Bob Diamond, Barclays’ chief executive officer, no more said something as inflammatory as “drop dead” to the UK Treasury select committee yesterday than Gerald Ford did in a 1975 speech refusing to extend financial assistance to save New York City from bankruptcy. But the substance was every bit as uncooperative.
Despite its artful packaging, Diamond’s presentation was yet another reminder of the banking industry’s continued extortion game, namely, that they can take outsized, leveraged risks and when they work out, pay themselves handsome rewards, and when they don’t, dump them on the taxpayer. And they’ve only been encouraged to up the ante. Not only did they get to keep their winnings from their last “wreck the economy” exercise, no senior executive was fired, no boards were replaced, and UBS was the only major bank required to give a detailed account of how its screwed up so badly as to need government support. And before you tell me Barclays was never bailed out, tell me exactly how well it would have fared had any other major UK or international bank failed, or had the officialdom not provided extraordinary liquidity support when interbank funding dried up.
As we have noted often in the past, the very idea that employees of major banks are entitled to even as much as average wages is a stretch. If the true cost of their operations was priced in, they’d all be out of business. By any standards, they should be paying all the rest of us to be allowed to do so much damage with so little interference.
Andrew Haldane of the Bank of England goes through the math. In a March 2010 paper, he compared the banking industry to the auto industry, in that they both produced pollutants: for cars, exhaust fumes; for bank, systemic risk. While economists were claiming that the losses to the US government on various rescues would be $100 billion (ahem, must have left out Freddie and Fannie in that tally), it ignores the broader costs (unemployment, business failures, reduced government services, particularly at the state and municipal level). His calculation of the world wide costs:
….these losses are multiples of the static costs, lying anywhere between one and
five times annual GDP. Put in money terms, that is an output loss equivalent to between $60 trillion and $200 trillion for the world economy and between £1.8 trillion and £7.4 trillion for the UK. As Nobel-prize winning physicist Richard Feynman observed, to call these numbers “astronomical” would be to do astronomy a disservice: there are only hundreds of billions of stars in the galaxy. “Economical” might be a better description.
It is clear that banks would not have deep enough pockets to foot this bill. Assuming that a crisis occurs every 20 years, the systemic levy needed to recoup these crisis costs would be in excess of $1.5 trillion per year. The total market capitalisation of the largest global banks is currently only around $1.2 trillion. Fully internalising the output costs of financial crises would risk putting banks on the same trajectory as the dinosaurs, with the levy playing the role of the meteorite.
Yves here. So a banking industry that creates global crises is negative value added from a societal standpoint. It is purely extractive.
The reality is that banks can no longer meaningfully be called private enterprises, yet no one in the media will challenge this fiction. And pointing out in a more direct manner that banks should not be considered capitalist ventures would also penetrate the dubious defenses of their need for lavish pay. Why should government-backed businesses run hedge funds or engage in high risk trading, or for that matter, be permitted to offer lucrative products that are valuable because they allow customers to engage in questionable activities, like regulatory arbitrage or tax evasion? The sort of markets that serve a public purpose should be reasonably efficient and transparent, which implies low margins for intermediaries.
But note the clever positioning by Diamond, per the Financial Times
Mr Diamond acknowledged the public anger towards bankers and the emotion surrounding pay, and admitted he wished he could “make the issue of bonuses go away”.
But he argued it was not possible to stop paying bonuses without severe consequences for the business and the broader banking sector and said it was now time for the bonus debate to move on.
Yves here. This is priceless. Diamond wants the “issue”, meaning the controversy, over bonuses to go away. I’d love to see the “severe consequences to the business” of forcing lower pay on incumbents. Yes, a very few might find be able to raise money from investors. But as John Whitehead, a former co-chairman of Goldman said in 2006 when hectoring Lloyd Blankfein over the firm’s “shocking” pay levels, the firms could afford to lose them. But Whitehead missed the dynamic of the post-partnership era. The partners had every reason to keep pay in line; it was their capital at risk, after all, and overcompensating staff reduced their take. Now the top brass is aligned with the interest of the producers in taking as much from any source they can.
Back to the Financial Times:
“We can’t just isolate bonuses and assume it won’t have consequences,” he said.
“The biggest issue is putting the blame game behind us. The time for remorse is over.”
While Mr Diamond said he would “show any restraint possible” on bonuses, he would not commit to waiving his own personal award, as he and rival bank chief executives did last year.
Yves here. If you believe that, I have a bridge I’d like to sell you. And of course, the excuse is that CEOs like Diamond have no choice, they are forced to do so by competition. That logic sounds remarkably familiar:
For banks, the threat is that if anyone puts their finger on the pay dial, the business will be hurt and by implication shrink. But if you are talking about an operation that is destructive, that’s a good thing. The banking industry is bloated and cancerous, sucking talent and resources out of the rest of the economy and allocating capital poorly (examples include the series of bubbles and busts, the way it has become acceptable for bankers to suck so many fees out of deals that they cannot possibly make sense for investors, as in the case with Goldman in the Facebook funding, the destructive impact of turning commodities into an investment).
And don’t even try the defense that the industry is “innovative” As we wrote in ECONNED:
The dirty secret of the credit crisis is that the relentless pursuit of “innovation” meant there was virtually no equity, no cushion for losses anywhere behind the massive creation of risky debt. Arcane, illiquid securities were rated superduper AAA and, with their true risks misunderstood and masked, required only minuscule reserves. Their illiquidity and complexity also meant their accounting value could be finessed. The same instruments, their intricacies overlooked, would soon become raw material for more leverage as they became accepted as collateral for further borrowing, whether via commercial paper or repos.
But even then, the bankers still needed real assets, real borrowers. Investment bankers screamed at mortgage lenders to find them more product, and still, it was not enough.
But credit default swaps solved this problem. Once a CDS on low-grade subprime was sufficiently liquid, synthetic borrowers could stand in the place of subprime borrowers, paying when the borrowers paid and winning a reward when real borrowers could pay no longer. The buyers of CDS were synthetic borrowers that made synthetic CDOs possible. With CDS, supply was no longer bound by earthly constraints on the number of subprime borrowers, but could ascend skyward, as long as there were short sellers willing to be synthetic borrowers and insurers who, tempted by fees, would volunteer to be synthetic lenders, standing atop their own edifice of risks, oblivious to its precariousness.
Institution after institution was bled dry. Yet economists and central bankers applauded the wondrous innovations, seeing increased liquidity and more efficient loan intermedation, ignoring the unhealthy condition of the industry.
The firms that had been silently drained of capital and tied together in shadowy counterparty links teetered, fell, and looked certain to perish. There was one last capital reserve to tap, U.S. taxpayers, to revive the financial system and make the innovators whole. Widespread anger turned into sullen resignation as the public realized its opposition to the looting was futile.
The authorities now claim they will find ways to solve the problems of opacity, leverage, and moral hazard.
But opacity, leverage, and moral hazard are not accidental byproducts of otherwise salutary innovations; they are the direct intent of the innovations. No one was at the major capital markets firms was celebrated for creating markets to connect borrowers and savers transparently and with low risk. After all, efficient markets produce minimal profits. They were instead rewarded for making sure no one, the regulators, the press, the community at large, could see and understand what they were doing.
Diamond’s candy-coated defiance shows that three years after the crisis, nothing has changed.