Last week, Britain's Parliamentary Commission on Banking Standards issued a report that lists a number of recommendations for an overhaul of the country's banking sector. The idea is that Chancellor George Osborne includes them in his Banking Reform Bill, a preliminary draft of which was publicly criticized by the Commission in March.
Whether the government will actually follow the recommendations, however, remains to be seen; PM David Cameron and his cabinet have sung their praises of the City and its importance for Britain's economy on countless occasions. Which looks a little strange at times, especially those times when the state is forced to bail out, save, break up and/or nationalize yet another bank. Lately RBS has been added to the roll, and by now every "High Street" bank must have had some sort of government "treatment". A few CEOs were fired, with Downing Street 10 obviously hoping that would calm the waters. So far, amazingly, it seems to work: it's all bout keeping the customer satisfied. And clueless.
The importance of Britain's banks may well stem mostly from the fact that they're bloated behemoths operating in a financial sector that itself is seriously bloated when compared to the nation's overall economy. But Albion has a government that is in love with this bloat; oh, to be a global financial center, the envy of the world!
An nice example of the level of deep thought, albeit on an unrelated topic, that prevails in Cameron's government came from Environment Secretary Owen Paterson. Paterson's been pushing for a British, if not European, full embrace of genetically modified food for some time now, and apparently he's not satisfied with the progress he's been making in his quest, so he goes for broke and states that GM crops are safer than conventional crops.
I don't remember ever having seen even Monsanto itself make that claim. It's like when the US Supreme Court ruled last week that corporations can't patent human genes, and certain members of the US media stated that the decision "stifles free market innovation". Boy, if ever physicists need proof for their multiple universes theory, look no further.
But let's get back to the Parliamentary Commission on Banking Standards. Here's a few news snippets about their report, starting with the Guardian:
George Osborne is facing pressure to radically overhaul Britain's banks by introducing a new law to jail bankers for "reckless misconduct" and force bankers to wait up to 10 years to receive their bonuses.
The proposals, among the key measures recommended in a major report by the parliamentary commission on banking standards, also include a call on him to consider breaking up the Royal Bank of Scotland. They come ahead of the chancellor's crucial set-piece Mansion House speech to the City on Wednesday night.
The chancellor is urged to restore confidence in the financial system by making top bankers more accountable for their actions in the wake of the 2008 bank bailouts, the Libor rigging scandal, and the shoddy treatment of customers mis-sold payment protection insurance.
The senior Conservative MP Andrew Tyrie, who led the commission, said the 80 or so recommendations were intended to "change banking for good". They also include giving regulators new powers to halt bonus payouts and pensions for bosses of any banks that have to be bailed out by the taxpayer in the future. "It is not just bankers that need to change. The actions of regulators and governments have contributed to the decline in standards," Tyrie added.
And Bloomberg said:
Senior employees at U.K. banks may face a 10-year wait for bonuses under proposals put forward by a committee investigating the failures of the industry, which also recommended making "reckless" management of lenders a crime.
A "substantial part" of variable compensation for the highest earners at banks including Barclays and HSBC should be deferred for up to a decade to better align their interests with shareholders, the Parliamentary Commission on Banking Standards said in a statement today. Its proposal to introduce a criminal offence for mismanagement, which could see executives of failed firms facing jail time, was endorsed by Prime Minister David Cameron.
"The potential rewards for fleeting short-term success have sometimes been huge, but the penalties for failure, often manifest only later, have been much smaller or negligible," the authors of the report said. "Banks should understand that many consider the levels of reward in recent years to have grown to grotesque levels at the most senior ranks."
Of the 80 recommendations, what stands out for the press is the threat of jail time for bankers, an obvious media favorite even if not very well defined as far as I can see. What might accomplish more is the 10-year delay in bonus payouts, since the typical addict seeks instant gratification and might be thrown off by having to live a modest life for 10 more years. A bonus delay without strict rules on salaries wouldn't help much, though, for obvious reasons. A third recommendation that stands out is the commission's desire to see more women on the trading floor, because it thinks this might prevent excesses from happening. I'm a big advocate of equal rights for women in all walks of life; however, being hired not for your qualities, but just to balance out testosterone levels looks like a mixed blessing at best.
More comments come from John Plender in the Financial Times:
As Sir Mervyn underlined in his speech at the Mansion House on Tuesday, the UK banking system remains in no condition to make an adequate contribution to economic recovery. There has been some regulatory progress, not least with a new resolution regime to ensure the orderly unwinding of insolvent banks and with the Vickers Commission proposals to ringfence the retail operations of universal banks. Until the commission’s proposals are implemented, though, we will not know whether the implicit subsidy enjoyed by banks hitherto deemed too big to fail has been removed or that banks will no longer be able to call on taxpayers to keep them solvent.
[..] … the Bank of England’s Andrew Haldane [..] would like more attention to be paid to a simple leverage ratio requiring a minimum level of equity capital in relation to bank liabilities. Yet Basel III’s backstop leverage figure is just 3% by 2019. For a banking system to operate on the basis that a fall of a mere 3 per cent in the value of bank assets will wipe out the banks is simply absurd; all the more so when banks’ risk-management techniques were shown to be hopelessly flawed in the crisis, yet remain substantially unchanged. [...] It follows that on current policy another financial crisis is probable.
On the issue of leverage the global climate is shifting a little in the direction of sanity, with the Brown-Vitter bill in the US Congress rejecting Basel III and demanding a minimum 15 per cent leverage ratio for the largest US banks. And the PCBS has recommended that political control over the leverage ratio, the single most important tool to deliver a safer banking system, should be relinquished in favour of the regulators. [..]
Mr Carney faces a formidable set of challenges as incoming governor of the BoE. The balance sheets of Britain’s largest banks still amount to 400% of the economy, which is too big for comfort. Their culture is rotten. Mr Osborne has clearly indicated that he regards the task of stabilising the economy as lying primarily with the central bank, so Mr Carney will be blamed if a decent recovery fails to materialise in the face of a heavy fiscal headwind. The interaction between monetary policy and the BoE’s new financial stability function is uncharted, risky territory. [..]
Banks everywhere are freighted with too heavy a burden of potentially toxic sovereign debt, leaving them vulnerable to rises in bond yields, especially in Japan. So while recent events in banking are modest cause for optimism, both the UK and the world remain hostage to unreconstructed bankers and their powerful lobbyists, to whom government ministers are extraordinarily deferential. The global economy and taxpayers everywhere are still seriously at risk.
While Simon Johnson writes in the June 26 Guardian:
The devil is always in the details. And the greatest devils of our economic age lurk in the details of how officials regard the capital – the equity funding – of our largest banks. Government officials have identified far too closely with the distorted, self-interested worldview of global banking executives. The result is great peril for the rest of us. [..]
To understand the precise problem, you must dip into the latest details of the Prudential Regulatory Authority's "capital shortfall exercise" with eight major UK banks. I won't pretend that the PRA's work is easy reading for a layperson; but anyone who spends a little time with the documents will first laugh and then cry.
With great fanfare (and generally favourable press coverage), the PRA announced that some banks do not have enough loss-absorbing capital – relative to target levels of equity that are ludicrously low. The Bank of England's financial policy committee (FPC) said that the target should be 7% of risk-weighted assets under Basel III definitions. And, in the PRA's presentation, this amounts to a leverage ratio of around 3% for most of these banks (again using Basel III definitions), though a couple of banks will need an additional adjustment to reach that level.
In plain English, a supposedly well-capitalised bank in the UK can have 97 cents of debt per one dollar of assets (and just three cents of equity). Such a low loss-absorption capacity would get you run out of town in the US, where regulators are weighing a 5-6% leverage ratio (twice as much equity on a non-risk-weighted basis), and some responsible officials are still pushing for 10% or higher.
[..] … the potential for more tears for taxpayers – still reeling from the cost of rescuing the Royal Bank of Scotland (RBS) – looms large. The invitation to banks to game the risk-weighting system further is stated plainly: "In line with the FPC recommendation, the PRA has accepted restructuring actions which, by reducing risk-weighted assets, will credibly deliver improvements in capital adequacy." In other words, the banks can change how they calculate risk – for example, by tweaking their own models – in ways that will make them look better as far as regulators are concerned.
All seemingly sane words, but the by far best take on the entire matter, in my view, comes from our friend Joris Luyendijk. He's run his Banking Blog (Going Native in the World of Finance) at the Guardian since 2011, for which the paper specifically assigned him the task of delving into the hearts, minds and psyche of the people who work in the City of London. He's interviewed over 200 of them, with often amazingly open access to key people, and written hundreds of articles about what he found out while talking to the bankers.
In one of his recent pieces, Joris draws a number of conclusions from his experiences. He was asked at an earlier stage to give evidence to the Parliamentary Commission on Banking Standards, but if they share his conclusions, or have even considered them, they're certainly not telling us. Ultimately, Joris draws what is in reality the only possible conclusion, but also the one that will meet most resistance. As long as the banks that are being discussed hold on to the political clout they presently possess, they rule the world.
Jailing reckless bankers is a dangerously incomplete solution. The market is bust. Institutions that are too big to fail are too big to exist
Seeing the British establishment struggle with the financial sector is like watching an alcoholic who still resists the idea that something drastic needs to happen for him to turn his life around. Until 2008 there was denial over what finance had become. When a series of bank failures made this impossible, there was widespread anger, leading to the public humiliation of symbolic figures. But the scandals kept coming, and so we entered stage three – what therapists call "bargaining". A broad section of the political class now recognises the need for change but remains unable to see the necessity of a fundamental overhaul. Instead it offers fixes and patches, from tiny increases in leverage ratios to bonus clawbacks and "electrified ring fences".
Today's report by the parliamentary commission on banking standards (to which I gave evidence) is a perfect example of this tendency to fight the symptoms while keeping the dysfunctional system itself intact. The commission, set up after last year's Libor scandal, identifies all the structural problems and nails the fundamental flaw in finance today: "Too many bankers, especially at the most senior levels, have operated in an environment with insufficient personal responsibility." Indeed, as they like to say in the City, running a mega-bank these days is like "Catholicism without a hell", or "playing russian roulette with someone else's head".
In response, the commission proposes jailing reckless bankers. Restoring the link between risk, reward and responsibility is a crucial step towards a robust and stable financial sector. But the report's focus on individual responsibility is also dangerously incomplete because it implies that the sector is merely out of control. This plays into the narrative that things can be fixed by tweaking rules and realigning incentives; in other words, by bargaining.
In reality the financial sector is not out of control. It's beyond control.
It's important to realize that measures ostensibly aimed at improving matters can instead be dangerous to any actual improvement. This is valid not just for this particular subject, it's widespread. There are lots of people out there busy defining goals and initiatives in all sorts of fields that seem beneficial at first glance, but work out to harm the very purpose they're meant to accomplish. Meaning well is mostly not enough, and moreover when it comes to a topic like banking reform you really have to spend some serious time wondering who truly means well and who is just pretending.
During the past two years I have interviewed almost 200 people working in finance in London: "front office" bankers with telephone-number bonuses as well as those in "risk and compliance" who are meant to stop them being reckless. I have also spoken to many internal and external accountants, lawyers and consultants.
The picture emerging from those interviews is of big banks not as coherent units run by top bankers who know what they are doing. Instead these banks seem, in the words of Manchester University anthropologist Karel Williams, a "loose federations of money-making franchises". [..]
[..] … employees at the big banks themselves do not believe their top people know what's going on; the big banks have simply become too complex and too big to manage. If this is true, the solution is not so much to jail the top bankers when something goes wrong, it is to break up the banks into manageable parts. But the British establishment still seems incapable of accepting the notion that a bank that is too big to fail or manage is also a bank that is too big to exist.
I don't know that the British establishment is incapable of accepting that (kind of) notion, as Joris suggests. They may simply not see how it would be to their benefit. Typically, the establishment (the word says it all) benefits from what has already been established, and that certainly includes the present financial system. They're like the alcoholic who doesn't want to turn his life around because he realizes drinking makes him rich. The metaphor slips way off track here, and that's no coincidence.
The same seems to apply to the need to restore market forces in the financial sector: the second source of structural dysfunctionality. Imagine a restaurant had served up product as toxic as that which big banks, credit rating agencies and accountancy firms were churning out until 2008. You would expect that restaurant to have closed. You would also expect new restaurants to have opened up in the area. This is how a free market should work: competition drives out bad practices.
But where are the new credit-rating agencies, accountancy firms or big banks? Even worse, not only are there just four major accountancy firms, they are also financially dependent on the very banks they are supposed to audit critically. It's the same with the three credit-rating agencies dominating the market.
And it gets worse. Imagine that a restaurant in your neighbourhood made the kind of money paid to top employees in banking, credit-rating and accountancy firms. You'd expect people rushing to open more restaurants, and with that increased competition you'd expect wages to come down. Again, this is how competition works. There are thousands and thousands of young graduates aching to get into investment banking, so no shortage of prospective chefs. So where are the new players in high finance?
Yes, it's ironic: free market advocates who defend systems and corporations that kill off the free market, and then claim that they have a divine right to do so, that indeed that's how you recognize a free market: by the right to stifle competition. It's as convoluted as the alcoholic's metaphor. Or the US Supreme Court ruling that a corporation is a person. A free market is truly free only when it allows for participants to kill off the free market.
The reality is that global high finance is de facto a set of interlocking cartels that divide the market among themselves and use their advantages to keep out competitors. Cartels can extract huge premiums over what would be normal profits in a functioning market, and part of those profits go to keeping the cartel intact: huge PR efforts, a permanent recruiting circus drawing in top academic talent; clever sponsoring of, say, an ambitious politician's cycling scheme; vast lobbying efforts behind the scenes; and highly lucrative second careers for ex-politicians. There is also plenty of money to offer talented regulators three or four times their salary.
Capitalists have an expression for this, and it's "market failure". Here is the source of so many of the perversities in modern finance, and the solution is not only to denounce those who can't resist its temptations, it's to take away those temptations. That probably means smaller banks, smaller and independent accountancy firms and credit-rating agencies, simpler financial products, and much higher capital requirements.
Cartel forming is of course the ultimate reason to break up the banking sector (it's as illegal as it gets). Ironically, it's also the reason that it is so hard to do.
Before studying bankers I spent many years researching Islam and Muslims. I set out with images in my mind of angry bearded men burning American flags, but as the years went by I became more and more optimistic: beyond the frightening rhetoric and sensationalist television footage, ordinary Muslim people go about their day like all other human beings. The problem of radical Islam is smaller and more containable than Islamophobes believe.
With bankers I have experienced an opposite trajectory. I started with the reassuring images in my mind of well-dressed bankers and their lobbyists; surely at some basic level these people knew what they were doing? But after two years I feel myself becoming deeply pessimistic and genuinely terrified. This system is highly dysfunctional, deeply entrenched, and enormously abusive, both to its own workers and the society it operates in. The problem really is exactly as bad as the "banker bashers" believe.
Few people by now will know what goes on behind the curtains of the City better than Joris Luyendijk. His conclusions are about as clear as can be. Still the banking commission can quite simply listen to him, declare they took note, and then ignore him because he's only a journalist, not a banker, and therefore what does he know?
The reality behind a parliamentary banking commission in today's world is that there are no politicians capable of doing things, no matter how just and justified they may be, against the implicit and explicit demands of the financial elites in their countries. As far as the most important political positions are concerned, they are available only to those who align themselves with these elites. So it's not just the financial world that should be subject to a total overhaul, the political world that should execute that overhaul needs one as well. And that's not going to come from within.
In essence it's as easy as pie: A financial world that cannot function without a constant influx of public funds is obviously dysfunctional. So start by putting a halt to the bank bail-outs. Break up the banks into smaller units, and separate commercial banks from investments banks. The question is not which are the proper measures. The question is who will execute them. It won't be the – political – establishment, because in the present situation they (like the bankers) can all keep playing russian roulette with someone else's head, and they like it that way.
Any changes would have to come from people who get sick and tired of having their heads played with.
Lewis Wickes Hine Sleepy Heads 1936
"Mt. Holyoke, Massachusetts – Paragon Rubber Co. and American Character Doll. Setting eyes in sleeping dolls (Jewish) A plus."