Debating Financial Reform

As we here in the States debate a means of relieving the financial crisis and preventing more of the same, members of Parliament are carrying on their own debate of the same nature.

If you want a good lesson on accountability and/or spin, tune in to the latest in the frequently passionate displays provided by a regular session of “Prime Minister’s Questions” on C-SPAN. In the spirit of such excellent interaction, today we bring you the transcript of a recent debate during Backbench Business in the House of Commons held on 29 November.

The sample below is from the statement made by Conservative Member of Parliament, Douglas Carswell, who invokes the name of Ayn Rand in a curious analogy. The embedded link presents the full debate transcript…

“We are in this mess not because of an absence of the free market but because we do not have a proper system of free-market banking. It was not the markets that caused the banking mess that we are in; the markets called time on other people’s unsustainable folly. They called time on an unsustainable credit boom and on the folly and stupidity of central bankers.

Banking is undoubtedly corporatist. To put it another way, if one were to read Ayn Rand’s Atlas Shrugged and to replace the words “railroad” and “rail company” with the words “credit” and “bank”, one would get a pretty good description of what has been going on in recent years. We have had a failure of the free market in the allocation of credit in this country. It is extraordinary that we compound that failure by talking ourselves into seriously suggesting that politicians and technocrats should ration credit. The absence of a pricing mechanism at the heart of the banking system is ultimately what caused the credit boom and the banking failure. In a normal market, when demand for a product increases, the price for that product goes up. That, in turn, stimulates supply.

In banking, unfortunately, things are a little different. When demand for credit increases, the price-the interest rate-is kept low or constant. Pricing does not therefore stimulate increased supply. On the contrary, a supply of additional credit is not met through higher savings. It is met by the creation of candyfloss credit-by banks being able to conjure up credit out of thin air. Banks do not meet the additional supply of credit by encouraging more people to save; on the contrary, they continue to lend IOUs on the basis of IOUs on the basis of IOUs. At the height of the credit crunch, for every pound deposited in a bank, IOUs had been written out some 44 times through the miracle of fractional reserve banking.

Banks have a legal privilege to conjure up credit out of nothing that ultimately stems from their ability-this is an extraordinary fact-to call a depositor’s deposit their own, to treat it legally as if it were their own, and to lend against it many times. It is that practice that has resulted in a credit pyramid and runaway credit booms, unrestrained by the pricing mechanism that would normally apply and would normally restrain demand and supply. The demand is unrestrained, the supply is unrestrained, and the price is low. The result is Ponzi credit bubbles. An incredibly distortive and disruptive effect is created every 20 or 30 years in supposedly free-market economies that have corporatist banking at their heart, and it leads to sugar-rush booms.

If a whisky distiller sold empty bottles or a food manufacturer sold empty food packets, they would be done for selling thin air, yet banks are essentially allowed to sell empty IOU promises-and people dare to call that the basis of the credit system that fuels capitalism. No wonder capitalism appears to be at risk. We have a crony system of corporate capitalism rather than free market banking.

Since the credit crunch, experts in orthodoxy have talked about three different solutions, the first of which is low interest rates. We have had pretty low interest rates, and do you know what? It has not really stimulated an increase in the supply of credit. That should not surprise us. Keeping prices low does not stimulate production. Secondly, people have printed more money: big government has shored up a big corporatist banking pyramid on the back of the real wealth creators. It is a system of indirect taxation, inflation and debauching the currency. Thirdly, people have talked about breaking up the banks.

I disagree with all those proposed solutions, but I take issue particularly with the idea of breaking up the banks. I think that instead of crude institutional separation of the banking system, we need an alternative that allows legal separation within existing banking structures. We need a new legal status for deposits, so that a depositor who opens an account can choose to ensure that his deposits are legally his property, and the bank cannot endlessly lend against them. That would not abolish fractional reserve banking, but it would allow us to decide over a long period, organically, whether we needed to move away from the banking system that we have at present, which allows endless candyfloss credit to be manufactured.

Banks do need reform, but I do not believe that they need more controls. We need to address fundamental flaws in the banking system, but in a way that ensures that the pricing mechanism allocates the supply of credit properly. We need less from central banks and fewer controls from central bankers, not more.”