The Lesson From Lehman Ten Years On


Forget all those jeremiads about how capitalism needs to be reformed, replaced even. Here’s what the Lehman Brothers story really teaches us, as does that Crash that followed.

Fractional reserve banking is a dangerous thing.

Fractional reserve banking is a useful thing.

So, much like everything else in life then.

It’s important to understand what the crash was. It wasn’t the bankruptcy of capitalism, wasn’t an indictment of the entire system and most certainly wasn’t a Gotterdammerung. Perceptive observers will note that the poorer parts of the world have continued to get richer at a rate unknown in any time period ever – the global economy is doing not just fine but wondrously. Billions are climbing up out of destitution to those bourgeois pleasures of three squares a day and a change of clothes.

What the crash was was simply a bank run. A wholesale bank run. And that’s all it was.

Bank runs are something that any system of fractional reserve banking is prey to. A bank does not need to have the money in the vault to lend it out. It can, and does, just lend money – then it goes to attract the deposits which fund that loan. No, a bank does not “create money” nor create credit. The banking system as a whole can be said to, but not an individual bank.

Such a system has a problem. If everyone turns up on the same day asking for their money back then they cannot have it. Those deposits aren’t there in the bank, they’re out in those loans. Further, we can all turn up – largely enough anyway – one day and ask for our deposits back. But the money has been lent out on 1 and 5 and 30 years terms. The bank could pay us all back if we were willing to wait 30 years but we ain’t. So, said bank is illiquid but not insolvent. Another way to put it is that banks borrow short and lend long, that’s just what banking is.

And that’s what did happen. All of the wholesale depositors would not lend money to other banks. And they also wanted back the money they’d previously lent. This was exactly those lines outside banks of people wanting their deposits back only run over computers and phone lines not physical lines of screaming malcontents.

OK, that’s what happened. So, why do we put up with this fractional reserve banking system prey to, prone to, such problems?

Because of what it does for us, it provides maturity transformation. You’ll note that the loans are out there for longer than the deposits. Well, we like that. It means that people can borrow for long periods of time. Much longer than an individual wishes to lend for. Almost none of us want to lend money into a mortgage for 30 years before we can get our cash back. Near all would like to borrow on such terms. Fractional reserve banking is the system that balances those desires.

Without FRB long term credit would be almost impossible to find. We like having long term credit. Therefore we put up with FRB and its risks. And, you know, that’s it.

Sure, we can insist on greater capital buffers, a tad more regulation and so on. But we’re still going to end up with a bank run or two simply because that’s what fractional reserve banking exposes us to. And we’ll put up with it because the results of the system are that we’re richer, even given the runs and the crashes.

Something that’s largely true of free market capitalism itself of course. There’s no economy that’s risen far or for long above the penury of a static system. Those swings of depressions, recessions, are the flip side of the system which leads to generally greater prosperity over time. Insist on the killing of the one and you’ll murder the other. As every single non-capitalist and non-free market economic system has shown.

Bit of a bugger, obviously, but There Is No Alternative.