I’ve been trying to follow a nagging thought through to its conclusion. We know to expect that flooding risk will extend to an ever increasing proportion of the UK housing stock. But in the context of financialisation, mortgages underpin bank lending, and by extension the wider financial system. And a majority of households depend on their house as a savings vehicle. So what happens when physical climate impacts destroy the real assets that households and the financial system are relying upon?
This is part 1. The power of banks to issue debt.
Most of us think of money through the lens of our personal finances. We think of the notes and coins in our wallets, the bank balances displayed on our screens. Beyond that, it gets a lot harder to conceptualise.
This is understandable. There is a large gap between our everyday experiences of money, and the forms of money that exist within the global monetary system. The notes in circulation represent only 2-4% of all money in circulation, even including demand deposits (money you can withdraw from the bank at any time). This is all dwarfed by the amount of debt deposits.
How debt exists as money
Money is made when commercial banks make loans.
This is contrary to the accepted notion that banks act as intermediaries by taking saving deposits and lending out multiples of these base deposits. They are not simple intermediaries; banks have the power to issue debt. This power to issue debt is a license to ‘print’ money for banks. When debt creates money, it generates economic activity from that debt, since when you receive a loan you spend that money in the economy.
Banks follow an ‘originate and distribute’ model. Banks originate (or issue) loans, and then distribute ownership claims to the revenue streams (i.e. the interest payments, fees and charges) from these loans throughout global financial markets.
This business model makes lending to households extremely profitable for banks and those who invest in debt securities (in which investors secure ownership claims to revenues from household debt).
Banks as loan originators create money by issuing new debt contracts. Loans are issued without any interference from government or regulatory oversight. They can decide the rate of interest that borrowers are charged and need only justify the charges by claiming that it does so on the basis of the likely risk profile of the borrower. This is in spite of the fact that interest rates charged on loans are not linked to any underlying rate of the cost of borrowing set by lenders or to the base rate set by the central banks. Moreover, lenders have a legally enforceable claim to collect the interest payments on the loan even if the borrower falls ill and cannot make a few repayments. The ability to collect payment is not contingent on good lending practices (e.g. whether affordability checks were made).
In addition to this power, lenders make profits from distributing claims to the anticipated revenue generated from these loans, which can be traded in many different forms across global financial markets. Banks and other loan originators (e.g. department store cards, car-finance) gather together newly issued loan contracts (legal contracts to collect interest payments on these loans) and move them off their balance sheet in a process called securitization.
Securitization allows banks to bundle together the anticipated interest revenues of outstanding loans as a source of capital. (This is a bit like how the owner of a small business could take a purchasing agreement they have with a supplier as proof of their credit-worthiness, and use it to secure additional finance). The anticipated interest payment revenues from loans are transferred to a special purpose vehicle wholly owned by the lender. These special purpose corporate entities have only one source of revenue – interest payments on outstanding loans – and investors can purchase a claim to a portion of the revenue generated from the outstanding loan pool (this is the equivalent of corporate bonds or equity shares).
This securitization process changes the nature of a loan: from a contract between lender and borrower, to a financial vehicle that has multiple and overlapping ownership claims against the loan originated by the bank. These ownership claims are traded across a global network of interrelated markets, which value, price, buy and sell the anticipated revenues on loan contracts. Debt provides a steady stream of present-day income that flows into the global financial system as interest payments on outstanding debts.
The power to originate and distribute loan contracts is a unique commercial power given to lenders, banks and the financial sector. It’s a power that is highly profitable, and which underpins the influence of the financial sector.
thejoyofrachel 