Banks and chutzpah
I’ve been trying to stay away from the banking crisis, which is a big fast-moving story which has been well-covered elsewhere. But some of the events of the past few days have reminded me of the story about the definition of chutzpah: the boy who kills his parents and then throws himself on the mercy of the court because he is an orphan.
In the Financial Times, Martin Wolf gets to grips with the case for tighter bank regulation in the face of bankers’ recommendations of ‘voluntary best practice’. The case is not very complicated; the historical record shows that they are extremely poor at regulating themselves, even over the last twenty years when conventional wisdom (i.e. the banks’ PR) has it that self-regulation has been satisfactory.
Wolf quotes a recent report from the bankers’ association, the Institute for International Finance:
In an interim report on “market best practices”, the Institute for International Finance, an association of bankers, offers devastating self-criticism.* Here then are some of the weaknesses it identifies: “deteriorating lending standards by certain originators of credit”; a “decline of underwriting standards”; an “excessive reliance on poorly understood, poorly performing and less than adequate ratings of structured products”; and “difficulties in identifying where exposures reside”. Would you buy a voluntary code from people who describe their own mistakes in this brutal manner? I thought not.
He cites two additional reasons to be sceptical about the banks’ capacity for self-regulation. The first is the obvious one; that in an industry under pressure, some will be tempted not to comply – which immediately tempts the hitherto honest compliers to break with the code as well.
The second is much more serious: that according to a recent paper, “the banks have form”. In 1983, large parts of the industry were effectively bankrupt, and they promised to sort themselves out. According to Carmen Reinhart of the University of Maryland and Kenneth Rogoff of Harvard (abstract here), the incidence of banking crises (measured by the proportion of countries affected) has been as high since 1980 as in any period since 1800, and the incidence of banking crises is correlated with liberalisation of capital flows.
In other words, as Wolf observes, the banks have failed – unlike pretty much every other industry or sector – to improve their standards of performance over a period of about 200 years.
At the same time, they are still hard at work lobbying governments to help them out. As has been observed several times since the current crisis began, one of the problems with the financial sector is that profits are privatised but losses are socialised, a continuing ‘moral hazard‘ – and an expensive one for the rest of us. On the Our Kingdom site you can almost see Tony Curzon-Price rolling his eyes as he describes the UK banks’ apparent proposals to the government to swap their now risky loans for government bonds.
Let’s be clear what this swap means: the banks hold loans, or derivative instruments on loans, guaranteed by properties whose value everyone now accepts were set in a massive debt-fuelled property bubble. Government bonds, on the other hand, are backed by the State’s power to tax us. Over the next three years – the term expected for these rescue loans – house prices will come close to halving, so the collateral for the banks’ mortgages will be bad. … No wonder the banks want to swap these assets for ones backed by taxpayers.
Curzon-Price suggests a different model for this trade-off between the citizens and the banks: as with Northern Rock, “if we own the risk, we own the bank.”
There’s a curious clue to the banks’ mindset – at least that of the US banks – buried in Paul Krugman’s blog today. Krugman follows the so-called ‘TED spread’ – which is the difference between the yield on all but risk-free Treasury bills, and LIBOR (“the London inter-bank offered rate”, or the reported rate at which banks are willing to lend to each other). Normally, these track each other reasonably closely; inter-bank lending has slightly higher risks, so LIBOR is normally slightly higher. A chart in his column from the Wall Street Journal shows how the inter-bank rate has surged at critical times during the current financial crisis. But the WSJ says it may be worse than it looks, because there are concerns that the banks are lying about the rates they’re having to pay. As the WSJ says:
The concern: Some banks don’t want to report the high rates they’re paying for short-term loans because they don’t want to tip off the market that they’re desperate for cash. The Libor system depends on banks to tell the truth about their borrowing rates.
In other words, pulling this together, banks are mendacious, unreliable, and are incapable of learning from their mistakes. You can imagine how the tabloid press might treat people with these characteristics who expected the state to give them money. They’d probably call them scroungers.
For some reason this brings to mind a joke I heard when I was working as a financial journalist during the 1983 crisis:
How do you buy a small bank? Easy – you buy a big one and wait for a while.