Why We Need Traditional Banking
Thirty years ago, Lowell Bryan, a McKinsey & Company director, declared, "a new technology for lending — securitized credit — has suddenly appeared on the scene. This new technology has the capacity to transform the fundamentals of banking, which have been essentially unchanged since their origins in medieval Europe." Bryan predicted that traditional lending might soon become obsolete: "About half of all debt in the national economy is raised through securities; that number might increase to 80% in the next decade."
His prediction of an impending transformation was borne out. Securitized credit, essentially tradable securities created by pooling mortgages and asset-backed consumer loans, surged by more than 10-fold after 1987 to over $4.5 trillion outstanding in 2001, and, in spite of a sharp decline after the 2008 crisis, recovered to over $8 trillion in 2017. Further vindicating Bryan's forecast, traditional bank loans have shrunk to just a fifth of private debt in the U.S.
This latter part of the equation — the declining role of traditional bank lending, and indeed traditional banking more generally — has been an underappreciated element of the transformation of American economic life. We have paid some attention to the growing role of securitization, especially given its centrality to the 2008 financial crisis. Specifically, the crisis crystallized the worry that securitization makes loan originators careless: Why waste your efforts on due diligence if you can pass on the risk of bad loans to diffuse buyers in anonymous markets? But this worry has generally been offset by the view common among financial economists and financiers that securitization makes for more "complete" markets (allowing more kinds of borrowers and forms of risk to be aggregated) and that more complete markets are inherently better.
This now-standard tallying of the benefits and risks of securitization omits the costs involved in the decline of old-fashioned banking itself. And those costs are quite significant. A financial system that downgrades the role of banks becomes dangerously dependent on nearly blind trust in generic credit scores — a risk still underappreciated even a decade after the financial crisis. The marginalization of traditional banking also discourages lending to small businesses, which are essential to America's economic dynamism. And it tends to over-centralize the supply of money, and therefore of credit, in ways that distort our economic life.
Instead of applauding the greater "completeness" of anonymous debt markets, we should lament the marginalization of traditional banking. And we should work to reverse it.