As DG Markt Director General Jonathan Faull writes to the FT about the lobbying of Basel III and European Commission, and politicians and protesters with their “Banker Wanker” posters (and worse) blame the banks alone for the recent crisis and current financial climate…
the more windows get smashed or buildings occupied… I just wonder whether any of us really know what banks are for?
Put in really basic terms, banks basically do two things: they take in short term deposits and give out long term loans. This is known as a “maturity transformation”.
But it seems that the major issues that caused banks to collapse were inability to properly manage this basic maturity transformation:
1) running out of funding (like Northern Rock)
2) running out of cash (like Lehman Brothers)
3) inadequate risk management regarding quality of loans (primarily a problem in the USA).
We’ve heard a lot about the last bit, complex packages of bad debt and whatever. Gordon Brown as PM blamed this third issue for the whole of the banking crisis. But it is really quite simple: loans are things like mortgages, car loans, student loans, the sorts of everyday loan we can get our heads around.
Everything else is just a different way of packaging these up – e.g. as bonds to flog on the market. That gives a different product which attracts a different sort of investor and therefore more money to be paid as interest, borrowed by those needing it etc. Is this an inherently risky business? Or is it the lack of transparency and understanding about what’s in the packages that’s risky?
I can’t help thinking it’s both the quality of the original loan and also management of the maturity transformation that are crucial here.
So banks borrow short and lend long.
Northern Rock basically seems to have run out of funding for its 25-year mortgages – for which it was borrowing a month at a time. D’oh.
Lehmans, meanwhile, ran out of cash – a liquidity problem. As a bank you need to be able to pay up at all times. Many deposits are repayable on demand, and banks have to assume they will be asked to do and if they can’t, the bank goes bust.
You can imagine Lord Sugar on The Apprentice shaking his head in disbelief that these simple concepts cannot be grasped by the self-proclaimed business experts standing before him.
While in the EU we were affected by the US sub-prime loans, unlike the US where these things were not really regulated, in the EU it was. It’s not that banks don’t have capital standards – the existing Basel standards have been around for about 20 years.
So the Basel Convention and the European Commission are trying to design two metrics for the other two crisis causes to stop all this happening again.
There’s going to be a Lehmans Ratio – so that payments out can always be made for a month – and a Northern Rock Ratio (known as a Net Stable Funding Ratio) for a year’s funding. And these new standards are being drawn up in just a couple of years.
Real care needs to be taken that the standards set are not so demanding that they will have a negative effect on the economy.
For example, one impact of the Northern Rock Ratio is that it reduces the amount of maturity transformation i.e. there’s more matching of assets against liabilities. That means it is more difficult to fund long term.
Good, we might think – that means the wrong people won’t get loans.
But what about large scale infrastructure projects? If we can’t fund them through banks, other sources of funding will need to be sought, such as the market. And that brings a whole load of other insecurity…
While banker bashing is fun, it is not going to fix the system. Nor will breaking up the banks fundamentally tackle this, merely making banking more expensive for consumers. All these things really do is make it look as though the failure is distanced from the political decision making process – which of course it never can be. Choosing not to act, failure to regulate or supervise effectively is a political decision just as much as choosing to do so.
The key question is whether our primary aim is to have processes for handling banks when they fail, or whether we should be focusing on building an economic system that doesn’t presuppose this.
As for the idea that if taxpayers don’t have to bail out the banks, we don’t have to pay, that’s to fundamentally misunderstand the nature of our economy. If a bank fails and we pay for nationalising it through our taxes, it’s a visible cost.
But the overall increase in costs from politically attractive but economically risky metrics also affect us all – as shareholders, as mortgage borrowers facing increased interest rates or higher entry hurdles, as entrepreneurs with start-up needs or business owners looking to expand through loans, and crucially through our pensions. Yes, you did read that right, reduced bank profits means reduced dividends which directly affect our pensions pots.
Ah, but not every one is affected, right? Mortgages, shares, workplace pensions… not everyone has them and this way the poorest don’t have to pay for the greedy bankers? But given the lowest paid have been lifted out of tax, they wouldn’t have been hit that way anyway, so that’s just disingenuous. We all pay.
And we shouldn’t, you may say. Let the bankers pay!
Bankers get million pound bonuses! Yep, some do. In the UK, according to former City minister Paul Myners, last year it was 5000 bankers out of a million people working in financial services. Well, if we want to debate the inherent unfairness in pay and reward structures in our capitalist economist, and the value to the economy of farmers, call centre workers, teachers -v- say, premiership footballers who merely kick a ball around a field for 90 minutes, that’s a whole other blog post.I think we need to differentiate between our sense of social injustice and convenient scapegoating of the bankers.
If we are to think about an economy that is about economic growth and not on bank failure, then we need to move away from the assumption that nothing can be done and these things just happen – somehow bubbles that burst bringing down the economy are an inevitability.
Alan Greenspan had a mantra that it is cheaper and easier to mop up after an economic bubble bursts. He’s been proved wrong.
What we really need is a more mature way of thinking about bubbles.
Bubbles are very rarely economy-wide. So if it’s a property bubble, we need to have targeted measures aimed at deflating that sector. How do we tell if there’s a bubble? Loads of economic analysts argue over this, but essentially it’s a bit like pornography – almost impossible to pin down but you know it when you see it…
Is there a bubble at the moment? Well, not easily seen.
But some food for thought – LinkedIn was recently valued at what equates to $100 a user. I don’t know about you, but I’ve not put $100 into my LinkedIn use and would withdraw my details before seeing them sold – so unless some people are putting in thousands of dollars, I can’t see how that worth is derived. Is this a new 1990s style internet bubble? Who knows?
But will all this activity make the banking system less likely to fail in future? Don’t bank on it.