The idea of the Enemy Class, to coin Sean Gabb’s term, gains credibility by the hour. A distinguished member of this class is Lord (but of course!) Adair Turner, now chairman of the Financial Services Authority, the regulator of UK financial affairs. The FSA was set up by the current Labour administration in 1997, and among its many achievements is to have largely failed to warn of the catastrophic expansion of credit – driven by central banks – which created an asset bubble in the UK. It failed to warn sufficiently about the high-risk lending policies of mortgage lender Northern Rock. Undaunted, the FSA churns out reams of consultations and reviews on how to make financial services more efficient and professional. It would require the patience of a saint to point out that the best way to promote competitive, high-quality financial services is for regulators and other agents of the State to get out of the bloody way and ensure that firms have to build a solid reputation and for consumers to exercise the virtue of caveat emptor.
But the latest foray of the FSA into the issues surrounding the credit crunch may be its lowest point yet. Lord Turner argues that the UK banking sector is too large, so large in fact, that it is harmful to society. He does not, in the widely cited Prospect magazine interview, elucidate what he means by “too large”, or whether it is possible for a civil servant, economist or other such person to figure out the optimum size of a specific sector. When Hayek talked of the “fatal conceit” of socialists imagining they can micro-manage the balance of human activities, this is the sort of hubristic thinking the great man was talking about.
I fear Lord Turner is also missing a crucial point, or just ignoring it. The point is that in a globalized economy such as we now have, financial centres such as London, Singapore, Zurich and New York are almost akin to nations in their own right; they dwarf the economies of their host nations because specialisation in finance has moved to a global arena. They rather resemble the old north European Hanseatic League of the Middle Ages. Take a different sector, such as telecoms. Finnish mobile phone firm Nokia is so large, as a percentage of Finnish GDP that a Finnish equivalent of Lord Turner would no doubt argue that the company should be punitively taxed, so that it shrinks and gives the reindeer industry in Lapland a greater share of GDP, or help those vodka retailers do so, or whatever. It is easy to laugh at such bizarre logic, but remember this: these guys have got where they are not by baldly stating their views in quite such terms, but by insinuating them through such question-begging terms as “excessively large”, or by referring to a sector of an economy as “swollen”.
Now it is true that as long as big banks can exert a sort of moral blackmail over taxpayers by stating that they are “too big to fail”, and as long as we benighted taxpayers are told we have to bail these guys out, then Lord Turner’s odd logic will gain a kind of ready audience. But he is looking at the problem the wrong way round: instead of making banking smaller and less profitable and simply driving it abroad, the better approach is to remove state-mandated deposit protection; to remove arbitrary and often counter-productive capital requirements and above all, to focus on the prime culprit in this business: the central bank as printer of funny money. But to do that will require the sort of analysis that does not give the FSA, or other bodies, the powers to tax and regulate. The FSA, like all regulators, is forever looking to increase its powers; it is hardly likely to consider the problem in such a way as to make itself redundant.
Perhaps we’ll soon be hearing that the casino sector is “excessive” in Las Vegas, gold mining is a “swollen” part of the South African economy, and there is too much reliance on fishing in Norway. And as for those Arabs, they spend far too much of their time drilling for oil. Cannot those chappies do something less fwightfully vulgar?
Lord Turner, by the way, is a former director general of the Confederation of British Industry, a lobby group for big business; he has had a consultancy role for Merrill Lynch and has wiritten a long and quasi-statist paper on UK pensions reform. He’s Enemy Class to the core. That he is, as I can attest, a thoroughly likeable guy does not alter that fact. It makes him actually quite dangerous.
Update: Tim Worstall points out how opposed to the notion of economic liberty this man actually is. When someone says that “an activity is socially useless”, what he or she really means is that “I don’t understand the use for it so it should be banned”.
A small detail, but I’m curious how you think removing deposit protection would have helped with the current situation. A quick guess suggests that no more than £150 billion was covered in total, and if even half of that was actually claimed the country would already be in so much trouble this would make no difference. Given, then, that the raw numbers don’t seem that significant, do you think that it’s more a question of tone than substance, i.e. that it sets the scene where govt. bailing out banks is ‘normal’?
Paul, the reason is that compulsory deposit protection encourages folk running these banks to think that if they mess up, the taxpayer will ride to the rescue. This makes bankers less cautious than they might be otherwise – what is referred to as the moral hazard problem.
You are correct in pointing out that such things add to the general tone of how banking is viewed by the political/regulatory realm.
As you know J.P. – once you accept the subsidy of the banks via the Central Bank (in the case of Britian the Bank of England) and, now, the Treasury also – then such pay controls and so on are on the cards.
That is why such people as Tim Congdon are not just dishonest (claiming to be free market people, yet demanding bailouts whenever their house-of-cards fractional reserve banks get into trouble) they are also poor guardians of their paymasters the bankers.
Not all bankers are like the (scumbag) Lord Turner – or the (even bigger scumbag) Sir whatever Blank – the head of Lloyds who sold out the shareholders of Lloyds because “my friend Gordon Brown” wanted someone to take over HBOS. But the regulations and taxes that Lord Turner suggests would cover all banks – not just the ones that get government support.
Things are not quite as bad as in the United States – where the head of General Electric sits on the board of the New York Fed, the very body that buys General Electric debt (with money it just creates out of thin air).
In Britain a “businessman” like Lord Turner has to at least resign from private business before being appointed to a government position – he is not allowed to just “print” money and use it to buy the debt of his own company (as the head of General Electric is in the United States) but the basic principle of government support for “private” compaines is the same.
The stock market rally is based on this (semi hidden) subsidy of companies by the government (Bank of England) buying their debt – and upon the general policy of expanding the money supply (i.e. creating money out of thin air).
It can not and will not last, it is destroying what is left of the capital structure of Britain and the United States.
So banks that wish to survive long term must move their legal H.Q.s and their assets (their real assets – not the debts that banks call “assets”) outside these nations.
“But we need the support of the Bank of England and….”
O.K. then you are welfare people – and should be on the same level of income as other welfare people (i.e. far lower wages than Lord Turner is suggesting).
Do not like that?
Then become indendent – set your bank up without “deposit insurance” and all the rest of it. Somewhere such things do not exist.
And, if you have any sense, go to live there also.
Sark is nice this time of year.
JP,
This was a major news item even in Australia. I was listening open mouthed to Lord Turner spouting this nonsense on the radio earlier today.
As you say, the monumental conceit of the man.
In the next couple of days I will be posting on the concept of Free Markets. We have not had them for a long time now in finance, we are not going to get them because the money men have fouled up, and London is anything but a free market. The last thing the City boys want is a market that is truly free.
Paul Marks as ever drives incisively to the heart of the issue!
I’m not sure that the moral hazard idea works particularly well. A bailout through deposit insurance helps people who need to keep their jobs, and those people are rarely senior enough to take a bank to the point where it needs the govt. guarantee (except in cases of outright fraud, and if prison isn’t enough of a deterrent I doubt unemployment would be). And those people who can make a difference will generally be well paid enough that losing their job isn’t disastrous. In addition if they’re that senior they’re probably going to lose their job anyway as part of the ‘heads must roll’ process.
Don’t get me wrong, I’m a big fan of the moral hazard principle (if one can be such a thing), I’m just not sure it makes much of a difference from this side of things. Perhaps for individual investors it might make them more cautious (though I have my doubts), but for bankers moral hazard starts to break down when your financial cushion is made of tens of thousands of £50 notes.
The deposit protection, capital requirements and the central bank as printer of funny money were not the cause of the current crisis but the greed of the banks’ management IS. To be exact, investment banks were the main culprits, e.g. goldman sachs, bear stearns, lehman, morgan stanley, all derive their income from non-banking activities like deposits.
US Feds might have started the ball rolling by supplying too much money to the economy, but it was the banks and finance companies who dished out cheap loans to people who have a bad credit score knowing that they could very likely default on their loans. And again it was greed that drove the management of too big to fail investment banks to approve transactions of subprime related derivatives. Those loans and derivative products were making so much money for the banks and of course the management that everyone turned a blind eye to the risks involved.
This time it’s subprime but the next crisis is just waiting to happen as the banks that have paid back the TARP money are back to their jolly old ways now with fat pay packages and guaranteed fat bonuses. All these while the economy is still suffering and the tax payers have not gotten a dime back from the bail outs yet.
The US government is being held ransom by these banks as they know that any bad news spooking the stock market will send the economy back to the 19th century so they have to play ball and let them have their cake with toppings and eat it. Unless there is legislation that dictates terms in pay packages to include claw back features and criminalise negligence in managing the banks I don’t see how history will not repeat itself. But that is wishful thinking as the banks will not have it and the government is probably too weak to implement it. Especially if they keep appointing ex-Goldman employees to decision making positions in the government.
I don’t carry water for these banks and I agree with a lot of what you say about TARP and the unhealthy influence of Goldman and a few other banks on government, but remember that the trait of greed and hubris has been around since the dawn of time.
Bankers did not suddenly turn from being guardians of moral rectitude into greedy, short-termist monsters. What seems to have changed was the way in which the incentives governing behaviour have altered. The “too big to fail” doctrine means these guys think they can hold the taxpayer to ransom – no wonder these self-styled “Masters of the Universe” fucked up. It is surprising this did not happen even more.
And for that analysis, you have to consider the arguments made by those who have argued that modern fractional reserve banking, coupled with the cult of central banking, have produced a toxic mixture. I don’t necessarily think that a return to 100 % deposit-backed banking is the solution, but the fundamental model of how many banks now operate is broken, and needs to be fixed.
Going on about greedy bankers gets us no-where, although it allows us to work up a righteous fury. There have always been greedy people, fearful people, power-mad people, shy people, cowards, etc. The issue is how to ensure that the forces of profit and bankruptcy work to reward prudent risk taking and punish recklessness. A tax on bank transactions as proposed by Adair Turner will not fix any of these problems, or at best, not by much. We need to be far more radical than that.
Very well put, Johnathan. There is blame aplenty to around for the current crisis (this isn’t the time or place for an extensive discourse on that topic), but “greedy bankers” are not at the top of the list. As with so much that’s bad, pride of place has to go to the government, with its toxic brew of market manipulation, cronyism and perverse incentives.
There’s more than enough blame to go around. The central banks got the ball rolling by spewing tons of new cash into the world economy. The treasuries & exchequers implicitly guarantee bailouts for the too-big-to-fail firms. In the US, Freddie Mac and Fannie Mae are explicitly subsidized and implicitly backed by the government. Securities regulators didn’t bother to check the capitalization backing of the firms writing these arcane instruments (loaning well in excess of capitalization is a kind of fraud). All government failures.
But it was the mortgage companies who made all the stupid loans – sometimes stupidly, sometimes fraudulently – and packaged them for sale. It was the rating agencies that gave AAA status to high-risk mortgage junk. It was investment banks that bought, sold, traded, hedged, and marketed these finance IEDs. And it was insurance firms who underwrote the whole shitpile, also well in excess of their capitalization.
Greedy bankers, incompetent officials, foolish borrowers, and obtuse legislators. Every one had a hand: capitalists and government agents alike come in for a whipping.
The Cato people are commenting on expat Americans now leaving London because of Brown, and his tax policies. How soon before Laetitia Casta, the French model for Republican France, moves back to France? The rot will be rampant then!
Not exactly correct, Joshua. Mortgage companies are just like any other producer of a commodity: they will manufacture the quality of product their customers want. A steel manufacturer will make low-grade steel if that’s what the demand is for. Same with mortgages. The buyers were Wall Street firms packaging the loans into securities, and it got so they were taking just about anything. If they had demanded better quality (by refusing to buy the worst loans) things would have changed quickly enough. But even there, the real culprit was the rating agencies, who were clueless.
There’s nothing inherently wrong with making AAA securities out of subprime loans provided that the subordination levels are adequate. If you have $100 million of loans you can safely issue $50 million of AAA bonds against them because you are certain that more than 50% of the loans will pay. (You don’t know which 50%, but it will be some 50%.) In fact, even with badly-underwritten loans you can be pretty sure that 70% will pay. The problem arises when you think that 95% will pay, and issue bonds accordingly. It doesn’t work, especially when the economy starts to contract, as we’ve all now seen. So the rating agencies (who never truly understood subprime lending; it can be done intelligently) are a major culprit but haven’t (in my opinion) received enough of the blame.
But even they aren’t the whole story, because even at the peak privately-issued mortgage-backed securities weren’t the majority of that market; the GSEs (Fannie and Freddie) were. Their credit standards kept dipping lower and lower, and they were essentially self-rated (thanks to their [then-implicit] government guarantee). These are the firms which truly drove the market, and they drove it into the ground. And their strings were being pulled by Washington.
So it all comes back to government. It always does, when you peel back enough of the layers.
Another Social-Fascist. There are many now trying to rule the life of others.
Aaron:
I wasn’t aware that banks have monopoly on the use of force – I thought the government is the one that can legally come after those who refuse to use their funny money?
I think that maybe you share the all-too-common delusion that the economy depends on the stock market, while in fact it’s the other way around.
Aaron I love the idea that bankers somehow became more “greedy” and that this greed was the cause of the present crises.
However, the laughter dies in my throat when I remember that the sort of nonsense you have just written (if you added a few mathematical equations and bit of techobabble language) would earn you a Nobel prize in “economics”.
“You are attacking me unfairly”.
Thomas Wood’s (Austrian School) “Meltdown” and Thomas Sowell’s (non Austrain School) “The Housing Boom and Bust” are both best sellers – and nether is a very long book (indeed they are both short books written in clear language).
Yet you have clearly not bothered to read either one – prefering to blame “greed” for the crises instead.
You are no better than John Hales (another man who was too close to what he was writing about – the mistaking the tree for the wood problem) in the 16th century – blaming prices rises on the “greed” of landowners and merchants.
If only they had not become so much more greedy than they had been in the past………..
Well, recessions and depressions, when they occur, always follow major stock market declines, but as you rightly draw attention, correlation does not imply causality.
So basically you could both be incorrect and both the economy and the markets are driven by another factor.
What we are seeing unfold at this time arguably has its genesis going back a hundred years and more. The creation of the Fed in 1913, which led more-or-less directly to the current global fiat currency regime of today, decimation of purchasing power(Link), two depressions (including the one after this crash), recessions, many inflation-funded wars, debt-enslavement of future generations etc etc
However, what the stock market does do is provide us with the best barometer of social mood that we have. And there is very little evidence to suggest that news or so-called ‘economic fundamentals’ have much to do with its movements over anything but the very short term.
And looking at the form and speed of the 50% bear market rally since March, well… I’d say it would pay to get out of the way of the train-wreck at this point if you haven’t already.
Well, yes and no. The way I see is that economy (by which I mean production and consumption of goods and services) is driving the market. It is true that those other factors you mention influence the economy, so they do influence the market too, but indirectly. OK, save for market regulation, but you didn’t mention that either:-)
Presently what has driven the stock market up (in both Britian and the United States) over recent months has been government credit money expansion – both in general, and specific support for certain corporations (not just the bank bailouts – but the support for corporate debt as with such examples as General Electric).
However, eventually the real market order (the real economy) will be reflected in the stock market – and hopes (“expectations”) of comming prosperity will be dashed.
“eventually – that is why you are poor Paul Marks, we
stock market players and practical businessmen look to the present and to the sure and certain knowledge that we will be supported by the government in the future”.
Sorry, but thinking like that is not just going to burn the economy (including even the stock market) it will burn such “practical” people personally – no matter how well connected they are.
For a government that is powerful enough to give you everything you want is powerful enough to take it all away again (to get some political popularity) – and to also take away things they never gave you.