Sunday, October 05, 2008

Punishing The Unrighteous


“Each member state will ensure that executives who have failed will be punished."

Thus spake Sarko at his emergency grandstanding event in Paris.

No question, the bankers have been greedy. They have indulged in a deal too much conspicuous consumption. And they have screwed up big BIGtime.

But punishment?

Like, what kind of punishment?

Financial punishment?

Maybe. But many bankers have already taken a caning: the CEO of failed bank Lehman lost a reported £139m in stock that is now worthless, and many other bankers have seen their stock wedges melt away. Tens of thousands are facing the chop, and even if they somehow find new work in finance, the word on the Wharf is that re-employment packages are a long way South of what they've been used to.

Criminal punishment?

Well, yes, if there has been criminality - as the US authorities suspect - it should be punished. Definitely. But in truth, while bankers may be scorpions, they are not, on the whole, criminals. This crisis is not the work of criminals.

These are dark times for those of us who believe in free markets. But this is by no means the first time financial markets have been through such a boom and bust bubble. Charles MacKay wrote his definitive work Extraordinary Popular Delusions and the Madness of Crowds 167 years ago. Examining the Dutch tulip mania of 1637, the South Sea Bubble of 1711-1720, and a number of other financial disasters, he concluded:

"Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one!"

And since MacKay wrote that, we've had a host of other bubbles, all ending in crashes. Which is why even we free marketeers now recognise that Mad Crowd Disease can carry the financial markets miles away from prudence and sustainability.

And that's why we all generally accept the need for some regulation and oversight. Because in modern economies the financial markets are central to the whole way we live. They pump round the life blood of capitalism, and we cannot afford them to stop functioning, even temporarily.

So we employ all those central bankers and financial market regulators - to spot the most dangerous excesses and stop them before they get out of hand.

And there's the rub: the question we should be asking is not how to punish our greedy bankers, but why those paid to regulate and oversee failed to do their jobs?

What were their failures? We're doing some proper digging on that, but in summary:

  • Money was too cheap - central bankers on both sides of the Atlantic, but especially the US, stoked the long boom with interest rates that were too low. We've already blogged the notorious Greenspan put - how the US Federal Reserve sustained the equity market bubble by repeatedly cutting interest rates - and later how central banks around the world failed to act against the housing market bubble. True, hindsight is a wonderful thing, but many at the time were warning that these bubbles were unsustainable and dangerous.
  • Financial regulation was weak- regulators failed to grasp the significance and risks of the rapid innovation in the last 10-15 years. In particular, they did nothing about the liquidity issues inherent in banks' increasing reliance on the wholesale money markets rather than deposits, the additional credit risks when lenders lose all contact with the ultimate borrowers, and the increasing opacity of financial instruments. In the UK, all these problems were exacerbated by the half-baked regulatory structure imposed by Gordon Brown in 1997.
  • Property debt was overpumped - politicians on both sides of the Atlantic strongly encouraged voters to buy their own homes - after all, Phil and Kirsty and everyone in between knows property is "a one-way bet". It was particularly pronounced in the US, where the Community Reinvestment Act was strengthened by Clinton in order to pressure mortgage lenders to push more loans in the direction of "disadvantaged" people - ie people who would not normally be able to afford the repayments. And guess what then happened (see here for a good summary)

So when we talk about punishment, Madame Guillotine should not be confining her attentions to the bankers.

2 comments:

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