The current “banking crisis” has been pretty hard to ignore of late, but here in the WhyDontYou ivory towers, we have tried. Partly this is because both of us are in (largely) economy immune employment sectors and partly (mainly) because neither of us can really fathom the nonsense being thrown about in the news. Given that both of us are required by profession to be mathematically astute (yes, really) it could be taken to imply that the average citizen would be even more lost.
With this in mind, it is entertaining to watch the news about the crisis when it pretty much only shows scared-to-death financial experts going on about weird ways of selling things you dont have (short selling) and how important the banking risk takers are to society. They are so important that the rest of society has to protect them should their risk taking go wrong. Being ignorant of the financial wizardry, this strikes me as being totally insane, let alone unfair. This post (long, sorry) is pretty much a way for me to let off steam about something that is destroying peoples lives and, basically, really annoys me. I would welcome your comments and feedback on my take – if I am wrong, please educate me.
There are two headline examples today (in the UK at least) – The UK Government take ownership of the crap part of Bradford & Bingley, after selling the good bits to a Spanish bank; The American government fails to secure a $700bn line of funding for its banks to keep them safe. (Neither are good news items. Neither are going to reassure people that their future is safe. Do not mistake a light tone here for a lack of concern)
UK first. Starting about 20 years ago there was a big rush for building societies to become banks – changing from being basically there for a group of people in one area (eg. Bradford, Halifax) where everyone who paid in was a member to becoming a limited company, where some of the members became shareholders. In the process, especially throughout the 1990s the drive was on for these banks to press hard and return massive profits for the shareholders (often a tiny subset of the Building Societies membership). At the time (and in principle it still does) this seemed a good idea. Most people got a bit of money (sadly for most of the members this was just a bit – around £100) and a few people got lots and lots of money. Everyone was happy.
From this, there was a drive in the finance sector to target more and more high risk trades, where often the winnings were large beyond the avarice of mortal man. City bonuses in the millions ceased to be newsworthy and sales of high end sports cars went through the roof. Being a “risk taker” became the nicest thing you could say about someone. We (the public) were dimly aware that there was a risk it could fall down on the bank (Barings) so we accepted the ostentatious lifestyle of the successful. For some reason we were convinced it was down to skill and intelligence rather than basically throwing dice and hoping for the best. These were people who worked hard predicting the markets and had a rare skill in knowing where the trades were. Or so we thought.
Hidden for most of the time were the downsides to this.
Insane wages in London made the already insane prices there spiral out of control. People began to think that paying £750,000 on a one bedroom apartment was a “good investment.” In turn, this priced even well paid people out of the city, so prices near London went up (often even faster if it was commutable and “nice”). For the last ten years it has been impossible for anyone on less than twice the average wage to even think of buying a house in the south of England, without a hugely fiddling their application – so they did. People overstated their income, understated their expenses, and took insane repayment terms hoping they’d get on the gravy train before they had to pay the capital. Lots of these people had “normal” jobs and were not aware that they were bearing the same risk that the Ferrari driving millionaires living in central London appartments had. The public never benefited from the wins so, rightly you would think, assumed it was safe from the risks.
Wrong. (More on that in a minute)
A similar story in the US (I assume, I have no idea of the background). From my visits, the gulf between rich and poor in America vastly outstrips that in the UK. I have always thought that if you were filthy rich, there is no better place to live than the US, but if you were penniless poor the UK wins. Rich people in America are really rich. I am amazed the poor survive one day to another.
In recent years, the risk loving traders have really had a few field days in the US. Massive windfalls made rich people richer. They took huge risks, which often paid off. People applauded them for having the guts to risk so much, making it hard to condemn them for their salaries and bonuses. As with the UK, most Americans had some fallout from this (house prices going up for example) and people begin to think that property is the best investment, so take some personal risks to buy a house. In turn the bank takes a bit of a risk lending to them, but often at crippling interest rates that will see the bank get its money back in spades.
Eventually, as everyone with hindsight knew it would, the whole system explodes. That is the thing with taking a risk, sometimes you get hurt.
Here is where my understanding and reality part company.
I have always thought that you took a risk, gambled something for example, sometimes it would pay off and other times it wouldn’t. Some risks are “low risk”: for example, betting that a tossed coin will land on either heads or tails rather than its side is quite a low risk bet – you are a lot more likely to win than lose. Some are “medium risks”: betting on heads in our example. Some are “high risk”: betting the coin will land on its side. They all make sense to us and we live with this sort of understanding on a day to day basis.
The world banks have paid their “High Risk takers” absolute fortunes because they take high risks. This is fair. If I bet £1000 on the coin landing on its side and I won, I would expect to win big, if I bet £1000 on the coin not landing on its side, I would expect to win a tiny amount simply because I wouldn’t expect to lose.
For most of the last two decades, the amazing thing is the risks have (on the whole won). The coin has landed on its side a lot. People have won big.
The problem is people then forgot what a risk it was. If you win something that is high risk enough times, you forget that it is high risk and assume the opposite. The merchant banks have been so successful with high risk ventures, they forgot that “high risk” meant dangerous and plowed more and more money into it. They still throw around the terms, they certainly still paid the bonuses, but everyone assumed it would never happen.
Then the coin came up tails and everyone lost. Everyone who had bet big, lost big.
Oddly, this came as a shock. The great and bold risk takers were mortified. Nothing hits a herd as fast as panic and the trading centres of the west are no different. Contagious fear spread everywhere and a generation of “risk takers” who actually had no idea about risk were the most affected. The less scrupulous traders saw a chance to strip the foundations of fragile structures and asset rich, stable organisations took a massive hit (Bye, bye HBOS). The wonders of a free market allowed short-selling and a few scares to destroy a company with solid resources – can you imagine how scared the rest must have become.
So, in the interests of a free market, the government steps in and saves the companies. The government spends billions of the taxpayers money to rescue institutions that have, basically, gambled themselves out into the street.
This is where I am confused.
In the UK, the government has reportedly taken over a £50billion debt on behalf of Bradford and Bingley. That is effectively £1000 per person so that the demutualised, risk taking, company can survive. Although we were not aware of the risk we were taking, nor did we share in the rewards, everyone of us in the UK was involved in the gambles these people were taking.
The US has the same problem. The $700bn bail out (good idea or not) is a phenomenal sum of money. The high flier financial wizz-kids and their high risk lifestyle would cost every one of the 300 million people in the US over $2000. For someone on federal minimum wage, that is 321 hours work – 40 working days – to save the rich from becoming poor (I know it is not quite that simple). Instead, the poor get a little bit poorer. Wonderful.
The US must be the only modern democracy where funding the rich bankers is a more appealing proposition than giving healthcare to the sick. That confuses me.
To confuse me even more, the news today had lots of talking heads on both sides of the Atlantic saying how it might seem strange but it was vital that the taxpayer (poor) bail out the bankers (rich) because. Often simply because. Sometimes there were vague, dire, warnings about the economy, but most of the time it was just a simple statement. We have to do it.
I don’t doubt that letting one or two banks slip will cause even more panic which will destabilise the economies, but if the US has $700bn and the UK has £20bn going spare, then surely we can weather some rough times. When the average person on the street still has money for shops to take off them, then the economy will still work. In my mind that is where the salvation needs to be pointed.
Equally odd, is this new definition of risk.
If I gamble my house on a high risk deal and lose, I lose my house. Will the government bail me out? (Well, in the UK we have social housing but that is different) It is unlikely. For me, betting on high risk stocks is just that – high risk. I stand to gain but I also stand to lose everything.
If a bank gambles the houses of 20 million people and loses, well they really lose nothing. Poorly paid staff will get laid off but the “risk takers” are immune. The organisation is immune because as long as it cries loudly enough the government helps. For the banks, betting on a high risk is actually risk free. They will either gain a lot, or lose nothing.
Why is this acceptable? Why is this considered normal? Why are we still hearing that it is all down to the taxpayers to save these banks? Why not claw back the multimillion bonuses? Why not fine the fund managers? Why are they allowed to gamble without risk, yet still be thought of as “cool” risk takers?
Crime and Punishment
The most sickening thing about the whole deal is not just that the taxpayer has to suffer.
If, through negligence or design, I caused someone to lose out to the tune of £1000 there are laws that would punish me. If I gambled £1000 of someone else’s money without their knowledge and lost it, I would expect the police to visit me and to end up in jail.
It seems, however, if you do it with enough people then not only does the government step in to cover your debts, but you dont even get punished. In the middle of the credit crunch, UK stockbrokers were still getting massive Christmas bonuses (just not as massive… poor things).
While it often smacks of unscientific voodoo, I accept what the “finance experts” say and that the state has to prop up these failing institutions. However, why should the people who have caused this problem be allowed to walk away? If, for example, the fund managers and directors of each organisation were to be fined in proportion to their participation, the rescue plan’s tax burden would be a sweeter pill.
Alternatively, if this heralds a new era of tightly controlled financial markets, where crazy risks are punished, and these people are not simply able to start ripping the world off again in a few years then, again, it becomes a bit more acceptable.
I think the problem is, this will never happen. The hint that the US bail-out would be followed with government involvement meant that the Republicans stood against the great George Bush and turned down the bill (*). It seems the only way a rescue plan will be approved is if it carries no strings or punishments. Basically, the bankers are free to risk all our money without having to worry…. (Slightly better over here, where we are more accepting of government control and oversight).
What a wonderful world.
(*) This adds an ironic twist. I strongly think that the Republican party expect to lose the next election. McCain/Palin are their idea of a joke. They know the country and the economy is about to tank, and the war in Iraq has gone badly. If they lose the election, Obama will be handed a hospital ball of a presidency. Unless he is truly Odin’s chosen one, come the next elections people will still be smarting from the economic crisis and will be ready to turn to the Republicans once more. Taken in this light, both Bush’s plan to asset strip the country, and the parties refusal to do something that (on the surface) benefits the public makes sense.
Can you be too cynical?