Banking for the Billions

Luke Pretz

OVER THE COURSE of March and April 2023 three banks failed, the result of a cocktail of interest rate increases and poor risk management strategies by bankers, spooking venture capitalists and start-ups who withdrew their money en masse.

The failure of Silicon Valley Bank, First Republic Bank, and Signature Bank and their subsequent inability to cover the debts they owed, including deposits, exceeded the scale of the first year of the 2008 Financial Crisis.

Compounding the crisis was the fact that the vast majority of deposits in the three banks that failed were uninsured. Having most or, in the case of Silicon Valley Bank, virtually all deposits in excess of the $250,000 Federal Deposit Insurance Corporation insurance limit meant that roughly half a trillion dollars in deposits were unprotected on the banks’ ledgers.

Fortunately for the depositors at those banks, many super-wealthy, the Federal Reserve and FDIC waived the deposit insurance limit and guaranteed everyone their money.

Motivated by the cloud of uncertainty surrounding the late-pandemic global economy, the Federal Reserve acted quickly to ensure that other banks had access to the funding needed to secure them against any potential wave of panic withdrawals and revelations of weak bank balance sheets.

The Federal Reserve also stepped in as a lender of last resort making loans available to banks via the discount window, 90-day loans, and the establishment of the Bank Term Funding Program, which are one-year loans collateralized by Treasury Bonds held by the banks.

The swift actions by the Fed, to ensure that banking institutions would have access to the credit they needed to ensure adequate funds to pay their debts to other lenders on time, appear to have stabilized the financial sector for the time being.

As does any economic crisis, near crisis, or glimpse at a crisis to come, this most recent set of bank failures give us a chance to peer into the hidden abode of the capitalist system and take stock of its inner workings. The crisis gives us a chance to pause and ask what are banks and what is their role in a capitalist society?

Importantly, the near financial crisis this spring, which demonstrated the risks of an economic system that relies on financial speculation, also gives us a chance to reflect on whether banks will be a feature of a democratic and socialist society.

This article takes up that challenge, looking under the hood of the capitalist system. In the first half, banking and finance in a capitalist society is critically described. Special attention will be paid to how capitalist banking limits economic democracy and the role that banking plays in stemming economic crises for the capitalist class.

The second half of the article explores the role of banking, or the lack thereof, in a socialist society; both market socialist and planned socialist systems will be considered. Again, special attention will be paid to the constraints that banking and financial markets place on democracy and worker self-direction.

What is a Bank?

At their core, commercial banks — the banks important for households — are institutions that make loans in the hope that those who borrow the money can pay it back in full plus interest and fees.

Investment banks on the other hand are banks that act as consultants and underwriters to firms wanting to create securities like stocks and bonds. Investment banks make money by charging consultant fees, and by selling the securities they create with those firms for more money than they paid for them.

Following passage of the Banking Act of 1933, commonly referred to as Glass-Stegall, there was a clear division between the types of banking institutions. But by the 1980s and 1990s the legal distinction between commercial and investment banking was severely weakened.

By 1999 the Financial Services Modernization Act was passed, repealing the portions of the Banking Act that made the commercial/investment banking distinction. This created the legal conditions for the 2008 Financial Crisis.

Banks, by virtue of their charter, are enabled to issue loans by electronically creating liquid funds (aka money) to loan to businesses or individuals, Banks also use these liquid funds to purchase financial assets like stocks or bonds. Loans, stocks, bonds, and other financial instruments are assets because they are either a flow of funds paid to the bank, or can be sold to pay back a bank’s debts — usually both.

A bank’s debts, or liabilities, are the origin of the liquid funds that they transferred to other entities while making loans — they create the electronic funds with which those entities purchased assets, or made loans based on the funds that they have received.

The money that people or businesses deposit into a bank is a liability to the bank — the bank must give the depositors the money in their accounts when they demand it, and pay the bank’s debts when they come due. To do this, the value of the bank’s assets needs to be great enough to cover that cost, and it must be able to liquidate (turn into transferable funds) those funds fast enough.

In theory, a bank could electronically create funds to pay back those loans in the same way that they did to make their loans, but in practice only the Federal Reserve is able to do this on a large scale. Since everything is denominated in U.S. dollars, the Federal Reserve could refuse to honor the electronic funds that a bank created out of thin air, which reins in a bank’s ability to create funds completely autonomously.

Put another way, banks are sites where funds are created and allocated to households, individuals and businesses in the form of loans. Banks are constrained by regulatory requirements on their balance sheets and, ultimately, by the willingness of the government to recognize those funds.

From this overview, it’s clear that banks have a huge influence over what types of businesses operate and what types of purchases happen and, importantly, how many of them.

Like any other capitalist business, banks are motivated by one thing — profit. A bank’s profits are derived from interest on loans, fees for various financial services, and capital gains. The presence of the profit motive creates an incentive for banks to make as many loans as possible, which means loaning out or purchasing the greatest possible amount of financial assets  within the legal and monetary constraints they face.

There is always the possibility that borrowers might not be able to pay back their loans, and if enough loans do not get paid back the banks that made those loans run the risk of not being able to make good on their own debt obligations, including paying depositors for the deposits in their accounts.

The consequence of that risk is enhanced as banks attempt to loan out increasingly large sums. As banks issue more debts, their financial cushion between solvency and insolvency, their ability to cover their financial obligations to depositors and creditors, shrinks.

Central banking institutions like the Federal Reserve and other regulatory agencies attempt to manage that tendency by requiring banks to hold certain amounts of capital on their balance sheets. Capital is the term for funds that a bank was able to use to make loans or purchase assets.

Those regulatory agencies walk a fine line: If the capital requirement is too great then there will be insufficient credit to keep the capitalist economy running smoothly in the medium term, or banks might push back politically when their ability to make profit is limited.

Capitalism as a Circuit

To fully appreciate banking’s role in capitalism and economic crises, it is helpful to think of capitalism as a circuit. At one end capital in the form of money flows into the circuit as the means through which capitalists hire workers, acquire raw materials, and procure the machinery they need to produce their product.

The workers hired are put to work transforming those raw materials into a new commodity, one which the business owners’ hope is more valuable than the money advanced to produce it. The finished product is then marketed and sold, a process that the business owners hope produces a profit — without a guarantee that it will.

If the circuit is disrupted at any point, such as a breakdown in the process of acquiring funding, resources and workers, or in selling the product, an individual firm runs the risk of going out of business because it’s unable to cover or recover the costs of production.

At the macro level, if the disruptions to the circuit of capitalist production are systemic and extend beyond a handful of producers, the economy as a whole may be thrown into crisis through a series of cascading effects on adjacent industries — such as real estate development and lumber — and affect their ability to repay creditors.

The banking and financial system plays a key role smoothing out potential disruptions by loaning out money to capitalists to begin the process of producing commodities, expand productive capacities, or cover costs until they can sell their inventories.

Banks and finan­cial institutions facilitate the transformation of commodities produced into commodities sold, through credit issued to individuals, including home loans, and other forms of consumer debt.

Limits on Banks’ Ability

Banking and finance’s ability to smooth out the circuit of capital is not unlimited because they are integrated into the circuit that they help smooth. If disruptions and their cascading effects begin to mount, the profit margins on the loans begin to shrink as borrowers are unable to keep up with their payments.

If the disruptions in the circuit of capitalist production become too great, banks may find themselves unable to make good on their obligation to their depositors and other creditors, leading to the sort of bank failures we saw during the 2008 financial crisis.

Finance and the overall economy have self-reinforcing tendencies towards instability. When the economy is doing well, banks and other entities (including individuals and households) foresee more good times and act accordingly. There are only so many low-risk investments to make, so banks make increasingly risky investments or pass on the opportunity to profit.

This dynamic produces asset bubbles like the housing bubble we saw burst in 2008. Housing seemed like a sound investment because banks and other capitalists kept pumping investment into it — until they could not. The bursting of such bubbles and the recessions that follow cause the exact opposite problem; when capital most needs financing the basis for it is no longer there.

Banks, Planning, and Democracy

Banks are like economic planners in a capitalist economy. They pool and direct the flow of capital in an economy because of their outsized role in determining which firms and consumers get access to loans and credit.

The profit motive is the basis for a bank’s judgement regarding who gets access to credit and who doesn’t. The industries that are the most profitable and appear to have potential for growth over the term of the loan get the green light, while those that might be socially desirable but are less likely to turn a profit get passed over.

The poorest and most socially disadvantaged workers in our society are either denied access to credit that could be used to gain access to housing, healthcare or transportation, or are granted access at great financial and personal cost.

The centrality of profit-driven banking and finance in a capitalist economy is yet another undemocratic feature of the capitalist world we live and work in. Our lives are structured around the struggle against the top-down power of our bosses on the shop floor and in the office at the micro level.

At the macro level, life in capitalism is defined by our struggle, as the working class, to wrest control of funding and investment from the profit-driven banking system, big business, and their counterparts in government.

Those institutions continue to invest in fossil fuels, weapons manufacturers, prisons and other environmentally and socially damaging industries that will provide profits. At the same time, the world continues to spiral deeper into a crisis fueled by those same investments.

The resignation that much of the working class feels in the face of those converging crises is symptomatic of the undemocratic nature of our society. People increasingly understand that the crises, especially the climate crisis, requires marshalling society’s resources to decarbonize how we produce and consume while also mitigating the current effects of climate change.

We know what needs to be done, but we lack the ability to directly influence what sort of enterprises and projects get prioritized because workers are excluded from the boardrooms of banking institutions.

Even if workers had a consequential seat on every bank’s board of directors, we would still be faced with the dilemma that the profit motive imposes on all businesses. Our choice in a capitalist society would remain, either to maximize profits by investing in socially and environmentally corrosive policies that further exploitation, or get crushed by the competition.

A Socialist Future and Banks

Until workers wrest control of resource allocation from banking, finance and profit-seeking capitalists and refuse the power of their bosses at work, we will be unable to address the challenges that loom large in an egalitarian and pro-social manner.

What, then, happens to banking and finance once we do so and we begin building a democratic and socialist society? Does banking persist but under the direction of workers’ committees? Is it relegated to the dustbin of history? Something else?

A partial answer to this question depends on how you envision a socialist society functioning.

For market socialists the answer is yes, banks will persist — i.e. for those who believe a socialist society will use markets as the primary means for allocating resources, and where most production would happen in independent worker cooperatives.(1)

At the very least there would need to be a bank-like institution that would keep track of how much money each consumer and cooperative has, and would facilitate the procurement of inputs for the goods and services they produce.

Moreover, because wealth denominated in terms of money would be individually held by consumers and cooperatives, there will be the need to pool individually accumulated wealth to channel it into larger scale projects much like we already have in a capitalist economy.

Some Marxist theorists like John Roemer and Thomas Weisskopf have advocated for additional forms of finance that act as analogues for the stock market, to further facilitate the allocation of resources to firms in a market socialist economy.

The market socialist approach and its reliance on banking and finance would reproduce many of the same problems of capitalist banking. The socialist bank, seeking not to waste the wealth stored in its vaults, would behave much like a profit-maximizing capitalist bank and would prioritize financing projects that would guarantee the return of the funds loaned out — at the expense of socially desirable projects with a lower return on investment.

Similarly, participants in the socialist stock market would likely invest their funds in those worker cooperatives most likely to return their capital to them.

The worker cooperatives would also be in competition with one another and incentivized to engage in cost-cutting measures that are harmful to workers and communities, in order to demonstrate their commitment to profitability.

The market socialist system of banking and finance would similarly reproduce the undemocratic aspects present in capitalist society. The reliance on market mechanisms to determine how resources are allocated would diminish our ability to consciously, democratically, and directly allocate resources, placing a wall of market relations between us and the satisfaction of social needs.

Planned Socialist Economies and Banks

Alternatively, models of socialism that primarily allocate resources through democratic planning mechanisms largely eschew banking and finance.

Banks would not play a significant role in planned socialist economies, because there isn’t the need for borrowing and lending through a profit-driven process to facilitate the start-up or growth of a firm, or to smooth over potential crises.

If collective control of resources and wealth is the starting point, then what remains is determining our needs and how to best satisfy them as a collective.

This of course is easier said than done. Valiant attempts at building a system of planning that did not rely on private property or markets were attempted, all of which ultimately failed at constructing something lasting. As socialists, what is important is that we learn from these past attempts in order to bring about something lasting.

In the Soviet experience(2) planning was orchestrated in a very top-down manner, with a few people at the top determining where resources would be invested, how much would be produced by each industry, and which enterprises would produce that output.

The planning committee Gosplan operated on a system of material balances where they assessed the resources that were available and what was needed, and matched the required resources to the goods and services that needed to be produced. This task was executed by a set of experts, with rank-and-file workers and households almost entirely excluded from the planning process.

Banking did exist in the Soviet Union, a singular state Gosbank. It was primarily used as an accounting tool for allocating funds for procurement by state enterprises and to facilitate foreign investment.

As such, Gosbank was subordinated to the planning process and acted more as a conduit for dispensing resources and funding rather than as the mechanism which decided which enterprise got what. So while banking did exist, its role was relatively minor compared to the role that banking plays in a capitalist society.

In many regards the highly centralized approach to economic planning was initially effective at developing USSR’s industrial capacity and improving the standard of living for many of its inhabitants through massive infrastructural projects. The logic behind its effectiveness was that the Soviet economy could identify economic and social needs and direct materials to satisfy those needs without the mediation of the market mechanism, unlike the chaotic and unplanned economic development of capitalist societies.

This approach to planning was incredibly undemocratic and excluded rank and file workers, students, parents and all manner of consumers who were left out of the decision-making process. The undemocratic nature of the system produced contradictions that led to inefficiencies in the planning process, especially as it related to consumer goods, and a high degree of state coercion.

As the Soviet economy became increasingly industrialized and increasingly complex so did the task of top-down planning. Without the households and workers who consume and perform the work thoroughly integrated into the planning process, how could planners accurately predict the variety and number of things like shoes, home decor, clothing, etc?

The use of coercion and force to compel Soviet workers into action was also a consequence of the lack of democracy within the Soviet society. Who wants to work in a society that only values their ability to work in fulfilment of a plan in which they have no say nor really reap the rewards?

Democratic and Participatory Systems

Democratic and participatory planning is an alternative to both profit driven systems of market allocation and bureaucratic top-down central planning.(3) The basic premise of democratic planning is that all people involved or affected by the use of a set of resources have the right to participate in the process of deciding how those resources will be used.

Proposals for democratically planned economic systems abandon markets, including financial markets, which allocate resources based on profitability rather than social or personal need. They also abandon markets because of their undemocratic nature.

Similarly, proposals for democratically planned economic systems reject the highly centralized mode of planning because it shuts out those who have the on-the-ground knowledge and experience to best judge how resources are spent and how needs are met.

While there are numerous proposals for how democratic and participatory planning would take place, their unifying theme is that the planning process involves three parties — those doing the work of producing, those consuming, and the various constituencies that are affected by the work and consumption.

Households and workers would estimate how much of what they want to consume and produce, respectively. If there was a mismatch between the parties they would engage in a process of negotiation that would result in adjusted estimated consumption and production plans.

The process of negotiating these plans extend beyond quantitative questions and into qualitative questions about how these plans will be fulfilled. At this point various community constituencies enter into the conversation about resource allocation.

People invested in preserving certain parts of the landscape, reducing noise, or preserving a community hangout have a chance to intervene. While these conversations might be challenging or cumbersome at times, they open up space for a community to self-determine what it values and how it wants to proceed.

In doing so, space is created for new knowledge and information to be registered in the planning process that would not emerge if we were relying on capitalists or a committee of central planners to make those decisions. As a result, decisions would more directly represent the community they affect and more accurately satisfy their needs.

Where do banks fit in in a democratically planned economy? In the initial stages of building a democratic and socialist society it might be the case that a national banking system would be necessary, especially if the economy existed amidst non-socialist economies or as a part of a constellation of independent socialist economies.

In this case the banking system would act as conduit between economies that were not totally integrated with one another, serving as a mechanism for wealth transfers and trade between economies. The goal however, would be to ultimately eliminate the need for banking altogether, entrusting the process of planning and allocation to the people best suited to the task — us.

Notes

1. John Roemer lays out a vision of a market socialist society in his short book Free to Lose: An Introduction to Marxist Economic Philosophy. The collection of essays Equal Shares: Making Market Socialism Work also presents a case for market socialism. For a critical perspective on market socialism David McNally’s Against the Market: Political Economy, Market Socialism and the Marxist Critique is an excellent introduction.
   back to text
2. Chapter 2 of George Garvey’s Money, Financial Flows, and Credit in the Soviet Union presents a good history of the development of the Soviet financial system through the reforms of the 1960s. Robert Brenner’s articles, “The Soviet Union & Eastern Europe, Part 1,” in Against the Current #30, January-February 1991 and “Soviet Union-Eastern Europe, Part II, ” ATC #31, March-April 1991 present a clear picture of the structure of the Soviet economy and its limitations.
   back to text
3. Michael Albert and Robin Hahnel’s book Looking Forward: Participatory Economics for the Twenty First Century and Pat Devine’s article “Participatory Planning Through Negotiated Coordination,” Science & Society, Vol. 66, No. 1, Spring 2002, 72-85 layout thorough visions of what a participatory, democratic, and planned economy could look like.
   back to text

September-October 2023, ATC 226