A catalo g ue of
credit-crunch cant
Simon Nixon challenges the new conventional wisdom that all bankers are greedy, share traders are spivs, governments know best and capitalism is doomed We live in frightening times. Markets are in freefall; economies are in turmoil; the financial system is on the brink. People want simple explanations and easy answers. They want to know who to blame for the mess and what can be done to clear it up. Just as well, then, that there is no shortage of politicians ready to fulfil this need. The dictionary defines ‘cant’ as insincere, pious or moralistic talk. If cant was a commodity, it would be the first big bubble of the post-credit-crunch world.
Already debate over the credit crunch is being reduced in some quarters to a series of simplistic narratives in which all bankers are greedy, markets are evil, governments are good and capitalism is doomed. Politicians who showed no interest in the City whatsoever for a decade — except to sing its praises as the engine of the UK economy — now claim to have seen this crisis coming for years. Often these are the same politicians who until a few weeks ago were still arguing over how to share the proceeds of growth.
Anyone who tries to challenge the emerging conventional wisdom gets short shrift. On Newsnight last week, Jeremy Paxman was breathtakingly rude to a respected City economist, Diana Choyleva of Lombard Street Research, who dared to suggest that the bubble may have been partly the fault of policymakers rather than solely the fault of bankers. But it is important that trite explanations for complex problems are challenged before they become the basis for muddled policymaking that leaves us even worse off. Here are my top five examples of creditcrunch cant.
It’s all the fault of greedy bankers. Bankers make an easy target — much too easy for an unpopular populist like Gordon Brown to resist: the Prime Minister who once boasted about light-touch regulation is now promising a crackdown on City bonuses. No doubt the City’s Heads-I-Win-Tails-You-Lose incentive structures did play a part in the crisis — but hardly the most important part. Bankers are no more culpable than anyone else who played their part in inflating the gigantic bubble: complacent central bankers who kept interest rates too low; greedy homebuyers with unaffordable mortgages; reckless gov ernments that hid their profligate borrowing off-balance sheet.
Besides, are bankers any greedier than their shareholders, who demand big returns on their investment? Or their depositors, who want the best rate of interest on their accounts? Bankers are paid to take risks with other people’s money and must compete for funds, so the temptation to overstep the mark will always be there. That’s what regulators are paid to spot. And before anyone puts too much faith in new incentive structures, remember which Wall Street bank famously paid the highest proportion of its bonuses in long-term locked-up share options: it was Lehman Brothers.
Financial deregulation went too far. Every Conservative who appears on the BBC faces accusations that it was their party’s blind faith in free markets that caused the crisis. It’s happening to John McCain in the US too. Of course this crisis is partly the result of shocking regulatory failure, but was it really because regulators had too few powers — or did they fail to use the ones they had? What aspects of deregulation are to blame? An Observer editorial last week even dredged up Big Bang, way back in 1986. Others have pointed the finger at the decision in 1999 to repeal America’s Glass-Steagall Act, that totemic piece of Depression-era legislation which separated commercial and investment banking to protect depositors from the volatility of the securities business. But GlassSteagall was already largely obsolete by the 1990s thanks to the growth in securitisation, which blurred distinctions between traditional lending and underwriting securities. That’s why the regulatory focus switched to supposedly stricter capital controls — which banks soon got around by using off-balance sheet vehicles and derivatives. But that’s an argument for smarter regulators, not new laws. Besides, any return to Glass-Steagall looks out of the question now: the last two independent investment banks, Goldman Sachs and Morgan Stanley, announced this week they are to start taking deposits.
Banks became too reliant on wholesale funding. It’s all the fault of greedy ex-building societies such as Halifax and Northern Rock, according to another frequently aired line of attack. If only they had stuck to their traditional deposit-taking rather than embracing the heady new world of securitisation for the bulk of their funding. With the benefit of hindsight, this looks like a statement of the bleeding obvious. When wholesale funding markets dried up last summer, banks were left with big liquidity problems and Northern Rock ended up being nationalised. The fact that even Goldman Sachs and Morgan Stanley are now seeking the solidity of retail deposits shows that wholesale funding was always a high-risk game.
But not so fast: this new-found enthusiasm for retail funding is not all it seems. At a time when fears over bank solvency are driving away other sources of funding, the big advantage of retail deposits is that they are government-guaranteed, which makes them potentially more stable. Without this guarantee it’s a reasonable bet that most Western bank deposits would now be safely tucked under mattresses. In the short term, propping up potentially bust banks with retail deposits can help put off the reckoning; but if solvency does become an issue, taxpayers will be left to foot the bill. Besides, regulators will extract a penalty from banks that turn to retail deposit-taking — by imposing stricter limits on the risks they can take: that means even less credit available to the market.
Short-sellers caused banks to collapse. Traders engaged in the age-old practice of selling shares they don’t own in the expectation of buying them back cheaper have been dubbed ‘spivs’, ‘speculators’ and ‘robbers in pinstripes’. In response, the FSA has banned short-selling of financial stocks. Yet the actual level of short-selling in Lehman Brothers and HBOS — two of the banks whose share price collapse prompted the ban — was very small. The real selling pressure came from existing shareholders worried that the banking sector was bust. And the risk now is that banning short-selling will do more harm than good. Smart traders will easily find other ways to express their bearish views via the derivatives markets, so any share price relief will be short-lived. On the other hand, this attempt at government manipulation of share prices will make it hard for investors to hedge positions, and so raise the cost of capital for banks.
Big is best. Government ministers were quick to take to the airwaves to tell us that the merger of HBOS and Lloyds TSB will be safer because it will be so big. Conventional wisdom says that the solution to the crisis lies partly in the takeover of weak banks by stronger ones. No doubt the mergers of the last two weeks were vital to prevent a catastrophic collapse of the financial system. But long-term, big is far from best since it creates new banks more likely to be deemed too big to fail, thereby increasing moral hazard and consequent risks to taxpayers.
The real lesson of the credit crunch should be exactly the opposite — that banks need to be smaller. In a healthy free market, it should be possible for banks to fail without triggering Armageddon. The credit crunch shows not that markets were too free — but that they were not free enough.
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