The economic equivalent of amphetamines

The dark arts of banking

Banking is an increasingly esoteric and occult art, so politicians tend to avoid thinking about it too deeply.

It also involves truly astonishing amounts of money - and politicians tend to respect money rather than morality.

Yet it's becoming steadily more apparent that if the structure of banking is not radically changed, further bank bail-outs will be inevitable. So even if you accept the dubious logic of "deficit reduction," all that pain will have been in vain.

Banking is an intrinsically risky business. Traditionally we have deposited our cash with banks, assuming this is safer than keeping it under the bed.

But banks can't profit from leaving our money alone, so they lend it out to other people.

It's a bit like asking a trusted friend to look after your flat while you are on holiday and finding that he or she has rented it out to someone else without your permission.

You could come home to find the locks have been changed or the guests have seriously partied in your kitchen.

In the same way two people cannot enjoy ownership of the same property at the same time - money can't be in two places at once.

In the 19th century banks would collapse on a regular basis. A "run on the bank" occurs when people don't believe the bank can pay back all its deposits. Those with bank deposits demand their money back, the banks don't have the money because much of it has been lent out, so disaster results. Thus a lack of confidence leads to financial catastrophe.

In the 19th century the Bank of England stepped in, regulating away some of the risk and injecting confidence by guaranteeing that it would act as "lender of last resort," ie being prepared to lend banks cash to stop them collapsing because of short-term confidence problems.

Such action made a risky but profitable system - it was safer but by no means ethical or crisis-free.

Fast forward to the 20th century when we saw an orgy of deregulation under Thatcher. Banks were freed up in a variety of ways and the deregulation trend spread from Britain and the US across the globe.

Banks have always looked for new sources of profit - buying and selling shares and government and company bonds, indulging in currency deals, they have kept on expanding their businesses into new areas.

Thatcher's actions also meant that British banks are highly dependent on Britain's unstable property market, which has injected short-term profits along with long-term risk.

But the big profits come from the "new financial architecture," which is something that 99 per cent of the population are unaware of and that the other 1 per cent, with the exception of some very well-paid mathematical geniuses, only dimly understand.

The new financial architecture is constructed from the dizzying world of derivatives, credit default swaps, short-selling and numerous other devilish instruments of high finance.

Banks have created a shadow and largely unregulated financial system. Banking has been fuelled by the economic equivalent of amphetamines.

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