Mutualisation isn\’t the answer

Having mutuals in the banking system might be a good idea for all sorts of reasons. But not perhaps for the reason that so many here claim.

Wh8ich is, of course, that mutuals wouldn\’t have gone so gung ho into excessive housing finance and thus wouldn\’t have pumped up the bubble that led to the crash.

This is hard to support for two reasons. One, that various mutuals in the UK did do exactly that and then go bust. The second is the situation in Spain:

Spaniards had been outraged at the €1m payoffs at bankrupt savings banks where executives had approved giant payments for themselves if they were laid off.

The fact that taxpayers would, in effect, be paying these to the executives who bankrupted Caja de Ahorros del Mediterráneo or Caja Castilla La Mancha – both of which needed rescuing – had added insult to injury for Spaniards suffering 23% unemployment and a double-dip recession.

That recession was caused, in part, by a housing bubble pumped up by loans from those same banks that now need taxpayer help.

All of those Cajas are mutuals. They\’re all run by the local great and the good (yes, including union peeps) and they\’re all supposed to take local interests to heart. Exactly what peeps over here claim would make sure that such mutuals don\’t do…..exactly what the Spanish mutuals did do.

Pump up the boom, go bust and hand out large rewards for failure.

It\’s a lovely example of the way in which the principal/agent problem and public choice theory are really the same thing. People are in matters economic eonomic animals. People do, without being restricted, help themselves to chunks of other peoples\’ money when they get the chance. Whether they\’re bureaucrats or politicians inside government, the great and the good running mutual banks or executives working for shareholders.

The incentives are the same so the behaviour is too. Politicians are motivated by the next election just as much as executives are by the next reporting season and bonuses…..

10 comments on “Mutualisation isn\’t the answer

  1. You’re missing the point. You are assuming that “mutual” or “employee owned” automatically means something warm and cuddly and with lots of political interference from politicians.

    This is not true.

    It is just that a plc is owned by its shareholder, who get dividends and big capital gains/losses and using the building society funding/ownership model, the business (it can be any business, not just a bank/BS) is owned by depositors, who get a profit share in the form of interest.

    The big difference is that with the BS funding/ownership model there are no big capital gains/losses to worry about, people can concentrate on actually making profits, that is the only metric that matters, and most of all, they’d focus on not making losses.

    By the way, you say “several” UK BS’s went bankrupt, can you provide a list or something? I know a couple of very small ones went down, but this was nothing compared to quoted banks.

  2. Deckchairs, Titanic, that kind of thing.

    Doesn’t matter what notional arrangements companies have (though mutuals e.g. Nationwide seem to be a bit less lighting-cigars-with-hundred-dollar-bills prone). It’s the money system that’s broken, and you can’t fix anything until you fix that. All the other financial sector problems-and many more general problems, such as land value inflation- stem directly and unavoidably from that broken money system.

    Without fundamental monetary reform- the adoption of a whole new paradigm- you aren’t going to be able to stabilise anything. The whole thing is predicated on instability. Disaster is inevitable.

  3. One thing about Building Societies is that they have strict rules about where they can borrow money from (under law). They can only borrow half their money from the money markets – the rest has to come from savers.

    The effect of this is that it stops expansion at the sort of rate that Northern Rock could achieve, which did so by almost entirely borrowing from money markets (and doing so in a very risky way that was based on short-term borrowing and longer-term lending)

  4. Mark Wadsworth: “The big difference is that with the BS funding/ownership model there are no big capital gains/losses to worry about, people can concentrate on actually making profits, that is the only metric that matters, and most of all, they’d focus on not making losses.”

    I can tell you that this is idealistic, and in the real life, not true.

    In my country, Finland, as well as in the neighbouring Sweden, there was a huge banking crisis in 1990’s. Rapid credit expansion, property bubble (there goes your “no big capital gains/losses to worry about”), recession, bailouts. And mutuals were not at all immune to it. To the contrary: in Finland, the biggest bail-outs were needed by the mutual savings banks; also many co-ops went bust. They had focused far *less* on not making losses than the commercial banks. In fact, they had taken insane risks, because there was lots of “new business” run by people who were not effectively accountable to the owners.

    So no, don’t trust on mutuals avoiding risk-taking and any related problems.

  5. Don’t forget the 1980’s Savings + Loan crisis in the USA – mutuals taking advantage of federal guarantees to make increasingly insane loans and investments to increase advertised returns to members.

  6. Re: Spain, I’m sure I remember as the thunder was clapping in the US and UK in 2008 loads of people were pointing out heartily that Spain had a law which prevented its banks from investing in the dodgy collateralised mortgages…

  7. Hopper:

    I came on here to say exactly what you already have.

    So, I’ll add one thing.

    The then president Bush had a choice of whether to bail out those S & L depositors with accounts exceeding the $100K guaranteed by the FSLIC on the taxpayers’ tab or to let them lose the excess. He chose to bail ’em out, of course. I believe that was the proximate cause, the “teachable moment” in piling on of the moral hazards which have given us the present situation.

  8. Hopper:

    One more thing has been a huge contributor to the
    present 9and continuing) malaise.

    Banks are not supposed to be money-lenders but loan brokers (of their depositors’ money). Their function is to make loans at a rate attractive to needs for working capital and needs of various types by borrowers prepared to substantially collateralize the loan. The role of bankers in the economy is enhanced through the establishment of fractional reserve banking in that the existence of the additional credit availability tends to lower the profitable rate at which loans may be made.

    Money-lenders of the institutional type have long been known as “investment banks” here in the U.S. (and I would suppose also in U.K.)
    Those (moneylenders) are in the business of assessing risks and evaluating business propositions of almost unlimited variety and “taking a position” of one type or another–spanning a huge gamut of risk/reward. Their loans (and other contributions) might well be fully or partially unsecured by anything other than some share of eventual proceeds.

    Formerly, “investment banks” were prevented
    by law from being involved in the ordinary business of banking; they were to have no access or influence connected with monetary
    practices or policies of the government nor were they be permitted even the possibility of incurring losses of amounts exceeding the depths of their own pockets.

    Somewhere, somehow, those laws were changed to permit what had heretofore been illegal–I just couldn’t tell you when that occurred.

  9. Gene Berman

    One of the many differences between UK banking and US banking is that we have never had legislated distinction between deposit-taking & lending and “investment” banking. So the laws weren’t changed. They never existed in the first place.

    In the US, of course, you have had a range of laws to limit what deposit-takers and lenders could and couldn’t do. Glass-Steagall is the most famous of those laws, probably, but certainly not the only one. But financial institutions have found ways of doing essentially the same functions as deposit-takers and lenders without the legal restrictions. For example, MMFs were created as a way of avoiding deposit interest rate caps. The result was of course the growth of the shadow banking sector – unregulated, and with no legal access to Federal funds, but in the end so crucial to the world financial system that it had to be bailed out.

    I’m really not convinced that your pile of legislation improved things. All banking is risky. Protecting one kind of banking while throwing the rest to the sharks discourages good risk management practice in the protected sector and encourages the rest to try to find ways of getting protection by the back door.

    I think we need a systemic approach to risk management. The more fragmented the banking system is, the harder it is to regulate and supervise it end-to-end and therefore the riskier it is. I don’t support the Vickers separation in the UK and I don’t support other legislation that would fragment the system more. The safest and most stable banking systems in the world are universal ones like that in Canada, not fragmented ones like that in the US. Why can’t people see that?

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