10-Year Retrospective: Lesson 6 | The State has Rewarded Bad Behavior and Bad Banks

How has the state punished the financial industry for its crimes,  corruption and anti-social behaviour?

By showering it with subsidies, privileges,  perks and by offering it protection from an angry public. And by reducing its profitability and capacity to change by piling new regulatory layers and requirements.

And this remains true not just of the UK and US. It is true of European countries as well.

There is no incentive to improve their behaviour.

Rather, the incentive must be to continue cheating, and see what happens next. No wonder trust in banks remains rock-bottom.

Well before the crisis, the culture of banking and finance had become rotten.

Right up to the late 1970s, banking was populated by proud names – great institutions with marvellous histories – names to celebrate. Names like Citibank, Chase Manhattan, JP Morgan, Wells Fargo, HSBC, Barclays, Lloyds, Deutsche, Standard Chartered, UBS, Credit Suisse and the rest.

I personally knew the top executives of all these banks. It was my job as the Editor of The Banker from 1971 to 1979.  They were not all the most cultured of people; many had not even been to university. They were, often, creatures of convention. They followed rules. But they were totally honest. They watched their peers like hawks. They were shrewd and usually very able people.

The reputation of these institutions – and others –  has been badly tarnished.   True, many bankers are trying hard to restore public respect for their profession.  New bodies have been set up to fight corruption.

But they are battling what in many institutions is a rotten – “we can get away with it” – culture at the top. For example, remuneration committees routinely rubber stamp the most outrageous recommendations on appropriate salaries for top executives that come from so-called remuneration consultants. They invariably  use comparability criteria that result in large upgrades for whichever nonentity happens to filling the CEO slot.

Their predecessors – the men I knew – would be profoundly shocked and horrified.

Non-exec directors are powerless to stop such scams.

There are, inevitably, honourable exceptions. But even post-crisis they are still fighting a losing battle. That is the real tragedy of the crisis and the way it h,as been handled.

According to the Boston Consulting Group, a total of $321 bn was paid by banks worldwide between 2007 and 2016; the crimes ranged from money laundering to rigging interest rates and violating US sanctions.

In some banks the senior managers in charge when crimes were committed brazenly remain in post.  Many others retired with their spoils.

Three hundred billion dollars!

Fines on firms are useless

We have also learnt that the practice of imposing fines on banks rather than the individuals responsible has been completely misguided. It has no effect on incentives.

As economist Charles Goodhart has concluded:

“I contend that the regulatory failures that led to the crisis and the shortcomings of regulation since are largely derived from a failure to identify the persons responsible for bad decisions.   Banks cannot take decisions, exhibit behaviour, or have feelings – but individuals can.  The solution lies in reforming  the governance set-up  and realigning incentives faced by banks’ management.”

“Regulators should not levy fines on banks, despite them having the legal status of a person, and instead apply the fines to those responsible at the time of the offense, whether subsequently retired or not. ”

Maybe fines werenevere even intended to improve bank behaviour or help society.

Maybe the State always regarded fines (as it views banking itself) as a means of raising revenue.

Very few individuals have been held to account for the crimes committed – e.g. in the foreign exchange, interbank lending and gold markets.

Are central banks investigating suspect practices?

That is not all. One sadly has to conclude that only the tip of the iceberg is visible. The illegalities that have been been unearthed, proved and punished are probably only a fraction of the crimes that have been committed – not to mention behaviour that is merely immoral. How many have got away with their loot?

One suspect area is indicated by the huge transactions costs involved in QE – quantitative easing – programmes. These have been investigated by impeccable central bank scholars from the Bank for International Settlements. Their research raises troubling questions: Are such costs necessary? Who receives them? Why and how?

“In the case of the United Kingdom, these costs are estimated at 0.5% of the total value of QE or over £1.8 billion. Although it is hard to identify the recipients of these transactions costs, it is unlikely to be entities that the government would wish to subsidise.”

Think about that sentence. What do you think it could imply? Then read the paper here.

Yes, I am aware of worthy efforts on both sides of the Atlantic to improve financial ethics, with the setting up of various boards to improve standards of behaviour.

Children throwing stones at an avalanche?

The scope for insider trading and front-running in the current environment seems to be huge – courtesy of the official sector – though impossible to prove.

Action against corruption

There are a few scraps of comfort from all this. There are groups such as Better Markets and some news media that are trying to hold corrupt elites to account. There are some experienced, honourable bankers left clinging on by their fingertips in boards. But in the end it will be the efforts of ordinary citizens doing the right thing as they see it that must power real change – from the grassroots.