Rebuild That Banking Wall

Article excerpt


A few years ago, an observer in a windowless boiler room in Zurich watched a horde of "gnomes of Zurich" - currency traders - responding to news clips racing across their computer screens, like air traffic controllers tracking blips on a screen and guiding planes in and out of an airport.

A news flash reported that the U.S. Congress had approved the president's budget. The traders reacted immediately. The observer asked the traders' supervisor, "What does it mean?"

"The dollar will go up."

The observer thought for a moment. "You know," he said, "the news is wrong. Whoever wrote that clip doesn't understand the American budget system. All that happened was approval of the annual budget resolution. Nothing really matters until the congressional committees get to work on the individual federal agency budgets."

The chief trader responded, "It doesn't matter. All that matters is that all the other currency traders in the world saw the same news. They will all react exactly the same way. Therefore, the dollar will go up."

Reality doesn't matter. To lemmings, all that matters is what other lemmings are doing.

Bankers all over the world bought U.S. mortgage-backed securities because other bankers bought mortgage-backed securities. It was impossible for anybody to untangle the bundles of mortgages to determine which were good loans and which were not. Therefore, many bad loans were made ("subprime" - like rancid meat - a lovely neologism!). Now we have a potentially disastrous "credit crunch," not because banks don't have the money to lend but because banks aren't making loans, well, because other banks aren't making loans. So, just as too many bad loans were made when the herd was stampeding in that direction, now not enough good loans are being made because the herd is stampeding the opposite way.

A strong argument can be made that we are in the mess we are in because we have ignored the painfully learned lessons of the past:

First: Banks are special. If things go sour for the buggy whip business, or the dodo processing industry, even for newspaper publishers, that is a terrible thing and it will have spill-over effects on their suppliers, their employees and the communities where they do business.

But when banks get into trouble, it ruins everything for everybody. What really put the United States on the verge of catastrophe in 1932-33 was the crisis caused by runs on banks. As banks closed in one town after another, panic spread like cholera, killing economic activity wherever it went. People had no money. Whole towns had no money. People couldn't get paid. They couldn't pay their bills. They couldn't buy anything - even a newspaper.

The runs on American banks followed runs on European banks, sparked by the failure in 1931 of the Creditanstalt-Bankverein in Vienna. And it was that particular fandango - the failure of banks, more than the collapse of stock markets - that brought both Franklin Roosevelt and Adolf Hitler to power in 1933. …