Blog - John Aziz's Protest

Most social and economic protestors oppose banker bailouts because it is unfair. Bankers — by and large the most privileged class in society — got at the last count over $14 trillion of interest free money from central banks and governments to keep on doing the same thing — getting rich from speculation, on the backs of workers and the productive economy. The rest of society — teachers, nurses, factory workers, entrepreneurs, the unemployed, etc — have to "share the pain" of unemployment, austerity and a depressed economy.

This is particularly unfair, because it is the bankers and speculators who caused the crisis in the first place. But there is a much deeper economic reason to oppose bailouts than simple unfairness. Bailing out failed and failing financial institutions creates a zombie economy. Why?

In nature, ideas and schemes that work are rewarded — and ideas and schemes that don't work are punished. Our ancestors who correctly judged the climate, soil and rainfall and planted crops that flourished were rewarded with a bumper harvest. Those who planted the wrong crops did not get a bailout — they got a lean harvest, and were forced to either learn from their mistakes, or perish.

These bailouts have tried to turn nature on its head — bailed out bankers have not been forced by failure to learn from their mistakes, because governments and regulators protected them from failure.

So it should be no surprise that financial institutions have continued making exactly the same mistakes that created the crisis in 2008. That crisis was caused by excessive financial debt. Wall Street banks do not just play with their own equity — they borrow huge sums of money, too. This debt is known as leverage — and many Wall Street banks in 2008 had forty or fifty times as much leverage as they had equity. The problem with leverage is that while successful bets can very quickly lead to massive profits, bad bets can very quickly lead to insolvency — a bank that leverages itself 50:1 only has to incur a 2% loss on its portfolio to have lost every penny they started with. Lehman Brothers' were only leveraged 30:1.

Following 2008, many on Wall Street promised they had learned their lesson, and that the days of excessive leverage and risk-taking with borrowed money were over. But, in October 2011, another Wall Street bank was taken down by bad bets financed by excessive leverage: MF Global. Their leverage ratio? 40:1.

So why was the banking system bailed out in the first place? Defenders of the bailouts have correctly pointed out that not bailing out certain banks would have caused the entire system to collapse. This is because the global financial system is an interconnected web of debt. Institutions owe huge sums of money to one another. If a particularly interconnected bank disappears from the system, and cannot repay its creditors, the creditors themselves become threatened with insolvency. If a bank is leveraged 10:1 on assets of $10 billion, then its creditors may incur losses of up to $90 billion. Without state intervention, a single massive bankruptcy can quickly snowball into systemic destruction.

But, ultimately, the system is extremely fragile, and prone to collapse. Government life-support has given Wall Street failures the resources to continue their dangerous and risky business practices which caused the last crisis. Effectively, Wall Street and the international financial system has become a government-funded zombie — unable to sustain itself through its own means, and dependent on suckling the taxpayer's teat.

The darkest side to this zombification is that it takes resources from the productive, the young, the creative, and the needy and channels them to the zombies. Vast sums spent on rescue packages to keep the zombie system alive might have been available to increase the intellectual capabilities of the youth, or to support basic research and development, or to build better physical infrastructure, or to create new and innovative companies and products.

Zombification kills competition, too: when companies fail, it leaves a gap in the market that has to be filled, either by an expanding competitor, or by a new business. With failures now being kept on life-support, gaps in the market are fewer.

The system needs to change.

As Professor George Selgin of the University of Georgia put it:

• Our governments chose to keep bad banks going and that is why quantitative easing has proven a failure. Quantitative easing failed because almost all the new money the government created has gone to shore up the balance sheets of irresponsible bankers. Now those banks sit on piles of idle cash while other businesses starve or cannot get started for want of credit.

It's the same scenario that Japan has experienced for twenty years. They experienced a housing and stock market crash in 1990, bailed out their banking system, and growth never really recovered:

Ever since then, unemployment has been elevated:

That is the fate that Britain, Europe and America face by going down the Japanese zombification route: weak growth and high unemployment over a prolonged period of time. They face having the life sucked out of them by the zombie banks and corporations, and the burden of an every-growing public debt to finance more and more bailouts:

Instead of bailouts, we need to allow failed banks and corporations to fail and liquidate so that new businesses can take their place. Nature works best through experimentation. Saving zombie banks and zombie corporations kills experimentation, by rewarding failure, and preventing bad ideas from failing. If bad ideas and schemes cannot fail, it is impossible for good ideas and schemes to truly succeed.

The role of the government should be to provide a level playing field for experimentalism (and enough of a safety net for when experiments go wrong) — not pick winners. If experiments go badly, that is no bad thing: it just means that another idea, or system, or structure needs to be tested. People should be free to go bankrupt and start all over again with a different mindset and different idea.