Why do banks make so much money?

In the controversy over bankers’ bonuses, no-one seems to be asking the obvious question. How is it that the banks have so much money to hand out in bonuses?

“Hold on,” I hear you say. "They don’t have so much money. Most of the money currently being disbursed in bonuses has been supplied by tax-payers." Point taken! We live in strange times. Nevertheless, it is generally true that, in normal circumstances, banks, in particular investment banks, can make enormous amounts of money - and I want to know why.

First of all, we usually expect those who make money to invent something, or to make something or to offer something rare and exceptional or to add value to something. Now, at the risk of offending bankers, it seems to me that investment bankers, especially those dealing in derivatives, don’t meet any of the above criteria for high financial rewards.

Many commentators have drawn the parallel between investment banking and gambling. Well, in that both seem to be activities divorced from the real world in which luck plays a critical role, the parallel holds good. But there is a difference. Gamblers usually gamble with their own money, not other people’s. And there’s another difference; gamblers tend to lose.

So what is going on? Why should those engaged in gambling with other people’s money in a construct divorced from the real world of invention, manufacturing and service provision make money out of all proportion to their contribution to the real world? What kind of economic system provides the greatest rewards for those who gamble with the wealth created by the inventors, manufacturers and service providers but who themselves do not invent or make anything?

So what is the answer? Well, there seems to be a serious flaw in the capitalist system. It seems that, in massive financial systems, such as our global economy, the financial sector takes on a life of its own, in which fortunes can be made or lost, almost irrespective, and certainly regardless, of the effects on the real economy. The closest analogy is that of leukaemia, in which what is usually a beneficial process (the circulation of blood, in this case money) gets out of control and, obedient only to its own rules of uncontrolled growth, quickly takes over the body. We know what happens in end. The body dies.

What is the answer? Well, we need a mechanism that reasserts the relationship between capital and production. First, the more obscure financial instruments which have allowed the separation to develop should be banned. We should never again allow the banks to play with and expropriate the world’s wealth in such a way that, when they broke the system, they had no idea how badly it was broken.

Secondly, the present system in which investment bankers have no liability should be replaced by one in which they have unlimited liability. Their own wealth should underwrite their gambles. If this were so, we can be sure that the insane chances that bankers took with the sub prime market would never have happened.

Thirdly, there should be a serious debate in our society about the distribution of wealth and how to make the rewards of work correspond more closely with the value of work to our society. The free market is a wonderful instrument but it needs to be finely tuned.

These suggestions are merely attempts to solve the problem. There must be other, better ideas out there.