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So why the hell do we bail banks out?

It's capitalism, stupid! You screw up then you lose everything

Worstall @ the Weekend Much to my joy, I have been asked a question I can actually answer. As opposed to those difficult ones, like does my bum look big in this, do you love me and has your cocaine use ever been more than recreational?

That question, coming from Reg reader John Smith 19, and it is, in essence, well, why do we bail out the banks?

One answer offered was that lots of politicians would like to have jobs in banks and while that's interesting, amusing and appropriately cynical, it's also wrong. We bail out banks because we rather like having this thing called an economy around us. On the grounds that we think that having an economy makes us richer.

Monetary theory, financial economics, these areas draw rather more of the loons to the arguments as moths to the flame than normal, and we'll try to dance around some of the angels on pins arguments. But the basic structure of the full answer is that the system we've got isn't perfect, it can and possibly will be made better and there's no possible structure that is perfect.

To haul ourselves all of the way back to the beginning, the point and purpose of a financial sector is to do two things: one is to move risk around, the second is to mobilise the savings of the populace into investment.

Derivatives (options and futures for example) are moving risk around, as is the insurance industry. That's not really our subject today: we want to talk about banking, which is about picking up the stuff being saved by some portion of the population and moving it over to where it can be invested in what some other sector would like to consume. We do this because we're really pretty sure that using someone's savings to invest in the next thing is a good idea: it's how the society generally gets richer over time.

So far so obvious, and obviously my savings could be invested in a portion of your business. You start it, I buy the kit and I own some slice of all future profits. That's equity and again not banking. Banking is about taking what people are willing to lend to other people and making that into loans that other people can have.

Obviously, again, we can (and we all do when we spot someone a tenner for a round or as peer-to-peer lending is starting to do) do this directly. But it does seem to work better when there's a specialist sitting in the middle doing the collecting and the allocating.

And here we come to the great problem of banking.

Next page: Bank on the run

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