The banks must be made to feel pain

Earlier this week, the bosses of banks like HSBC, Barclays, HBOS and RBS, together with leading investment bankers and hedge fund managers, trooped in to see Gordon Brown and demanded that the government ‘do something’ about the credit crunch. Sure enough, this was followed soon afterwards by the Bank of England’s bail-out plan in which the taxpayer will take on the liability for the the banks’ mortgage loans in return for government bonds.

Now am I missing something here or have the bankers just taken chutzpah to new heights? Through their incompetent investments and dodgy financial instruments they get the economy into a mess, then they demand that the government does something to dig us all out of the cesspit they have dropped us in.

Let’s briefly recap on how this happened. Banks packaged up dodgy mortgages using financial instruments that made them look like good bets. Other banks bought them without looking too closely at the potential risks. These financial instruments were so complex that, when things began to go wrong, the banks were unable to work out who was left holding most of the sub-prime babies. Therefore they stopped lending each other money.

So if the banks aren’t willing to lend to each other, is it reasonable for them to demand that the government does so? If the banks can’t work out which mortgage assets are sound and which ones are not, how on Earth is the government going to make this call? Sure, the government may issue bonds for a lower value than the mortgages it takes on but how will it be able to accurately assess the value of these mortgages when the banks themselves admit that they don’t know where the toxic debt is? Once again, this looks like another case of privatising profit and socialising costs. Vince Cable, one of the few politicians who cuts to the chase on these issues, is worried. As he says:

We cannot have a situation where the banks are able to privatise their profits and nationalise their losses.

The Government must now insist on a orderly programme for identifying the losses in the banking system to ensure the banks themselves cover those losses.

This looks like rewards for failure and irresponsibility.

Indeed it does. In most industries, if you screw up there is a penalty but banking, it seems, does not work like that. Because the banking system is so crucial to the stability of the economy, the industry’s magnates know that the government cannot let even one bank go to the wall for fear of the knock-on effect that might lead to the whole system collapsing. Therefore, they can be confident that, when push comes to shove, the government will always step in and bail them out.

If you mess the travelling public around by cancelling their flights, forcing them to sleep airport terminals and making their bags disappear, eventually you get fired. But if you make people homeless and destroy their pensions, savings and livelihoods by making silly investments, hey, that’s just the way things go isn’t it? The government has to ‘do something’ and the bankers slink off into the shadows, having been let off the caning they so richly deserve.

Free-market fundamentalists will argue that the only way to deal with this incompetence is simply to let banks collapse. The idea of a metaphorical Anne Robinson saying “Adam Applegarth, you leave with nothing” does have a certain appeal. However, the effects on the economy would probably be catastrophic and even in the spiritual home of free-market capitalism they are not prepared to let that happen.

Yet, as Martin Wolf said in yesterday’s FT, it is important that bankers suffer for their bad decisions or they will get us into this mess again.

It is…crucial that the institutions, and unsecured creditors, feel some pain: the burned child fears the fire; singeing is less effective.

But he is sceptical about the effectiveness of regulation.

Regulators are doomed to close the stable doors behind financial institutions that always find new and more exciting ways of losing money.

In other words, the same weasels that invented the instruments that got us into this mess will invent new ones to get round any future regulation.

Those bankers that demand government intervention to get them off the hook will, probably in the same conversation, also assert their right to be free from state regulation. But it is time governments stopped allowing them to call the tune. If they want state intervention, they should be made to accept regulation as a quid pro quo. I don’t know enough about banking to know what would work and what wouldn’t but I have heard a few interesting ideas recently.

Forcing the banks to keep higher levels of liquidity would be a good start. Making them pay some of their huge profits into a bail-out fund as an insurance against a bank’s collapse would ensure that the costs of a rescue would not have to be met by the taxpayer. Other professions such as lawyers and travel agents do this so why not make the banks carry similar insurance too?

And as for the government taking on their dirty mortgages, shouldn’t it also take a share in the banks or impose a special tax on their profits until these debts are either paid off or returned to their original owners?

Bank shares have already risen this morning in response to the Bank of England’s rescue package. Soon, the banks will be making vast amounts of money again. By right, shouldn’t they owe some of that cash to the taxpayer? Isn’t it time that pain and profit were shared more equally between the banks and the the rest of us?

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4 Responses to The banks must be made to feel pain

  1. Pingback: Mortgage News Aggregator » The banks must be made to feel pain

  2. Dr Ed says:

    Three things need to happen:

    1) Banks need to be forced to conform to Basle II regulations. This would stop them lending £40 for every £1 they own and just hiding the extra debt in ‘separate’ companies. (I’d imagine this probably will happen)

    2) The government should demand some shares in all the banks it lends to; not huge amounts, just a few percent. Then the tax payer will reap at least some of the rewards that the banks shareholders will gain from the public intervention. (I think we’ve already missed the boat on this one).

    3) Moodys, S&P et al should be held accountable for their actions. If they are there to rate the debt being sold, they should be paid by the buyer and not the seller, and should be forced to pay out some compensation if their forecast differs significantly from the actual returns.
    Or banks should be forced to hold10% of the loans they give out. Both would work.

  3. Pingback: Barclays - not short of cash after all « Flip Chart Fairy Tales

  4. Pingback: Curbing excessive pay « Flip Chart Fairy Tales

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