What Happened to Wall Street?
In 2007, it was already clear that multiple bubbles (consumer credit, the housing market, the trade in derivatives, and so on) were going to burst sooner rather than later. In 2009, banks and entire countries started to collapse. Today, we are still picking up the pieces and the bill. Most of us were — and still are — surprised and shocked. The common view was that banks were invulnerable. After all, they were among the wealthiest institutions on the planet. They were literally “where the money was.” How can a bank’s share price go down? Later, as bank after bank failed and had to be rescued by the taxpayer, the general public was shocked. The only possible cause must have been corruption and fraud.
For sure, corruption and fraud were present. As Naomi Klein lucidly explained in her 2007 book “The Shock Doctrine”, any crisis is an opportunity for the mega-bandits to move in and empty the coffers. It’s certain that some groups knew that banks would collapse and bet heavily on that. The crisis was long in the making. It was fully predictable; indeed, it was inevitable.
Here’s why. Let’s rewind 30 years and see how the banks work. We’re in 1980, and banks are the shining cornerstones of modern society. They are large, boring houses for financial machines. The banks arbitrate between those who have money and those who need it, a vital service for which people gladly pay. Critically, this service takes vast amounts of computing power. Simply adding and subtracting and multiplying and dividing all those figures takes industrial-strength brute force. Banks have huge data centers: rows of blinking mainframes and humming disk drives, all adding up to tons of heavy metal in massive air-conditioned halls.
Meanwhile — silent and unstoppable — the spread of knowledge drives down the cost of computers. First, smaller and cheaper minicomputers spread into departments. Then the personal computer explodes into the home, university, and business. Large firms like IBM try to keep their prices stable, meaning they give their customers more and more computing power for the same price.
The true cost of building a bank-sized data center drops by 50% every two years. The result is that older banks start to face competition from small aggressive competitors, especially as the Internet begins to make the local branches obsolete. The big banks grow by buying smaller local banks, an easy task due to the fact that they possess lots of excess capacity. Then, they cut costs by shutting branches and merge with insurance companies to expand their services.
All the while, competition is driving down profit margins. If your bank asked 5% per year for a mortgage and another bank 1,000 km away offered 4%, you would not hesitate to go with the lower rate. Similarly, if your bank offered 3% interest on savings, and a foreign competitor offered 6%, where would you put your money? For years, in Europe, you could literally earn 2–3% more on deposits than you had to pay on a mortgage. This should have been a clear sign of trouble, yet people just assumed there was some magic at play.
Fast-forward a few more years, and banks’ main traditional markets are close to worthless. The European single market means they face ever more competition. They’re in a trap, borrowing money from the stock markets in order to expand internationally so that they can compete. It’s a one-way trip. If you don’t make your quarterly profits, your stock price falls and your cost of borrowing rises. The only banks that escape are those who stick to luxury products for the richest clients and avoid the stock markets.
The large banks must find ways to continue to make their 6% profit annually. And higher profits come only from higher risks; there is no other route. So governments oblige by removing regulations, and banks get new high-risk space to move into. They push mortgages onto people who cannot afford them. They push credit cards so aggressively that even a dog can get one. And as they accumulate more and more risk, they hide it from view by repackaging it all into derivatives, which they sell to foreign banks. Eventually, the trade in derivatives becomes the new territory and banks turn into bookmakers, betting against themselves and taking a commission on each deal.
Meanwhile, cost gravity never stops. By 2013, the cost of running a 1980’s bank had fallen by 128,000 times. If it cost $10 per month to handle one customer in 1980, by 2013 it cost just over $75 per month for 1M customers. And by 2052, it will cost only $1.00 per month to handle the banking needs of every person on Earth.
The collapse happened because those ever-riskier bets didn’t pay off. It was predictable, and some people did predict it, yet there was a huge incentive for those involved to not think it through. You might feel as though it was criminally stupid to make those bets. Certainly, it was immoral to have the public purse pay the debt while still giving bonuses to all involved. In the end, every empire bets on borrowed time. It’s always the same, whether the time scale is “next quarter” or “next century.” Bank or beggar, life is always “so far, so good.”
When we understand that cost gravity caused the banking crash, we can try to predict the future of banking. Banking is an essential service. However, it cannot be profitable except by rolling back time and banning cheap information technology, or by creating artificial barriers to competition.
There seem to be two plausible outcomes. One is to nationalize the large banks and turn banking and insurance into a not-for-profit service of the state. Europe seems to be going this way. As part of their rescue packages, many countries took control of failing banks like ING, BNPParibasFortis, Dexia, and ABNAmro, and cleaned out the existing management. Whistle blowers have helped the new technocrat owners launch prosecutions for manipulation of share prices and other forms of fraud. Ironically, 20 years ago and before the trend of privatization, many of these banks were publicly owned state banks.
In the US, the trend is quite different. Instead of intervening in the running of the banks, the US government intervened in the markets. They helped the largest banks like JPMorgan Chase & Co. buy up their competitors at fire sale prices, keep their existing management with no investigations or prosecutions, and gain monopoly control over the market to extract profits as before. The US approach seems similar to how mobile phone operators have an effective cartel, with government support, to extort profits from phone and Internet users.