Fumbling for the Truth: Why Did We Ever Trust Banks?

Here’s a subject I don’t know anything about, but I’m going to attempt to fumble my way toward some truths. It’s going to be more rambling and stream-of-consciousness-y than anything else I post here, but might actually get at what I’m seeking. So!

Here’s how investing works, ideally: you have an idea, I have capital, and that’s how I profit from your invention. Of course, I don’t understand the risks behind your proposed product, and you don’t have the time to hunt down the hundreds of people like me that you’d need to fully finance your design, so that’s where a bank comes in: they have “professionals” who can assess the likelihood of getting a return on that investment, and they can hedge risky gambles with surer bets, thereby ensuring that everybody both gets the money they need (the lubrication of capitalism’s intricate machinery) and that the seed money continues to flow in from clients who are getting a regular percentage of their money back. It’s really just one step further from the more basic function of a bank, which profits from holding my money in a savings account (with a dismal annual percentage) while they lend it out at a much higher rate (on the one hand to protect themselves from defaulters, but on the other to maximize their profits), which they’re able to do on the premise that they’re a trustier institution than you, I, or a loan shark. Except, as Frank Partnoy and Jesse Eisinger discuss in The Atlantic‘s “What’s Inside America’s Banks” (January 2013), things aren’t nearly a straightforward or transparent as that; not content to merely profit off basic investors by bundling their small-scale accounts into large-scale (and more expensive) loans, they’ve branched into harder and harder to explain activities: 

One billion dollars from [Wells Fargo’s] “noninterest income” are “net gains from trading activities.” Another $1.5 billion is income from “equity investments.” Up and down the ledger, abstruse, all-embracing categories appear: “other fees earned from related activities,” “other interest income,” and just plain “other.” The income statement’s “other” catchalls collectively amounted to $6.6 billion of Wells Fargo’s income in 2011.

Now, instead of safely storing your money in a bank and accepting a tiny percentage of what the bank earns by using that idle cash, you invest it directly in the bank, which means that banks are no longer competing to deliver reliable profits (I can remember putting the savings from my first year of employment into a two-year CD at 6.6%) but are instead competing for the shareholders who trade in their company, “an inherently opaque and volatile business . . . subject to the vagaries of the market.” Now I have to trust that the bank is doing something profitable, and while I suppose it’s nice that I can ethically separate myself from the gimmicks and gaming of the system that they’re doing (“Clever bankers, aided by their lawyers and accountants, can find ways around the intentions of the regulations while remaining within the letter of the law”), I also don’t have a choice. I really don’t–and can’t–know what’s going on. The question isn’t “Why should we trust banks?” It’s “Why did we ever trust banks?”

As far as I can see, we only ever used banks because we were limited in options. They had the reach, scale, and scope to do what an individual like myself couldn’t; they had the connections to the people looking to borrow money, or who were pitching ideas, and if we wanted to get our skin in the game, we’d have to use banks as a profiteering middleman. If we trusted them, it was only because they were screwing both us, the loaners, and them, the borrowers. Even after the stock market grew, banks and other Bigger Than Us institutions remained the easiest form of entree; they were the best-paid doormen in the history of the world. So then, as the Internet made it easier for us to bypass their unnecessary services (or to purchase them from new, highly competitive, smaller-scaled and specific financial entities), banks adapted by taking larger risks and obfuscating their books so as to make it seem as if we still couldn’t do it without them, not if we wanted to make a profit. You pay for the Oracle of Omaha’s wisdom because he’s smarter (or at least richer) than you are; if you make it on your own, you probably get other people to pay you for your advice, however instinctual and tenuous it may be. It gets further and further from the safest way for a bank to make money: loan money that you’re not using (paying you a small percentage to ensure that you don’t use it). The only real difference I can see between a bank and a loan shark is that the bank comes after you through the government; I’ll leave it to you to determine which of those two is using a more ethical means of remuneration. In fact, Partnoy and Eisinger even note that one reason people may have once trusted banks, even after 1929’s crash, was because they were “understandable” (even if not “financially simple”):

The banks’ disclosures were more straightforward and clear. That clarity sprang from the fear of consequences. The law, as Oliver Wendell Holmes Jr. said, is a prediction of what a court will do. And the broadly scoped laws of that time gave courts wide latitude. Going to jail for financial fraud was a real risk back then, and bank executives worried that their reputations would be destroyed if a judge criticized what they had done.

Instead, we got the glorification of ruthless Glengarry and “Greed is good” in the ’80s, and now the language like this, which Partnoy and Eisnger state is among the most clear in Wells Fargo’s 236 page annual report (from 2011):

For the majority of our customer accommodation trading we serve as intermediary between buyer and seller. For example, we may enter into financial instruments with customers that use the instruments for risk management purposes and offset our exposure on such contracts by entering into separate instruments. Customer accommodation trading also includes net gains related to market-making activities in which we take positions to facilitate expected customer order flow.

(We should have a Razzies version of the Clios — perhaps the Bungles — that celebrate the worst and/or most confusing copy writing.)

I recently read an article that cluelessly wondered why people would use Kickstarter, why they’d pay (and sometimes overpay) — with no real guarantee of a return — for a product that didn’t yet exist. The conclusion seemed to be that Kickstarting was a form of charity, that the benefits you received would be of lesser-value, in accordance with, say, a tote-bag from a PBS fund-drive. What they seemed to gloss over was that Kickstarter also allowed a more direct form of grassroots investment (the majority of people investing at an affordable tier), in which rather than putting our money in some black-box bank product that we couldn’t understand and hoping for the best, we could watch personalized videos (and clear-as-day status updates) that allowed us to feel personally connected to the person asking for money, assess the likelihood of eventually getting our product, and actually invest in a physical product rather than an intangible stock. The next step, a Kickstarter that offers profit-sharing, is a death-knell for banks, if they can’t adapt. (And they seem to be Too Big To Adapt, at least if you listen to Justin Fox’s take on “The Web’s New Monopolists” — also in the January 2013 The Atlantic — which posits that inefficient things sometimes become common place, like the QWERTY keyboard, because even though Dvorak might be less strenuous and faster, it would be too difficult to learn). Consider Kiva. Or imagine a network like Facebook allowing you to invest in people. (A more frightening sci-fi take on this? The Unincorporated Man.) You’d be able to rank the trustworthiness of friends, to recommend people (as on LinkedIn), and more readily be able to discern the sorts of things you’d want to invest in. (Imagine, too, a program that automatically capped investment amounts based on the number of interested investors: you’d be less beholden/liable to 10,000 people than to one Angel Investor, no?) 

You could leave the big investments to the banks, assuming you couldn’t find a better way to manage them; in doing so, you’d also force them to be far more cautious and above-board. After all, they wouldn’t be dealing with the sort of riff-raff they’d be able to bury in court; they’d be clashing with organizations more able to defend themselves in the event of any impropriety. But for you and me, the little guys in this story who are fumbling for truth, wouldn’t it be nice to know where your money was going? Wouldn’t you even feel better losing the occasional investment or so, since you’d theoretically understand why they failed, as opposed to simply being told that the pension fund you didn’t have any say in has been drained? I know I’m probably overstating and wishfully thinking, but at least I know how much I don’t know; go ahead, then, bring on the truth.

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