Financial earthquake
Banking regulations still have a long way to go to secure order and stability
About 640,000 years ago, the area now known as the Yellowstone National Park in the United States was formed by the eruption of a super volcano. Will it happen again? Seismologists say they are keeping the Yellowstone caldera under close scrutiny and that a repeat performance with a huge loss of life and disastrous changes in the earth’s climate is unlikely for now. Meanwhile, in Europe and the US, similar soothing noises are being made about the future stability of the western banking system.
Europe in particular is still struggling with the economic consequences of its brush with financial disaster in 2008. Millions of lives have been damaged by unemployment and cuts to welfare arrangements. And social and political climates have changed for the worse.
Banking experts are reluctant to forecast when the next disaster may hit, although there is surprising agreement that there will be one sooner or later. In the meantime, governments in the US and Europe have been patching together defences not so much aimed at preventing the next crash as at limiting its impact on consumers and taxpayers.
This is the purpose of the European Union’s proposed banking union. Negotiations have been stilled for much of the year by the German election campaign, but it seems that the European Council is about to sign up to a single resolution authority for bailing out or closing down troubled banks.
Fear of another financial earthquake is driving governments. The danger threatens one and all but, like diners convivially assembled in an expensive restaurant, each is hoping that someone else will pick up the bill. Naturally, the gaze of the majority is fixed on the richest of their number: Germany, whose ambition is to shell out as little as possible in support of bailout programmes for non-German banks.
The avalanche of new financial regulations adopted in the US and Europe is supposed to reduce the probability that very large banks will again land themselves in so much trouble that they have to be propped up or closed.
Regulators are forcing them to sharpen assessment of risks to their balance-sheets and to fortify themselves with more capital and liquidity. All of which is good. But will it alter those delinquent inclinations to make huge bad bets that so recently brought many to the edge of disaster, and put others out of business?
New rules to bring more transparency into transaction processes and market operations are supposed to block the path to recidivist behaviour. In many cases, however, their authors know that bright young men and women, highly qualified in mathematics and philosophy, are generously paid to step around the rules without breaking them. There will always be risk in banking and investment banking. Society’s task is to frame it and constrain it and, perhaps one day, current efforts will change mentalities and behaviour.
For now, the amended regulations remain a long way short of entrenching a new order and stability. As good an indicator as any is the vertiginous fines that regulators are imposing for continuous and continuing rule-breaking, much of it since 2008. Only last week, Lloyds Bank was fined a record £28 million for imposing entirely disproportionate rewards and penalties on staff to hit sales targets. Failure brought the risk of demotion and pay cuts. This was under the supervision of a new management and while publicly owned.
Compared with fines in the US, Lloyds got off lightly. J.P. Morgan, one of the giants of American investment banking, has paid close to $20bn since mid-2010. No other bank matches that, but eight were fined €1.7bn by the European Commission earlier in the month for collusion in fixing London Interbank interest rates (Libor). Last year a total of $10.7bn of fines were paid by just ten American and European banks. Jamie Dimon, chief executive and chairman of J.P. Morgan since 2005-06, is still holding down his job and took home $23 million in pay in 2011.
Bankers have forfeited public trust and respect and may even rank below journalists in public esteem. Their bonuses speak of considerable greed and their ways of doing business of ethical blindness. Apologists say that many are frequently driven to do wrong by commercial pressures in competitive markets and by the obsession with shareholder value. Such pressures exist across most sectors of the economy. But few companies outside banking have shown such a frequent disregard for clients’ and the consumer interest.
One way of limiting banks’ ability to gamble with their depositors’ money is soon to be tried in the US with the introduction of the “Volcker Rule” largely forbidding banks from trading for their own account as well as for clients. By heavy lobbying and good personal relations, banks are successfully nurturing negative expectations that the rule will limit their capacity to build liquid markets and sustain business recovery and growth.
They are now inviting us to admire their new training schemes designed to instil ethical brand behaviour and to reinforce codes of conduct built on the nostrum that “clients come first”. We cannot know when, if ever, this will bear fruit. In the meantime, we must hope that the next financial crisis lies, like the next Yellowstone eruption, in an indeterminate future. Fingers crossed.
John Wyles is an independent consultant based in Brussels.