Why Do Banks Go Bust?

It's all in the nature of capitalism, of course. It may be a bad time for the economy, but it's a potentially great time for the Marxist critique of capitalism: high time to dust itself down and spruce itself up for the extra attention it's getting. It's a bit like the way that sports shops sell more tennis racquets during Wimbledon, I guess.

Still, more needs to be said than "It's all in the nature of capitalism, of course." So here is an attempt at a little more detail on 'why banks go bust'.

The essential 'nature of capitalism' that we are talking about here is that capital does not sit still. If you get a twenty quid shopping voucher for your birthday, it might sit in your wallet for a couple of months before you get round to spending it. But capital? Oh no. A capitalist who gets twenty quid - or twenty thousand - will immediately find a way of selling it on for twenty-five. Then investing that twenty-five to turn it into thirty-five. Then placing a bet and making it fifty. If it doesn't do this, then it's just not capital.

The daily business of banks is to take your money and try to turn it into more money (giving only a small portion of the extra, if anything, back to you). As soon as you give them your money, they do something with it - they don't just put it in a securely-locked vault. So while a bank nominally holds a certain (very large) amount of money, it actually doesn't: most of it is out in the world trying to make itself bigger. The law obliges banks to physically hold a certain amount of their deposits just in case you want your own money back, but that amount is 'calculated' pretty much by guesswork, and is only around 7%.

During 'good times', that may not be a problem, because the chances that a significant number of us will walk into our branch and empty our accounts is minuscule - and even if we did, the bank would deal with it by borrowing from another bank. Lending between banks is such an everyday occurence that there is an established interest rate for it: the LIBOR (London Inter-Bank Offered Rate).

It all helps the banks pursue their goal of sending out as much of their (or your) money as possible out into the world to make itself bigger, while keeping as little as possible in their vaults.

But 'good times' don't last for ever, as the manic drive of capital to bring ever-greater returns can over-stretch itself.

The additional factor in the current crisis is the behaviour of mortgage lenders, particularly in the USA. They bundled together mortgages into groups containing loans to both reliable and unreliable repayers, called them 'securities' and sold them. The banker who buys it wants nothing other than to sell it on for more money. Then it gets sold on again and again. Of course there is a risk involved: perhaps no-one wants to buy it for more than a particular banker paid for it; perhaps some of the borrowers start to default because they can no longer afford to keep up their repayments. In that case, the banker will have lost the bet. So what do they do? Insure themselves against bad investments - and then you have another piece of paper, the insurance policy, that can be sold, then sold on, forever in pursuit of making more and more money.

The banks have also made the situation more unstable by various sneaky ways of under-cutting the 7% rule, for instance by setting up dodgy subsidiaries.

The securities, insurance policies, 'derivatives' - all pieces of paper to be traded in pursuit of money-making - become more and more complex, more and more numerous, and change hands more and more quickly. It becomes a bit like a hyper-charged balloon-blowing competition: everyone wants their balloon to get bigger and bigger, and then one bursts. Then the other blowers panic, and balloons start popping all round the room. Mortgage borrowers default; savers wtihdraw their deposits; banks stop lending to each other; banks go bust. Northern Rock, Bradford & Bingley, Belgium's larget bank Fortis, Lehman Brothers, IndyMac, Washington Mutual, ... Some predict that half of the USA's banks may go bust.

These bankers may have failed - although most have walked away with more hurt to their pride than to their personal wealth - but they did not act irrationally within the logic of the system itself. If you want to win the balloon-blowing contest, you keep blowing. It might pop, but then you just walk away.

It is the capitalist system itself that created this crisis: a system based not on organising production of goods and services to meet human need, but on capital relentlessly trying to make more.