The Game of Bank Bargains

My progress through by Charles Calomiris and Stephen Haber is ever so slow (partly because of the distraction of Chimamanda Ngozi Adichie’s wonderful novel ), but I’m enjoying it a lot.

[amazon_image id=”0691155240″ link=”true” target=”_blank” size=”medium” ]Fragile by Design: The Political Origins of Banking Crises and Scarce Credit (The Princeton Economic History of the Western World)[/amazon_image]   [amazon_image id=”000735634X” link=”true” target=”_blank” size=”medium” ]Americanah[/amazon_image]

Take these two quotations from Chapter One, ‘If stable and efficient banks are such a good idea, why are they so rare?’:

“Banking systems are susceptible to collapse only when banks both expose themselves to high risk in making loans and investments and have inadequate capital on their balance sheets to absorb the losses associated with those risky loans and investments. If a bank makes only solid loans to solid borrowers, there is little chance that its loan portfolio will suddenly become non-performing. If a bank makes riskier loans to less solid borrowers but sets aside capital to cover the possibility that its loans will not be repaid, its shareholders will suffer a loss but it will not become insolvent. These basic facts about banking crises are known.”

So the question about system instability is why are banks allowed to take risks without adequate levels of equity? Of course, Adam Admati and Martin Hellwig asked the same question in their brilliant book .

[amazon_image id=”1480577006″ link=”true” target=”_blank” size=”medium” ]The Bankers’ New Clothes: What’s Wrong with Banking and What to Do about It[/amazon_image]

The chapter concludes:

“The fact that the property rights system underpinning banking systems is an outcome of political deal making means there are no fully ‘private’ banking systems; modern banking is best thought of as a partnership between the government and a group of bankers, a partnership that is shaped by the institutions that govern the distribution of power in the political system…. We call this process of deal making the Game of Bank Bargains.”

Exhibit number one is the stability of the Canadian banking system (zero systemic crises since 1840) versus the instability of the US (12 crises). In this light, it was interesting to read Edward Luce’s strongly worded article on finance and US democracy in this morning’s Financial Times.


Canada versus Minsky, and the politics of banking

With Eurostar journeys coming up, I anticipate making decent inroads into Piketty’s , but meanwhile the enormous buzz about it makes it harder than ever to understand why the popular and intellectual anger about plutocracy has not translated (yet?) into political consequences.

This thought was underlined by browsing through  by Charles Calomiris and Stephen Haber. They write: “There is no avoiding the government-banker partnership.” The book combines history, economics and political science to analyse the nature of the state-bank relationship, within a framework of bargaining. One section compares and contrasts the US (12 systemic banking crises since 1840) and Canada (zero). Another looks at the relationship in authoritarian contexts and democratic transitions.

[amazon_image id=”0691155240″ link=”true” target=”_blank” size=”medium” ]Fragile by Design: The Political Origins of Banking Crises and Scarce Credit (The Princeton Economic History of the Western World)[/amazon_image]

One important conclusion is that no general theory can explain why banking crises have not been equally likely in all countries in the recent past. For example, ‘s theory of endogenous excess followed by fear has enjoyed a revival – indeed there was a recent BBC Radio 4 Analysis on it (Why Minsky Matters) that is well worth a listen – but why was Canada exempt from these oscillations arising from human nature? It isn’t that Minsky is wrong, but rather that context matters for crises too. “Useful propositions about banking generally are only true contingently, depending on historical context.” And, to mangle , every country (except Canada?) has its own unhappy politics.

Which brings me back to the strange absence of any political consequence of the financial crisis for banking. Bankers will complain about excess regulation but the only result has been to cause them to employ more compliance officers, and more lawyers to game the regulations. There has been little action on leverage and capital ratios, next to none on scandalous rent-seeking bonuses and none at all enforcing competition and new entry. The financial sector isn’t the only locus of the modern plutocracy, but it is one of the most significant.

One possibility is that the political classes are befuddled because – as I describe in  – the national accounts figures overstate the contribution of the financial sector to the economy. Maybe some politicians genuinely believe they cannot risk killing the goose that’s laying the golden eggs even if it is keeping all the eggs within its own nest. Whatever the explanation, the bargain between banks and politics is working for bankers, and not for other citizens.

Here is an excellent VoxEU interview about the book with Charles Calomiris. For now, I’m off to St Pancras and on with Piketty.

[amazon_image id=”067443000X” link=”true” target=”_blank” size=”medium” ]Capital in the Twenty-First Century[/amazon_image]


Enlightened banking

Adam Smith had firm views about the banking industry. He believed that services in general were unproductive, and would clearly have taken a dim view of claims about the contribution of banking to GDP (see my forthcoming Feb 2014 book, ).

[amazon_image id=”0691156794″ link=”true” target=”_blank” size=”medium” ]GDP: A Brief but Affectionate History[/amazon_image]

I was just looking at the new  (editors Christopher Berry, Maria Pia Paganelli and Craig Smith) as I prepare for a panel session on banking at the Festival of Economics in Bristol later this month.

[amazon_image id=”0199605068″ link=”true” target=”_blank” size=”medium” ]The Oxford Handbook of Adam Smith (Oxford Handbooks in Economics)[/amazon_image]

The essays in the section on money, banking and prices underline Smith’s caution. It describes a metaphor in The Wealth of Nations (I didn’t remember it) comparing banking to a wagon road through the air – immensely useful in helping business expand beyond its earth-bound confines, but in danger of melting if it gets too close to the sun. He was explicitly opposed to banks investing in real estate, and his descriptions of what they should be lending for are exactly the kind of provision of working capital to business that modern banks hardly do at all – it amounts to just 3% of UK banks’ total lending. A figure worth bearing in mind when the banks claim that higher equity capital requirements would restrict their ability to lend to business, as a small decline in next to nothing is less than next to nothing….

The Handbook, by the way, is a great resource for Smith-ites. I’ve dipped into it, and found some great chapters, including those on his Enlightenment context and (by Amartya Sen) on his contemporary relevance. One part covers economics; others are on the entire range of his work – for example on history, civil society, moral society. I also liked the introduction from Nicholas Phillipson, who write an excellent biography of Smith, (which I reviewed for the New Statesman).

[amazon_image id=”0713993960″ link=”true” target=”_blank” size=”medium” ]Adam Smith: An Enlightened Life[/amazon_image]


A room full of naked bankers

This morning I had the pleasure of attending a breakfast debate hosted by Prospect for Anat Admati, co-author of the  The book has a clear, simple message: banks should be required to  behave like normal businesses, and invest their own funds in projects with a good (risk-adjusted) return. They should not be subsidised to borrow money to invest in risky trading activities. “What is special about banks is what they get away with,” Admati says. The mechanism for moving from our world of zombie banks that can still bring down the whole economy and are still receiving massive taxpayer subsidies to a world of viable banks that finance the real economy is to require them to hold much, much more equity on the liabilities side of their balance sheet, moving towards that by not paying dividends for the foreseeable future.

[amazon_image id=”B00BBYLPYY” link=”true” target=”_blank” size=”medium” ]The Bankers’ New Clothes: What’s Wrong with Banking and What to Do about It[/amazon_image]

The book is terrific, and if you don’t want to read a  whole book, its website has a short myth-buster addressing the most frequent objections to the proposals ( For of course bankers object to being told their industry harms the economy and is not commercially viable without government subsidy. Many people – including both politicians and many bankers – don’t understand the issues. There’s a lot of jargon and few people want to look stupid by admitting they don’t understand.

The meeting this morning split between bankers and economists. I think all economists agree on the need for banks to be much better-capitalised. This includes a senior economist at one of the UK’s biggest banks, who recently told me so then pleaded with me never to reveal their identity. However, this has little political traction. Bankers are confident chaps who talk a good (confusing) game and donate funds. The GDP figures greatly overstate the contribution of banks to the economy (see my forthcoming book, or   by Brett Christophers). I think the best practical path in the short term is to encourage regulators and politicians to enable new entry into financial services. After all, only 3% of banks’ lending in the UK goes to business, and if start-ups including P2P and private equity can eat into that, it will be even clearer that the banks we have are not socially useful. If they are, they can prove it by raising equity and reducing their lethally dangerous leverage.


Banker bashing*

This week I’m getting to attend an event at which Anat Admati is speaking, which is exciting. Her book with Martin Hellwig,  is terrific – it’s on the shortlist for The Enlightened Economist prize, and I reviewed it here. The main message is simple: banks need to hold more capital, less debt, on their balance sheet, because it’s too risk to have massive financial institutions made insolvent by a 4% decline (say) in the value of their assets. We’d consider the kind of debt/equity ratio that characterises the banks as ludicrously over-leveraged in any other business, so why is it considered ok for banks to have so little capital? The book thoroughly debunks the claim that higher capital requirements would squeeze lending to businesses: the proportions of debt and equity on the liabilities side of the banks’ balance sheets have no automatic implications for the amount lent on the assets side. (Banks’ cost of funds would increase somewhat.)

[amazon_image id=”0691156840″ link=”true” target=”_blank” size=”medium” ]The Bankers’ New Clothes: What’s Wrong with Banking and What to Do about It[/amazon_image]

I’ll report back on the event. Meanwhile, there is a new book on RBS, Iain Martin’s . Ian Fraser’s  is due out early next year.

[amazon_image id=”147111354X” link=”true” target=”_blank” size=”medium” ]Making it Happen: Fred Goodwin, RBS and the Men Who Blew Up the British Economy[/amazon_image]

[amazon_image id=”1780271387″ link=”true” target=”_blank” size=”medium” ]Shredded: The Rise and Fall of the Royal Bank of Scotland[/amazon_image]

Quick update: Admati has a letter in today’s Financial Timesknocking down the undead myth that ultra-high leverage has some benefits: “If banking shrinks because some banks are not viable at a level of 30 per cent equity, the economy stands to benefit. … Lending suffers when banks are weak, and bankers use subsidised funding to boost their ROE in derivative and other markets.”

* They still deserve it for fighting tooth and nail every post-crisis attempt to prevent the same kind of thing happening again.