Why Even the Best Banks are Insolvent and Inherently Dishonest
We are told that Barclays is a good bank and it did well not to take the taxpayers shilling. We are told that it has recovered and is prospering and this indeed is a sign of the economic recovery.
Part of the mission of the Honest Money Movement is to explore and expose these fallacies.
Banks only exist with entrenched legal and accountancy privilege. Privilege for all sectors of the political spectrum is a bad thing. Trade Union privilege to operate a closed shop cuts back on employment and price gouges the customers who buy the goods that the closed shop workers produce. A group of countries who restrict the price of say oil will push up the price of oil and gouge their customers and so on and so forth. All privilege is bad.
Contrast Normal Commercial Activity…
Any business in this country from the plumber to BP will have current creditors, those people it owes money to such as suppliers and current debtors, those people who owe it money for the goods and services sold. It is a legal offense to not pay your assets and your liabilities as and when they fall due. Indeed as a company director you become personally liable should you trade in this position whilst you are insolvent.
…With That of a Bank
A bank has current creditors: on the whole, these are people like you and me who have our salaries or savings paid or deposited into our accounts on our behalf. We do not actually “own our money” that is deposited in the bank. The bank does.
This may come as a surprise to you. However this is a very well established point of law. Since 1811 in Carr v Carr, this has been the case. So you and I are the current creditors to the bank i.e. we are owed money by the bank. In fact your bank statement is just an IOU from the bank acknowledging that it owes you however much it says on the statement on demand.
The assets of the bank are those people to whom the bank has lent its (formerly your) money to i.e. all the borrowers of loans. As has been so clearly displayed during this crisis, they have lent their money out (formerly yours) over 33 times on average to borrowers. I explain the money credit creation multiplier here for a refresher on understanding this process. So when more than 1 of 33 of us wish to withdraw our money that is on demand, the bank can not pay it back as it does not have it.
I enclose a link to the balance sheet of the UK’s largest company, BP here here. Page 106 has the balance sheet.
| Non-current assets | £161,854M |
| Current assets | £66,384M |
| Total Assets | £228,238M |
| Current liabilities | £69,793M |
| Non Current liabilities | £136,129M |
| Net Assets | £92,109M |
This would suggest that BP has current liabilities marginally greater than their current assets. No doubt the timing of the payment to suppliers is carefully balanced off otherwise their auditors could not sign off the accounts if they thought the company could not pay off its assets as and when they fall due.
Contrast this with the Barclays Bank full year 2009 results shown on this spreadsheet.
See tab 4 where we have the consolidated balance sheet. There are just assets and liabilities and there is not a distinction in their accounts between current liabilities i.e. your and my money that has been deposited that is on demand now and a long term liability such as a mortgage to pay off a loan on some property they may occupy etc over a long period of time. There is £322 billion of money on deposit in current creditors that could be withdrawn “on demand” as that is what the bank tells you that you can do with it. Indeed you only deposit it that way because you need to make sure payments happen on demand. They have no requirement to provide you with the ability to make this happen despite the fact that you may have deposited money there!
So unlike BP and any commercial business from the lowest one man band plumber to the mighty BP, who have to account for keeping payments set aside to cover their current liabilities, a bank is not required to. Indeed, it is specifically allowed not to by accounting law and legal privilege under law. If the deposit base of Barclays wanted what it thought was “its” money back i.e. it wanted the £322 billion redeemed into cash or taken out of the bank and moved to another, then as there is no corresponding current asset to pay for this and only assets that have long term payment implications, it would have to suspend redemptions as North Rock did and hope people would wait until it could try to sell some of its long term assets or collect in its loans. In reality, this would be a run on a bank. Barclays by its very nature is inherently insolvent and can only exist by this accounting / legal privilege that does not apply to any other non bank business in the UK!
One of the first things you will ever learn in a law of contract course is that an agreement is reached between parties and a contract established when an offer is accepted with a mirror image of understanding , from the Latin “pacta sunt servanda” or agreements must be kept. So it would strike me that as the vast majority of people think that they deposit their money and it remains their money in a bank and that the law and accounting standards say otherwise, there is a very good argument that there is not a contract in place between any depositor and bank. Certainly as most depositors also want easy access.
I commissioned a survey for the Cobden Centre in Oct 2009 with ICM over 2,000 people. 74% of people think that they are the legal owner of the money in their current account rather than the bank. Paradoxically 61% know that their money is lent out even though 67% want convenient (now) on demand access. The full results of this survey will be published shortly in another paper.
Now we can understand how the banks have the biggest salaries, the biggest bonuses , the biggest offices, the most plush terms and conditions of employment and so on and so forth. If you do not have to provide for your creditors then you can use their money to do what you like with and this is what happens!
Just to give you an idea what this would mean for me in my company Seafood Holdings Ltd if I was allowed to do what the banks are allowed to do. As of December 2009, I had trade current creditors of £8.276m against trade debtors of £12.275m. If I was a bank, I could pick up the full £8.276m and pay a dividend or bonus and still be lawful. I could build a megalomaniac size corporate head office and stick a gold plated statue with me dressed in a Roman Caesar like uniform to please my demented ego! I could behave like the worst most vulgar of City bankers.
We must always remember their key service other than the safe keeping of our money is to act as an intermediary between saver and borrower. This is “Captain Mannering” style boring banking. Like and estate agent who mediates between buyer and seller of houses, he has a High Street presence like most providing a consumer service. Places like the City of London / Canary Wharf and Wall Street etc can only exist as they do today on this legal privilege and on the welfare state of credit whereby we allow them to exist at the tax payers’ expense.
This article claims that BP is insolvent because of the relationship between its current assets are marginally less than its current liabilities. It then claims that this might not be a problem for BP because it can juggle its accounts and pay its bills.
Perhaps, but BP can borrow to pay off current liabilities replacing one set of current liabilities with a new set coming due in the future. As long as BP’s total assets are greater than its total liabilities (current or not) then the creditors may be willing to lend. The longer term assets will gradually become current.
There is, of course, a risk that no one will lend to BP. And so, it will not be able to pay off its current liabilities. It will default and become bankrupt. And all of its liabilities will be paid off only partially. One of the reason why those lending to BP earn interest is to compensate them for the risk this might happen. Another reason, of course, is the risk that no one will buy BP products.
To me it seems like British accounting rules involve massive government intervention in business. While a firm may choose to organize on the basis of personal liability for directors if one set of assets was less than one set of liabilities, and then there is a default (though it would seem to me this would always happen when there is a default,) other firms may wish to operation on another basis.
As for banks, deposits are loans from the depositor to the bank. The represent liabilities of the bank. It is true that the assets of the bank (such as loans, securities, and reserves) are assets of the bank.
Banks are solvent if the assets are greater than the liabilities. The notion that a bank, or any other firm, is insolvent because something might happen is absurd. There are many things that might happen to a firm making it unable to pay off its liabilities. For BP, no one being willing to buy its gas, no one being willing to buy is existing assets (current or not) would do the trick. For a bank, if none of its creditors could pay off its existing loans, it would fail. It could happen.
The scenario where many depositors want payment now and the bank cannot borrow new money now, and it cannot sell off enough of its assets (current or not) at high enough prices now, so that the bank defaults, is possible. A bank could operation to make this scenario impossible. (Charging people to store cash and for payments services,) but failing to do so doesn’t make the bank insolvent.
The article actually says….
“This would suggest that BP has current liabilities marginally greater than their current assets. No doubt the timing of the payment to suppliers is carefully balanced off otherwise their auditors could not sign off the accounts if they thought the company could not pay off its assets as and when they fall due.”
So Bill, it does not say what you imply.
I presume the word creditors should be swapped with debtors when you say “For a bank, if none of its creditors could pay off its existing loans, it would fail.”
On average , if more than 1 person in 33 in the UK banking system walks into a bank to get “their” money, the whole system collapses.
If BP stops selling petrol etc as their is no demand, its current creditors are virtually fully paid out, in fact 95% paid out in days according to their balance sheet. Happy days – assuming their are no secured creditors ranking before them. The sale of some fixed assets would mean all current creditors are made whole again.
If Barclays bank customers go in and demand “their” money, then on average , if they are the average in the UK banking system, they will get a 3% recovery. Like the Northern Rock creditors, absent a government gaurantee and they will have to wait years!
So, I rest my case. Normal commercial law on the whole protects creditors. The special status of banks and the legal protections they have , gives them a unique position that no other commercial instittion has in society. This is antithetical to Liberty.
Your view about BP is absurd. If BP’s sales fell to zero, it would fail. Nearly all of its assets would have next to no value. The balance sheet is conditional on that not happening. (Happy Day. You must be kidding.)
You are wrong about banks as well. Why do you think that the payoff value would be equal to its current reserves?
You misuse the word solvency.
Generally, the sorts of errors you are making happen when people determine that excess money creation is bad because it is inflationary. They learn that banks create money, and then get all focused on the relationship between bank reserves and the money created by banks. Then they ball up the various sorts of bank liabilities and treat them all as if they are money.
For U.S. banks (I don’t know about Barclays) transactions deposits are only a small fraction of the total liabilities. Savings accounts, which are generally payable on demand are the biggest part. And CD’s are intermediate.
If a bank defaults, then depositors of all sorts don’t get paid in full. How much they get paid depends on the value of assets less liabilities. That is why bank capital, rather than reserves, determines the possibility of loss to depositors.
The people who get to the bank first, at least, before it closes its doors, get paid in full. Then, after it is closed, no one gets anything until the bank is liquidated. The assets are sold off. Whatever reserves rain in the bank, plus the liquidation value of all the other assets–loans and the like, determine what all the depositors get.
The whole “the system will collapse if 3% of depositors remove their money,” ignores that possibility that the banks might convince the other 97% of the population to put more money into banks.
And, of course, it assumes the quantity of the monetary base is constant. Why should it be?
If the quantity of base money is constant, and their is an increase in the demand for it, then its price must rise. But it serves as unit of account, this requires other prices, including wages, to fall. And so, increases in the demand for the monetary base are very disruptive to the economy. Many businesses will fail if the disruption is large enough. Including banks.
Bill, thank you for your comments. You posed a hypothetical situation that I thought at the time was ill thought out and extreme. I played along with it. You said…
“There are many things that might happen to a firm making it unable to pay off its liabilities. For BP, no one being willing to buy its gas, no one being willing to buy is existing assets (current or not) would do the trick.” i.e. make it go bust.
So you then say
“Your view about BP is absurd. If BP’s sales fell to zero, it would fail. Nearly all of its assets would have next to no value. The balance sheet is conditional on that not happening.”
In the real world, if BP went down, the current creditors, in the absence of any secured creditors would get the collection in of the debtors book (cash owed) which makes up the vast majority of the BP current debtors. This is a cash payout.
The interesting thought that you have given me is that the law should be changed to allow current debt to be secured on current assets and not let long term lenders secure on short term assets, which they do. Thank you for that inspiration Bill.
I think you have made a mistake here as well..
“transactions deposits are only a small fraction of the total liabilities.”
A deposit is not a liability, but an asset. Our Chancellor Alistair Darling makes this mistake as well.
You say…
“the system will collapse if 3% of depositors remove their money,” ignores that possibility that the banks might convince the other 97% of the population to put more money into banks.
“That is why bank capital, rather than reserves, determines the possibility of loss to depositors.”
I think not. The banks found it very hard to raise capital and some even failed last year to raise anything. My bank, RBS moved from 2% capital to 8% I believe. That capital would be lost, period, in an administration, shareholder funds in this situation are zero as the Administrator owns the Bank not the shareholders! Capital of the bank would never pay current creditors!