Why do banks go bust?
When commercial banks make loans, they create new money. The loan contract is an asset and the money created is a bank liability. This is called credit creation. If borrowers stop repaying their loans to the banks, the banks liabilities cannot be honoured. If enough borrowers default on their loans the bank becomes insolvent. It is estimated that non performing loans above 10% would make most banks insolvent. Creating credit for the speculative housing market is what triggered the last financial crisis in 2007-2008.
Credit creation for asset purchasing and consumer spending is what creates unsustainable credit debt. Only money that already exists in the banking system should be loaned for these types of transactions. Credit creation is only sustainable if used for productive purposes that are aimed at employment and wage growth. ( Similar to the way trade credit works)
The illustration below shows how banks create credit.
The Bank Bailout
Firstly I recommend that all neoclassical economists be locked up and heavily sedated for the safety of us all. They have been discredited so many times that it is now beyond a joke that anybody takes them seriously. They are cranks and should be treated as such. Phrases such as ” Escape Velocity” and “budget surplus” just show how ignorant the neoclassicals really are.
The global financial crash was caused by neoclassical economics, the problem was compounded by choosing neoclassical solutions to fix the broken banks. We were told that unless governments bailed out the banks with taxpayers money the whole system would collapse. This was an absolute and outright LIE. We were told that Central Banks ( the banks of last resort) could not bailout the banks. Indeed the central banks have a self imposed mandate stopping them from buying up non performing loans. Reasons for this absurd SELF IMPOSED rule vary from ” It would cause Inflation” or ” It would devalue the currency”.
Think about this.
We know that banks create money when they lend. Therefore the non performing loans have already created money in the real economy. We know that the central banks can create money out of thin air. So if the central banks created new money and bought the non performing loans from the bankrupt banks, how much new money would go into the real economy? The answer is ZERO!!!! So if no new money enters the real economy there can be NO Inflation and NO currency devaluation.
The Con Trick
So why don’t the central banks just buy up all the non performing loans and reset the system? The bottom line, is that it is all one big con trick. If governments are forced to borrow money to bailout out the banks, more government bonds are created, the interest earned from government bonds is a nice little earner for the banks. Remember banks create the money that is being loaned to buy the government bonds. State bailout of banks increases the public debt of sovereign states, this gives the neoliberal establishment a reason to inflict Austerity on the population. High public debt also gives the” freemarket” neoliberals the excuse to privatise everything the state owns. You often hear the neoliberal mantra of the benefits of a “small state”. What they really mean is, “we want to profit from the privatisation of state assets and infrastructure”. If these neoliberal debt peddlers really wanted a small state and reduce public debt , surely the best place to start would be by reducing costs such as the Royal Family , the house of lords and the many other perks of the state elite.
The bank of Japan created a property bubble with low interest rates, then killed the bubble by raising interest rates. See graphs below.
The Federal reserve played the same trick years later.
So yes Austerity is a lie, bank bailouts are a con trick and creating crisis through housing bubbles and debt defaults is the way the neoliberals have tricked us all.
Author Paul Fear