10 years since the crash: Where did banking go wrong, and how do we fix it?

10 years on from the financial crash, how Britain was brought to the brink of collapse

A DECADE on from the crash of 2008, major questions are still unanswered about how successive governments and global financial elites led Britain to the brink of financial ruin. How did they get it so wrong? 

"The [financial crash] was a combination of irresponsible capitalism and irresponsible government that has brought us to instability and our present crisis," not the words of a radical Marxist, but those of David Cameron two years before he entered Downing Street as he analysed the causes behind the 2008 financial crash. 

Few have failed to be affected by the tsunami that was sent across the world as major banks admitted they could not cover their liabilities, exposing a truth which one economist said goes to the heart of the problem -  that the public and politicians simply did not (and still do not) understand how banking works. 

On 14 September 2008, the UK's Northern Rock bank had to be nationalised by then Labour chancellor Alistair Darling to prevent its collapse. 

Northern Rock’s nationalisation exposed widespread illusions about the banking system. Most falsely believed that banks simply borrowed to one customer against the deposits of another customer, with savers and the bank profiting from the interest paid on credit. But Northern Rock’s liabilities bore no relation to savings in customers current accounts with the bank.

"When banks lend money, they create money, and for a long time lots of people didn't realise that and they thought that banks took money from deposits and lent it out,” Frank van Lerven, an economist with the New Economics Foundation [NEF], explained to CommonSpace.

"Post-1980's, the new macroeconomic thinking was that banks took peoples savings and lent it out to borrowers. The thinking was that for every borrower there was a saver, almost like there was an army of pensioners who put their saving in the bank and the bank would lend that out. 

"They had no idea that banks created money in the process of lending. This gave banks enormous powers over the economy and without regulation it meant they could extend credit to a massive extent.”

Explaining the power that credit creation gave banks over the economy, van Lerven said that it was crucial to understand the dominant economic thinking which emerged in the 1980's which said that all finance was good, with no distinction made for where credit was allocated and how it was used. 

"You can aggregate where bank lending goes into essentially two categories; for either productive purposes or for the finance, insurance and real estate sector. 

"If you have massive levels of lending going into the latter, where most of the things are pre-existing assets, what happens is you end up increasing the price of those assets.  This means you end up with asset bubbles. 

"If you don't have enough money going into the real economy for productive purposes, which is what happened, you don't generate new flows of income which boosts household incomes and allows people to pay off their debt. 

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"Lending can be very cyclical in terms of its effects on asset prices. If you have no limits of lending, then a landlord can boost the price of a house because they know the bank will lend more money to finance the borrower. 

"That leads to a cyclical loop where you have higher levels of debt which leads to increasing house prices, which in turn leads to more debt and so on." 

Between 1997 and 2008, the money supply in the UK tripled, and according to van Lerven 85 per cent of that newly created money was used to finance mortgages, which increased house prices. Only around eight per cent of that lending went to productive sectors of the economy. 

"If banks decide not to lend into the productive sectors, then that has a really big impact on the economy. If they don't lend to businesses then we don't get the jobs that come from that," van Lerven said, highlighting that lending decisions have an impact on our investment in the green technology and infrastructure that will be needed to stop catastrophic climate change. 

Northern Rock was not the biggest casualty of the financial crisis, with Gordon Brown's government famously having to step in and bail out several of the UK's biggest banks, including the Royal Bank of Scotland [RBS], Lloyds TSB, and HBOS. 

Chronicling the near collapse of one of the world's largest banks, the Scottish journalist Ian Fraser has long investigated the practices at RBS and exposed a series of scandals at the bank. In his book Shredded: Inside RBS, The Bank That Broke Britain, Fraser provides a comprehensive timeline of the collapse of RBS and the wider financial crash. 

Fraser's book argues that under the banks then chief Fred Goodwin, RBS was a rogue institution which had acted recklessly in pursuit of growth. 

"The total cost of the banking crisis was about £2.4 trillion in terms of lost output, and the largest component of that was RBS. The title of the book may be slightly hyperbolic, but at the end of the day RBS didn't break Britain but it certainly came very close. 

"If RBS had been allowed to fail, had Gordon Brown's government not managed to rescue it, then it certainly would have broken us financially as a country and in other ways too I think,” he said. 

Alistair Darling, who was in charge of the UK Government's treasury when RBS faced collapsed, described the crisis in similarly catastrophic terms. Writing in his memoirs, he said: "If we didn't act immediately, the bank's doors would close, cash machines would be switched off, cheques would not be honoured, people would not be paid.

"My initial reaction must have been a bit like that of the captain of the Titanic when he was told by the ship's architect that it would sink in a couple of hours. There were not enough lifeboats for all the passengers."

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After RBS was bailed out, it's boss Fred Goodwin was forced to step down, and in the following years he faced public disgrace as stories from inside the bank were made public by journalists such as  Fraser. 

Fraser agreed with others that the revolving door between the top of politics and government and the banking sector was part of the problem, fuelled by politicians believing that bank bosses like Goodwin would behave themselves. 

"There is a view that the Treasury is essentially an enclave of the City in terms of a lot of the senior people being former investment bankers who are implementing a policy which is beneficial to the sector they just left. 

"You do have this revolving door between the investment banks, the big four accountancy firms, government, regulatory bodies and other quangos," Fraser said.

Fraser and van Lerven both agreed about the relationships banks have with society, and that little has changed in that respect.

"The evidence suggests that the banks haven't learnt the lessons of the crisis, and the evidence suggests that their social contract is still in tatters,” Fraser said.

"That's evident in the way in which RBS has arguably betrayed local communities by closing half of its branch network across the UK, ignoring the wishes of some customers who still want a relationship with their local branch. 

"It shows them to be more interested in boosting profitability than looking after the needs of their customers." 

Fraser pointed to some new, online-only banks such a Starling and Monzo, which are aimed at the younger generation, which he said show some early signs of behaving in a different way which is more focused on restoring good social relations. 

Despite RBS suffering a near-fatal blow to its reputation, there has been a series of fresh scandals over the past 10 years, leading many to question whether the bank can ever be trusted. 

This failure by the bank to learn can be attributed to the lack of punishment driving behavioural change for those at the top, according to Fraser, who argues those responsible were never held criminally accountable for their actions. 

But what about Cameron's condemnation of irresponsible capitalism – how did the Tory-Liberal coalition respond to the  worst excesses of capitalism as it cleaned up the fall out of the 2008 crash? 

Both Fraser and van Lerven agreed that some government initiatives have been helpful, such as the introduction of "stress tests" which help to ensure that banks have enough capital to cover their debt. 

However, assessing the reforms, van Lerven quoted the financial journalist Martin Wolf who said in 2017 that the situation has "gone from the insane to the merely ridiculous". 

"Banks are still at a ridiculous level of risk, banks still use debt to finance their assets at a ratio of 25 to one. In the run-up to the financial crisis, it was a ratio of 50 to one, so it has been halved but that is still unacceptable. 

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"If banks assets were to fall by just four or five per cent then we would have serious problems and some banks would become insolvent. As we saw in 2008 that can happen easily, house prices are starting to fall in the UK and we don't know what Brexit is going to do," he said. 

Fraser agreed, noting that the reforms to banking had been largely conservative and failed to make fundamental changes. This view is also shared by Mervyn King, governor of the Bank of England between 2003 and 2013, who regularly makes calls for "radical reforms" to banking and has said without an overhaul the UK could face another financial crash. 

But the attention of government and the media has generally been focused on government debt and deficit levels rather than those of the banking sector, something Van Lerven says was a political “masterstroke” by the Tories.

"Politicians at the time ingeniously somehow managed to make it seem like the 2008 financial crisis was about government debt. It had nothing to do with government debt, it was about private debt and what the banks were doing. 

"Perhaps the greatest masterstroke of the Cameron-Osborne era was to divert attention from the banks, which caused the crisis, to government debt and make it about 'living within our means' and make it seem like it was the government that caused this.

"Austerity was the biggest policy failure post-2008. How will you stimulate the economy if you are not doing it through government spending? The answer to that was to ask the Bank of England to do their quantitative easing programme to stimulate the economy and get banks lending again. Wasn't that what caused the 2008 crisis in the first place?"

As we enter the next decade, it is still unclear if banking will undergo the kind of fundamentals reforms which many economists and banking experts say must be undertaken to prevent a similar crash to 2008. 

Timidity around radical reform extends to advocates for Scottish independence, with the SNP's landmark growth commission report, authored by former RBS staffer and corporate lobbyist Andrew Wilson, arguing for an independent Scotland to maintain a similar policy approach to banking as the UK. Fraser described this approach as understandable but uninspiring. 

Even those in favour of more radical reform often disagree, with  NEF and figures such as Mervyn King supporting calls to break up the big banks and establish smaller, regional banks. Others, including Andrew Fisher, a key architect of Labour's 2017 manifesto, argue for a nationalised banking system which would be run for the public good and could be used to help fund public infrastructure projects and other government initiatives.

Read More: Ian Fraser: The Growth Commission's banking regulation proposals miss an opportunity to give finance a social purpose

Another idea gaining attention is so-called credit guidance, a system which would set targets for banks in relation to lending, such as asking them to borrow a certain percentage of the money they lend to small businesses.

However, perhaps most radical of all is the commentators who see the future of traditional banking services happening elsewhere, outwith banks completely. Billionaire former Microsoft CEO Bill Gates has said “banking is necessary, banks are not”.

Fraser highlighted the "payments revolution" underway in China which side-step banks: "China is streets ahead of the rest of the world in terms of mobile payments through services like AliPay and WeChat."

The Financial Times reported in July 2018 that the value of mobile payments in China in 2017 overtook worldwide totals for both Visa and Mastercard, which are operated by banks. With mobile payments becoming increasingly popular, it is likely banks could soon no longer be the dominant provider of payment systems. 

Demand for cashless payment systems has been on the rise across the world, and in the UK customers are less and less likely to shop with physical cash and instead opt for increasingly common contactless and mobile payment options. 

Their future remains unpredictable, but a failure to keep pace with technological advances and stand up to the scrutiny of a more socially responsible customer base could be an unexpected route to the fat-cats’ downfall. 

Picture: Stock image

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