"The banks we once worried about as too-big-to-fail are in many cases even bigger today"by / February 1, 2016 / Leave a comment
The film, The Big Short, is in cinemas now—the timing of its release is spooky. Based on Michael Lewis’s 2010 book, it captures the culture of the years leading to the financial crisis of 2008, and reminds us that fraud, collusion and market abuse all thrived in an environment in which de-regulation had for many years been de rigueur. We still debate and argue who was to blame and why so few have been held to account, punished or incarcerated. But what about now?
The film’s arrival is so apposite because we have just been through a bad month in financial markets. To this can be added rising concerns over China’s economic slowdown and the consequences of a looming debt crisis; today’s Financial Times story that economists place a 20 per cent probability on another recession in the US this year; and chatter about a new financial crisis. “Surely, not again?” I hear you say, from behind the sofa.
The positive news is that banks are certainly less leveraged than they were in the build up to the financial crisis. The new focus is on their leverage ratio, or the amount of equity, or loss-absorbing, capital as a share of total assets. The minimum requirement now is 3 per cent, with some countries such as Switzerland and the US requiring banks to meet a 5 per cent requirement. Even this, alone, wouldn’t have been enough in 2008 to meet losses in every bank, but there are also new regulations that determine even higher capital requirements depending on the nature of the business.
Despite the problems in global markets, there is no mania in the housing market or in mortgage lending, as there was during the 2000s. There doesn’t appear to be any systemic fault-line as there was in 2005-08. Stress tests, resolution planning, liquidity buffers, risk management, compliance, and supervision are ubiquitous.
The more worrying news is that the banks we once worried about as too-big-to-fail, are in many cases even bigger today. In the US, for example, the biggest six banks manage $10 trillion of assets: twice as much as the next dozen combined. In the UK, which is dominated by a handful of large banks, nothing has really changed. The opportunity we had to restructure the financial sector—to downsize it, and make banks more duller and safer—has gone. Policy inertia has set in as far as more radical banking reform is concerned, whether from fatigue, or the effects of lobbying. The fear of making tax-payers liable for failed banks means that from 1st January 2016, according to the European Bank Recovery and Resolution Directive, if your bank fails, your deposits are protected up to the amount of £75,000. Above that, tough luck.
It is arguable that since 2008, we have made the system better able to spot and address problems in a single bank. If it got into trouble for some reason, new regulations and procedures may lessen the transmission effect to the rest of the sector and the economy. But if there were ever a new systemic problem—I don’t think there is at the present time, but if we ever think never, it’s probably coming—it is most likely that the biggest banks would still be too big to fail, and that none of the rest of us would be too small to pay, either directly through the deposit system or indirectly via the tax system and macroeconomic effects.
And that brings me to one of the stand-out lines for me of the The Big Short. There’s a moment where Mark Baum, one of the handful of anti-heroes who has bet on the coming financial crisis, says “I have a feeling, in a few years, people are going to be doing what they always do when the economy tanks. They will be blaming immigrants and poor people.”
Mark Baum didn’t actually exist. He is based on a character in the book called Steve Eisman, a real US investor, and so I have no idea whether the words were presciently said at the time, or are simply a script-writer’s benefit-of-hindsight creation. In any event, they certainly resonate, and not just in the US and Europe but in a swathe of countries including Brazil, Russia, and China where hard economic times or recession have laid bare over-indebtedness, corruption and social and income inequalities.
In the aftermath of the financial crisis, and especially where weak economic growth and high unemployment persist, it is all too easy to attribute weak wages and constrained living standards to immigrants, and to pillory the feckless or the favoured in a circular blame game.
JK Galbraith noted in The Crash of 1929 that at the time and until the New Deal the “burden of reputable economic intelligence was invariably on the side of measures that would make things worse.” Perhaps we have fared a better this time in some respects, especially with regard to monetary policy. But he also noted that: “Finally, when the misfortune had struck, the attitudes of the time kept anything from being done about it. This, perhaps, was the most disconcerting feature of all.”
Even if the economic and financial worries of early 2016 turn out to be squalls that we can muddle through, we should remain keenly aware that the inertia in the aftermath of the financial crisis might lead to danger. Banking reforms, investment, inequality, employment and assimilation within communities are all highly relevant and suitable cases for treatment all the time.