Bending the Bank

For generations, banks have played a pivotal role in the lives of local residents throughout the globe. Whether it was checking accounts used for day to day purchases, savings accounts for the long term, or mortgages to buy houses … in the eyes of the populace, banking is all about money.

Word that JPMorgan Chase & Co, the biggest U.S. bank, agreed to pay $410 million to settle accusations that it manipulated electricity prices, may have raised some eyebrows among some of its customers.

It turns out energy is only one of numerous commercial ventures they are dabbling with.

According to Bloomberg News, commodities are just one area in which the largest U.S. banks have sought to expand at taxpayer expense. Aside from trading and issuing securities and derivatives, they have gotten into water utilities, electricity generation, natural-gas distribution and even the operation of Chicago’s parking meters. The full extent of the sprawl is hard to assess due to a lack of public disclosure.

According to recent investigative report by The New York Times, Goldman-Sachs, another huge financial institution has gotten into the business of storing aluminum for other banks, traders and aluminum producers in a complex of warehouses outside Detroit. While this may sound harmless, the Times claims that since the bank entered this business, the time it takes buyers to get the metal from those warehouses has shot up to more than 16 months, from 6 weeks.

Those delays have bolstered Goldman’s profits, because the bank earns rent for each day the metal stays in its warehouses. It also is said to cost companies that use aluminum billions of dollars, because the additional storage costs mean that the price for aluminum has gone up.

While these charges have not been proven in a court of law, and like individuals, companies ought to be considered innocent until proven guilty,  the question why banks have gone into these types of ventures in the first place is a legitimate one.

According to Bloomberg News, this is because they are among the country’s most subsidized enterprises. The Federal Deposit Insurance Corp. and the Federal Reserve, both backed by taxpayers, provide an explicit subsidy by ensuring that banks can borrow money in times of market turmoil. Banks that are big and connected enough to bring down the economy enjoy an added implicit subsidy: Creditors will lend to them at low rates on the assumption that the government won’t let them fail.

The subsidies arose because banks perform a special public service. The lending they do and the payments they process are crucial to the functioning of the economy. Problem is, access to cheap, subsidized financing gives banks a big advantage if they move into markets beyond their core business. That’s great for the banks, but it distorts the competitive landscape.

The allegations of rigging in the aluminum market is a classic example. Taxpayer subsidies gave the banks an edge in holding the metal. Subsidized financing — made particularly cheap by the Fed’s efforts to stimulate the economy with near-zero interest rates — encouraged banks and their clients to build bigger stockpiles than they otherwise would have, tying up supplies. If the bets were to go wrong and lead to distress at a big bank, the Fed would have to provide emergency financing for an activity that taxpayers never intended to support.

There’s no good economic reason for banks to be in such businesses. All they bring to the table is their privileged
access to cheap financing.
Hundreds of U.S. banks, including the country’s biggest banks, received taxpayer bailouts during the financial crisis that struck in 2008 and triggered the worst economic downturn since the Great Depression of the 1930s.

The Obama administration, like a group of senators who recently proposed legislation that would break up banks, says it wants to ensure that risky banks can’t bring down the system. But it hasn’t specifically endorsed the legislation proposed by a bipartisan group of senators that would force banks to split off their conventional lending and deposit-taking into separate companies from investment banking and other riskier activities.

All the potential ramifications from such an approach should be carefully — but speedily — studied before such legislation is passed into law. But the arguments in support of such a step appear to very valid ones.

If banks want to deal in commodities they have every right to do so. But the U.S. taxpayer shouldn’t be subsidizing it.

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