetuated many myths about their activities, so the bankers themselves are often the source of arguments about why they should be saved.

If normal capitalism was governing the process, banks would be allowed to fail and a competitive marketplace would determine what mechanism would replace them. In a capitalistic approach to banking, the Federal Reserve would not be providing billions of dollars in loans at low or no cost to banks. With these two changes alone, it is highly unlikely that a bank would take the amount of risks that they have during the past ten to twenty years. If the purpose of the last bank bailout was really to restore a healthy economy, several astute economists have accurately observed that a much more efficient route to accomplish that outcome (a healthier economy) would have been achieved by taking the same amount of capital devoted to the bank bailout and instead distributing it directly to individual consumers.

For example, if each family had been given funds that allowed them to buy a house and a car, the current state of the real estate and automobile industries would be quite different than what exists currently. That example might seem preposterous to some, but in fact the amount devoted to the bailout of banks was sufficiently high that it would have enabled such a creative economic solution. Taxpayers would certainly have gotten a lot more for their money in this scenario. But even in a more conservative example such as each family being given a lesser amount (perhaps $5,000 to $25,000), it is likely that this amount would have been spent in short order by those families in a way that was immediately productive for the economy. Solutions based on economics should always take effectiveness and efficiency into account, and banking appears to have reached a point in which banks are ineffective and inefficient.

by: Stephen Bush

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