Tuppence In The Bank

Now for a charming and nostalgic look back at how banking used to be. It was a simple business then; banks would take in customer deposits and make loans with the depositor’s money. The difference between what the banks charged for the loans and the interest they paid on the deposits, this “spread”, was the profit. Back then the banks were primarily interested in “self liquidating” loans on productive endeavors. Business loans, that produce profits, that enable the loans to be re-paid.

Today things are different and banks don’t need deposits or savings to fund their lending activity. Instead they borrow endless amounts of money, at little or no cost, from central banks and lend it back out at interest. Productive and self liquidating loans are also largely a thing of the past. Today most loans are made to governments to fund deficit spending, or to consumers for consumption, or for leveraged speculation. Since these loans are not self liquidating they generally don’t get paid off but are instead rolled over or refinanced.

T-Bill yield curveGovernment deficit financing: Borrow money from the Federal Reserve at 0% to .25% and use the money to buy United States Treasuries paying up to 3%, depending on duration. A nice risk free spread; No main street depositors or loan applications required.

One thing that hasn’t changed is the concept of “to big to fail”,  the idea that the banks are too systemically important to be permitted to suffer for want of tuppence.  “While stand the banks of England, England stands! When fall the banks of England, England falls!” cries the old banker in the video. I wonder if that’s what Hank Paulson told congress, behind closed doors, when he snatched the $700 billion for TARP. Now that was a lot of tuppence!

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