No Apology for the Banking Crisis

...banks have done more injury to the religion, morality, tranquility, prosperity and even wealth of the nation, than they... ever will do good. Our whole banking system, I ever abhorred, I continue to abhor, and shall die abhorring.. every bank of discount, every bank by which interest is to be paid or profit of any kind made by the deponent, is downright corruption.

-- US President John Adams, 1799.

It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.

-- Henry Ford.

A moment comes while you’re watching Ron Howard’s outstanding Frost / Nixon when you suddenly realise that Howard has crafted pure entertainment gold out of some ostensibly unpromising material. A televisual battle of wills between a glib showman and a disgraced politician? But Frost / Nixon, boiled down to its essentials, is about just one thing: a bilked nation craving an apology.

So its relevance to the current financial débacle speaks for itself. The scale of the banking crisis is so huge, and the dislocating damage wrought across all financial assets so extensive, it challenges language and thought just to try and articulate it. But one response has been almost universal: having been monumentally cheated, we demand an apology. Yet answer comes there none.

The lack of contrition may have something to do with the breadth and diffusion of the guilt.

We can justifiably start with the politicians. The Gramm-Leach-Bliley Act of November 1999 repealed enough of 1933’s Glass-Steagall Act to allow commercial and investment banks to play in the same sandpit. (At the risk of appearing parochial or partisan, all of the proponents of Gramm-Leach-Bliley happened to be Republicans.) The regulators played their part, not least the SEC in its decision to outsource its regulatory function in overseeing the credit markets in the 1970s to three for-profit companies, the ratings agencies Standard & Poor’s, Moody’s and Fitch.

The decision to require issuers of debt to pay for their own ratings, leaving credit ratings as a “freely provided” public good, it no longer requires noting, created monstrous conflicts of interest for the ratings agencies. And the role in the crisis played by fraudulent mortgage originators, and the ethical vacuum of the “originate to distribute” model, and deal-hungry bankers divorced from true accountability, has been widely discussed. But since a housing and credit bubble also requires the willing participation of a greedy and credulous public, there are really few people who emerge entirely untainted from the wreckage. By and large, we are all complicit. What matters is how we reach resolution.

And that is where the problems start piling up, because there is no broad agreement on how to solve the crisis, and perhaps there cannot be. Jeremy Grantham expresses it nicely: “even the near-consensus case for great stimulus is lacking in historical certainties or intellectual vigour”. By citing the work of Murray Rothbard last week, we expressed our scepticism of government bank support. But a completely non-interventionist approach would be politically unacceptable in every country groaning under the weight of the banking crisis. Perhaps the most ominous development in a rolling saga of gloom has been the sudden weakness of the Chinese economy: the recession is now confirmed as a global phenomenon.

In the face of an avalanche of worsening economic news, it is easy to become fatalistic or depressed, or both. But Grantham also makes a valid observation at least as regards the ailing property market: we have not lost real housing wealth, so much as the illusion of wealth. One could make the same point about the stock market: except for the lucky or uniquely gifted few who bailed out at the highs in 2007, the stock market values – before the Crash – were never real either, they were just the illusion of wealth. And investors either lucky or gifted to be sitting on significant cash reserves now have the luxury of picking up high quality stocks at huge discounts from their 2007 and 2008 prices.

But outside a necessarily selective list of stock market investments, it is difficult to see compelling value in a number of asset types, either because there is still great anticipation of future waves of forced selling (for example in hedge funds, private equity and housing) or because the government has badly distorted free markets and left confusion and opacity in its wake (in the outlook for, and assessment of value within, both the government and corporate bond markets). Outside selective pockets of the equity market, then, the only really compelling investment – and portfolio insurance – opportunities now on offer would seem to be in precious metals and, at some later stage, in inflation-protected government bonds.

Because as Grantham points out, there is simply too much private debt clogging the markets (he suggests to the order of between $10 trillion and $15 trillion), and there are only three ways of making it go away. We can write it down (which would appear to be unpalatable politically – and that may have to change); we can let a combination of time and increased saving do the heavy lifting, as the Japanese have largely done; or we can inflate the hell out of this private debt mountain and collapse its real value. But as Grantham suggests,

Each of the three realistic possibilities listed above would be extremely painful, each is loaded with uncertainties, and even the quickest of them would take several years. Our path this time is likely to involve a hybrid approach: we will certainly take some painful debt liquidations; this crisis will almost certainly take far longer than normal to play out; and probably, before a new equilibrium is reached, we will see inflation rates that are well above normal.

Determined not to be overcome by gloom, Grantham also points out that “real wealth lies not in debt but in educated people, laws and work ethic, as well as in the quality and quantity of fixed assets and the effectiveness of corporate organisation”. In a 24/7 news culture that seems to venerate bad economic news, it is also worth taking the perspective of “economists of happiness” such as Warwick University’s Andrew Oswald, who has pointed out that our sense of well-being does not rise hand in hand with real national income: we seek economic growth without questioning its desirability relative to less tangible accomplishments, such as well-being itself. In a 1997 report (“Happiness and Economic Performance”), he suggests that given the significant role played by unemployment in causing unhappiness, governments might well choose to prioritize job creation over maintaining largely spurious economic growth:

In a country that is already rich, policy aimed instead at raising economic growth may be of comparatively little value.

And for readers wondering how best to deal with that constant flow of recession coverage and bad news, our best advice: just turn it off.

Comments

[Hefaistos:]

"...we demand an apology."
What you ask for is in reality a collective apology from a whole system.
For it's a failed system of 'arms-length' banking, relying on markets and rating agencies to provide necessary transparency and confidence.
The article never gets down to some of the major culprits, the ones hiding inside banks: THE problem has been the lax credit policies, lack of true risk management in banks. Not so much the preferences of the consumer to take on excess credit and consume, but more with sub-optimizing banks, always to prone to forget the persistent history of bank-related crises.

Jan 26 08:03 AM

[prairiedog555:]

As this author has pointed out, bankers cheat and are corrupt and create situations where they get rich and their customers are swindled.
I am a free market person but history shows that bankers cannot be trusted and must be regulated, or as they do in China when caught stealing they have a date with the hangman.

Jan 26 08:40 AM

[Ray Winter:]

Bankers don't need to apologise they just need to take the hit.

Solving the Credit Crunch.
It is important to differentiate between debt created by the Financial Sector and debt created by homeowners and non-financial businesses. For all practical purposes the real problem debt has been created by the greed of the financial sector Banks and Hedge Funds.

As Anotole Kaletsky postulates in his Business column in ‘The Times’ of London.
In the past, if a manufacturer wants to buy a £1M machine tool, the Company would go to its Banker, HSBC, and they would provide the cash required. Job done.

But since the 1990’s in the brave new world of securitized hyper-finance, such a transaction would be handled in a very different way.

The Company would sign a £1M lease with General Electric Credit.
GE would then sell £1M of bonds to an SPV to fund its contract.
The SPV then sells £1M of commercial paper to a Hedge Fund.
The Hedge Fund would borrow £1M from Barclays Capital.
Barclays Capital then borrowed £1M from HSBC via the inter-bank market.

The net result being that HSBC have supplied the loan as in the pre-1990s, but in the processes now followed, £4M of extra inter-bank debt has been created.

Solving the credit crunch can be accomplished by simply unwinding the financial sectors’ incestuous trading. This is not a job for Governments to support with their taxpayers cash. The Banks got themselves into this trouble, so they can get themselves out of it and as with game of ‘musical chairs’, those left holding the problem will fail if they cannot afford to pay their dues.

In the case outlined above, HSBC are the true lender-of-last-resort and the legitimate holder of the original borrowers contract, all other parties should be made to cancel their inter-company paper, taking the hit on their sales revenues.

Clearly, the credit crunch ‘Bubble’ has been created by the Financial Sector for its own greed, and frankly I am amazed they still have the gall to demand that their bonus’s be paid by the taxpayers.

As for non-financial sector businesses, they do not need to share any of the blame for the problem but they are being penalised by the financial sector because the Banks just does not have the money to loan them.

Jan 26 10:55 AM

[thatguy57z:]

I agree with that also, and they have there assets striped and left with nothing but the clothes, they all have done nothing but steal from the coming person, and are government is any better. WE THE POPOLIE VS THE UNITED STATES. IT TIME TO FIGHT BACK AS ARE FOUR FATHERS WOULD HAVE DONE.


On Jan 26 08:40 AM prairiedog555 wrote:

> As this author has pointed out, bankers cheat and are corrupt and
> create situations where they get rich and their customers are swindled.
>
> I am a free market person but history shows that bankers cannot be
> trusted and must be regulated, or as they do in China when caught
> stealing they have a date with the hangman.

Jan 26 11:08 AM

[carey_jim:]

'One could make the same point about the stock market: except for the lucky or uniquely gifted few who bailed out at the highs in 2007, the stock market values – before the Crash – were never real either, they were just the illusion of wealth. And investors either lucky or gifted to be sitting on significant cash reserves now have the luxury of picking up high quality stocks at huge discounts from their 2007 and 2008 prices.'

Neither lucky nor uniquely gifted, unless gifted with common sense. Many, many people saw both the housing and the stock market crash coming back in the 1990s.

Timing, of course, is everything and the roller coaster riders made a lot of money climbing the mountain of worry.

I would turn your observation around and say instead,

Only the uniquely stupid or grossly unlucky failed to make money from 1990-2007 and only the blind, halt and lame failed to bail out with some kind of reasonable profit.

What do all those new millionaires do now? That is the real question.

Jan 26 11:43 AM

[kelm:]

We will never see an apology. Not from bankers, politicians, Greenspan or anyone else. Our system is tolerant of failure. We hold that as a great thing as it encourages people to take risks and not be ostracized if the results go badly. That is how all of the culprits view themselves. They ether deny that they saw it coming like Rubin or they take consolation in the fact that everyone was doing it and it was legal. They feel no ownership for the consequences to the system. It is really very similar to the" was only following orders" argument. I this case, "I was only doing what everyone else was doing and it was legal".

I'd like to see the regulators held accountable to the point of losing their jobs for negligence and being banned fro life from the industry. But we won't do that either. We will argue that "moving on" is better than seeking justice. The result is that no one will be punished or held accountable and those who participate in the next bubble will do so safe in the knowledge that as long as everyone else is doing and the regulators don't care they will get off free and easy with their accumulated annual bonuses.

I am not lucky and while I'd like to think I'm gifted there is scant evidence for it. I got out in October of 2007 because I had read the Financial Times for years and had taken the time to read ALL of the articles that discussed the credit derivatives markets and how a perturbation in housing could bring the whole edifice down. I watched the mortgage crisis unfold and saw stocks making new highs. "This is going to end in tears" I thought and I acted. The information was there for everyone to see - politicians, bankers, the lot. This was willful ignorance on the part of our business and political leaders and they should be asked directly why they don't read the paper.

The FT interviewed the chairman of BP a few weeks backed. He too expressed astonishment at how the crisis was unforeseen - this when the same paper that was interviewing him had been running full page adds of reprints of their articles from 2003, 2004, 2005 etc. detailing how the credit derivatives market was a bomb waiting to explode. Instead of buying him lunch they should have give him a free subscription.

Jan 26 11:59 AM

[Chris B:]

"The Gramm-Leach-Bliley Act of November 1999 repealed enough of 1933’s Glass-Steagall Act to allow commercial and investment banks to play in the same sandpit."

Absolutely right! Just a few years after the effective repeal of Glass-Steagall, we have a repeat of the 1930's banking crisis - SHOCKER. There might have never been a mortgage crisis if this important depression-era reform had been left in place, and if the investment banks had still managed to destroy themselves in a housing bubble of their own creation, their collapse would not have taken down commercial and retail lending, or the whole economy, with it. Reinstating Glass-Steagall should be the administration's top legislative priority. Perhaps we can then go another 60 years without a banking crisis - or until a new generation fails to learn the lessons of its grandparents.

“real wealth lies not in debt but in educated people, laws and work ethic, as well as in the quality and quantity of fixed assets and the effectiveness of corporate organisation” -Grantham

Excellent quote. We've been told for years that our nation was doing well because a number we calculated - GDP - was increasing. Yet, our GDP was increasingly based on debt-fueled overconsumption on all levels and the earnings of people who flip assets for a living, rather than improving them.

Meanwhile education became unaffordable, people who flipped assets for a living became more respected than people who did productive work, the quality and value of assets became dubious, corporate organization became focused on finding ways to compensate executives instead of improving products, and the government failed to enforce the laws that allow for a vibrant marketplace. By these measures, the "real wealth" of the US has been in decline for years, despite what the GDP numbers say.

Jan 26 12:16 PM

[TinyTim:]

Nice perspective in the article.

"The decision to require issuers of debt to pay for their own ratings, leaving credit ratings as a “freely provided” public good, it no longer requires noting, created monstrous conflicts of interest for the ratings agencies."

How is this different than hiring accounting firms to audit the books?

Jan 28 03:33 AM