michaelkMichael Keenan suggests that, if Labour policy-makers want to make a better society, they have to understand how the banks create money and how we can take back control in the interests of us all. 


We think we know what’s wrong with the banking system. Banks are too big to fail, they are guilty of mis-selling products to us and their service to us is poor.

Aren’t these the main things?

In fact there is something much more fundamental to worry about, and it’s something that policy-makers, the public and even economists don’t properly understand: banks create money out of thin air, and they steer that money into areas of the economy that benefit the bankers rather than our society.

People imagine that banks take money from depositors – you and me putting our income or savings into the bank – and then lend that money out to borrowers – you and me taking out a bank loan, or a company that wants to expand.

In fact, only half of this equation is true. Banks lend money to borrowers, but what they lend doesn’t depend on depositors, it depends on the banks’ levels of optimism. When banks are feeling optimistic, as they were before the 2007-8 crash, they lend large amounts of money, without thinking too hard about whether the loans are wise, because their profits rise. This isn’t good
for us because people are encouraged to take loans they can’t really afford. As a consequence, our society labours under heavy levels of debt.

When the banks are feeling pessimistic, as they were after the crash, they stop lending, and people can’t borrow money. Individual borrowers feel pessimistic too, because they worry about having large debts, so they stop spending and use the money they save to pay off their loans.

The result, as we have seen over the last few years, is that money disappears, is in fact destroyed, and that is bad for us too, because wages are held down, full-time jobs are turned into part-time jobs, good contracts are turned into zero-hour contracts, and people who need loans turn to pay-day lenders or loan sharks.

This system took many decades to develop, but it amounts to privatisation of money, and it has happened largely without the public noticing.

The Coalition Government has blamed the last Labour Government for causing these problems through over-spending, but this is simply not true. We had a global crisis caused by banks making unwise and risky loans which turned sour when so-called sub-prime mortgages in the US could not be repaid, and the resulting crisis almost brought the Western banking systems

The Coalition has also used the crisis as an excuse to undermine the public services which we all rely on. One of the worst symptoms of this problem is the housing crisis in the UK.

Housing in the UK is wildly over-valued compared to people’s incomes. The picture is complicated, because statistics vary from area to area. But what we can say, definitively, is that house prices have risen in the last 20 years much faster than incomes have. In Scotland in 1990, the average house was 2.4 times the value of the average income; by 2010, it was 3.7 times the annual average income.[1]

The idea that demand for housing may exceed supply may have some truth to it. In Scotland, there are 1.46 million owner-occupied homes, a further 963,000 homes that are rented, and 37,000 second and holiday homes.[2] The most recent figure for new builds, 2013, is less than 15,000, almost three quarters of which were private-sector houses,[3] which means social housing is not a priority. From 1979 until now, new builds exceeded 25,000 in only two years, 2005 and 2006.[4]

But demand exceeding supply cannot explain the rapid rise in house prices in recent decades. Nor can it explain the recent stability of these prices in the midst of an economic down-turn. Why didn’t house prices plummet?

Consider this.

A lot of houses lie empty. Even the Scottish Government is not sure how many, but it says that “there are around 25,000 long-term empty homes in Scotland that are liable for Council Tax”.[5] Demand is not bringing these houses into use.

If the issue was simply demand, then you’d expect the private building sector to be booming, but it isn’t. A 2010 report by Shelter on England and Wales said that “… since 2008 the contraction of construction activity has been far more severe than for the economy overall and there is evidence of considerable capacity”.[6] The term “considerable capacity” means that a lot of
construction workers were laid off. The money to pay them had disappeared.

The same seems to be true in Scotland because, as I just pointed out, the recent peak in new builds was just before the crash of 2007-8. The number of new builds thereafter fell by around 40%.

And, more importantly, consider this.

The banks like lending on property: it is low-risk, it makes the banks a lot of money, and if loans go bad then they have a property to re-possess and sell on. The statistics are eye-opening. In 2011, the banks loaned a total £341 billion to businesses outside the financial sector, to the public sector and to individuals for personal and credit-card loans. At the same time, they loaned £1,482 billion, or more than four times as much, to commercial property businesses and for mortgages and secured loans.[7] (The banks also loaned a further £461 billion to the financial sector – property and finance together represented 85% of loans in 2011, and that percentage makes it clear why our economy is so skewed.)

The government also likes high house valuations, because they make people – people with property, anyway – feel good. That’s why George Osborne was so keen on the Funding-for-Lending and Help-to-Buy schemes.

But high valuations are bad for our society. The consequence of inflated house prices is that buying a house becomes beyond more and more people, no matter how hard they work. Others have to extend themselves to the absolute limit to buy themselves a home, and more and more of family incomes goes on paying for somewhere to live.

In some ways, it’s even worse if you rent. House prices (on average over Scotland – it varies from region to region) rose very rapidly from the late ’90s to the time of the crash (2007-8), but have been fairly stable since[8] (which of course does not make houses more affordable, since wages also are stagnating). But rents over the period 2010-14 have risen (depending on the
size of the house) between 6% and 13%.[9] You have to be careful in interpreting these figures, but if there is pressure on renting, it makes the incentive to try to buy even greater.

A key problem, then, is that, for many people, a house is not a home but an asset that, whether lived in or not, in increasing in value.

To sum up, then: banks create most of the money in the UK economy as debt, the loans they create go overwhelmingly into the property and financial sectors, house values get pushed up, and people have trouble paying for somewhere to live. That’s good if you’re a banking or financial executive, or if you have a house and few ties. It’s bad if you have a mortgage, or if you’re
trying to get a mortgage, because you have to take a big personal risk on the loan. It’s bad if you rent, because your landlord is tying the rent to the rising value of the house.

A group called Positive Money believes it has an answer to this. The answer is to take back the power that we have allowed the commercial banks to take from us – the power to create money and to devote that money to areas of the economy that benefit the financial sector at the expense of the rest of us.

The way it would work is this.

At the moment, the government directly controls only notes and coins, or 3% of UK money. 97% of money in the UK
economy is created by the commercial banks as debt.

Under Positive Money’s proposals, banks would be able to offer only two kinds of account: transaction accounts which would be much like current accounts are today, and investment accounts.

The money in transaction accounts would not be created by the commercial banks but by the central bank, the Bank of England in the case of the UK. The money in these accounts would be owned by the customers, and be risk free, because that money would be backed by the central bank. The funds in these accounts would attract no interest but would be entirely safe.

Investment accounts would attract interest, but would not be risk-free. They would simply be records of how a lender’s money was transferred from the lender’s transaction account to the borrower’s transaction account. Because these transfers would involve only money under the control of the central bank, the commercial banks would not be able to create money themselves. If a borrower failed to pay back a loan, then any losses would be split between the central bank and the lender.

These are big changes from our current system. At the moment, the government guarantees £85,000 of an individual’s money whether it is in a current account or an investment account. Under the new system, the government would guarantee any sum in a transaction account because, although it would belong to you, it would be government-backed money. The government would not guarantee money that attracts interest in investment accounts, but that seems right. It means that people have to think about the risk they are taking with their money and make sure they are investing wisely. More importantly, the banks would have to act more wisely because they too risk losing that investment money without any guarantee of a government bail-out when things go wrong.

Another important feature is that the commercial banks would no longer be able to create money in the form of debt. Almost all commentators agree that the UK has unsustainable levels of debt, and the new system would mean that, over a period of time, we could reduce that debt.

There is also the question of democratic control over our economy and the need to put money at the service of our citizens, rather than putting citizens at the service of money. Positive Money’s proposals would split control over money. Politicians would decide where public money should be spent, and commercial banks, in co-operation with their customers, would decide where private money should be invested. However, a new committee, along the lines of the present Bank of England’s Monetary Policy Committee, would be created to decide how much money in total should exist in our economy – in other words, how money should be created or destroyed to match prevailing economic circumstances.

How would all this affect housing? I believe that removing the power of the commercial banks to inflate house prices in the banks’ own interests would cause house prices to fall, and that would be an overwhelmingly good consequence. Offering government loans helps a small proportion of people, like first-time buyers, but this doesn’t address the main problem that housing is just too expensive. The only way to make housing affordable is for house prices to fall.

That said, we would have to consider the circumstances of people who found themselves in difficulty if they had taken large mortgages on houses that began to fall in value. At the end of 2013, there were thought to be just under 73,000 homes in Scotland that were in negative equity,[10] in other words where the loan on the property exceed its value. This is a tricky area. I do not believe it would be right to subsidise property owners who had taken a financial risk in, say buying to let. But, since one of the main points of Positive Money’s proposals is to reduce the impact of debt on our society, we don’t want to find large numbers of people with housing debt that they cannot repay.

In the long run, however, it is surely in the interests of us all that houses cease to be assets and become homes.



[1] Source: House of Commons Library: “Regional house prices: affordability and income ratios”, Standard Note: SN/SG/1922, 29 May 2012, Table 14. Might have been better to compare median house prices with median earnings but, although I can find figures for England and Wales, I can’t find comparable figures for Scotland.

[2] Source: Shelter Scotland, “National housing statistics”, scotland.shelter.org.uk/housing_policy/key_statistics/the_facts_about_scotlands_housing

[3] Source: Scottish Government: “Housing Statistics for Scotland – All sector new build”, www.scotland.gov.uk/Resource/0046/00463933.xls, “Housing Supply – Data”

[4] Interesting that the figures for 2005 and 2006 are exactly the same, which makes you wonder about the accuracy.

[5] Source: “Empty Homes”: www.scotland.gov.uk/Topics/BuiltEnvironment/Housing/supply-demand/emptyhomes

[6] Source: Shelter “Research briefing: Housing Investment: Part 1”, June 2010

[7] Source: Positive Money website: www.positivemoney.org/how-money-works/howmuch-money-have-banks-created/

[8] Source: Scottish Government: “High Level Summary of Statistics data for Housing and Regeneration trends”, www.scotland.gov.uk/Resource/0046/00463534.xls, “House prices – chart”

[9] Source: Scottish Government: “Private Sector Rent Statistics, Scotland (2010 to 2014)”, www.scotland.gov.uk/Resource/0046/00463501.xls, “Table 11, Chart 12”

[10] Source: Mortgage Finance Gazette, “Negative equity: in decline, but still a major issue for many”, www.mortgagefinancegazette.com/industry-comment/negative-equity-indecline-but-still-a-major-issue-for-many/