Some bloke talking about how central bankers caused the Great Depression
Did everyone hear former HBOS deputy Chairman Sir Peter Burt on BBC R4 Today yesterday (listen again here, or Times summary here)? As a taxpayer I found it very concerning.
He was on with our friend Prof Buiter, who had just explained how the Bank of England should provide further assistance to our cash strapped banks.
As the Prof has argued right from the start of this crisis, the BoE should always stand ready to act as lender of the last resort. Moreover, it should be prepared to lend against a much wider range of collateral, and for longer, than it has done historically. That way, banks know they can always access liquid funds even when they are too scared to lend to each other.
But - and this is a BIG BUT - the BoE's loans should be at a price. Not only should the interest rate charged reflect the risks involved, but the collateral should, in the Prof's words, be "priced aggressively"- ie the amount of collateral demanded as security should be scaled up to incorporate a healthy safety margin for credit risk (he suggested banks might need to pledge say £1bn of mortgage collateral to secure a £500m loan).
If this isn't done, he said, we will be sending a message to banks that "if they screw it up they will get bailed out at generous prices". We will encourage reckless behaviour and precipitate an even worse financial crisis next time (aka moral hazard).
All of which we wholeheartedly agree with.
But Burt - the voice of the banks, and presumably reading from the self-same script delivered at their emergency meeting with the Governor on Thursday - took a very different line:
"There seems to be some confusion. Dr Buiter talks about banks lending imprudently and mentioned should people be bailed out?
[But] banks don't lend money: it's the management of the banks who lend money, and they're not bailed out. A lot of the senior executives in the States have lost their jobs.
So I'm less concerned about moral hazard because the penalty for the individuals who make the mistakes is that they lose their job."
Hasn't Sir Peter been paying attention? The point about today's bank remuneration structures is that the management get huge upside when things go well, and others get all the downside when they blow up. Even if they do get sacked, the managers walk away with gzillions (eg Merrill's ousted chief walked away with a reported $159m). That kind of asymmetry means the incentive to be reckless is enormous.
And as for that tenuous distinction between banks and their managements, the last time I checked, the banks themselves were nothing more than buildings with a few faux marble columns: sure, they don't lend money, but they don't do anything else come to that, other than just stand there.
Burt went on:
"What is very important is that the system is protected against systemic risk. If you force them to take massive write-offs at this stage, then their capital is reduced and their ability to lend to businesses in the real world is reduced.
Let's make sure we register what he's saying here. He's saying if the banks are forced to write-off too many of their duff loans "at this stage", it will erode their capital (aka shareholders' funds), limiting their ability to fulfil their public service obligations.
Bank's public service obligations? Never heard of them before? Hadn't you realised those pampered limo'd wedged up bankers are only doing it to serve the public? There's more:
"Dr Buiter remarked that the problem of being too loose is that you stoke up the problems for the next crisis. But as Keynes said, in the long-run we're all dead. If you don't get through this crisis without the economy imploding, then there won't be another crisis: we'll be looking at something like a depression."
Keynes, depression... I think we get the message: unless we write a blank cheque to the banks, we're heading straight back to the thirties. Which is no doubt the message Burt's ex-banking colleagues delivered to Mervyn King on Thursday.
Talk about special pleading. Nobody's saying the Bank of England shouldn't help banks with secured loan facilities, as Buiter outlines. Because we all know how badly the Fed handled the Great Depression, and how starving the system of liquidity caused a huge contraction in the money supply (see Milton Friedman's vid above).
But providing liquidity is not the same as bailing out bank shareholders. Shareholders shared the spoils during the good times, and shareholders condoned the reckless behaviour by their managers that's now landed them all in the soup. Their reckoning is now at hand.
Does that mean the end of banks? After drugs, sex, and arms, financial intermediation is one of the world's most profitable businesses, and always has been. Even if current shareholders take a mauling, there will be plenty more capital to come in, much of it via acquisition of existing banks at knock-down prices. There's no way taxpayers should be forced to bail anyone out.
As we said at the start of the Crock fiasco, taxpayers should never have to part with a bean until a bank's shareholders have lost the lot.
PS We dare say Prof Buiter might possibly have heard Burt's Keynes quote once or twice before. Long-dead Keynes was a brilliant quotesmith, and one of his other lines springs to mind: "The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.” And then there's this one: "A sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional way along with his fellows, so that no one can really blame him." In current circs, our guess is that the great man would line up with Prof Buiter.