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The financial crisis was good for some

All the chest-beating about the financial crisis distracts attention from the fact that many parties gained from it. Governments – except for a few peripheral countries – obtained cheap financing. The US benefiited from a boost to international demand for the dollar, helping to put the euro in its place, just as a previous wave of monetary expansion had put Japan in its place  in the 1990s (whenever the US wants to show who is top dog, along comes a crisis to prove it). Governments in general gained greater control over their banking systems,  allowing them to direct credit to politically favoured groups. Higher capital ratios will mean a subsidised market for their bonds – even after central banks start to “taper” their purchases. Some financiers have lost, but if you belong to the senior cadres of the globally systemically important banks you have probably won. Banks are more entrenched in the power systems of their various countries, just as in China. Wealthy groups who have assets have benefitted from QE. Real incomes of the median US household have declined – and in many countries are lower than they were 10 years ago. The wealthy have shot ahead everywhere. Even in relatively egalitarian Japan, people say one of the greatest threats the country faces is growing inequality of income and wealth.


What are the lessons? Take banking. The first item on the (informal) agenda of board meetings at every big bank is the same: how do we keep our too-big-to-fail (tbtf) status? Obviously we should step up our investment in political lobbying, but nowadays that must go well beyond just keeping our local legislature or government sweet. Recruiting elites in major emerging markets is also an avenue – in case the bank has trouble, a few phone calls from top officials in China to the US or European officials threatening sanctions unless “x bank” is rescued will make most host countries see sense.


Divestments and spin offs that would make perfect sense commercially must also be critically examined from this perspective. If they might risk the groups tbtf status – and the cheap market funding that goes with it – of course it would be crazy to go ahead. Of course we know that regulators will try to stop us exploiting it by a lot of red tape, but we can always work round such rules. We just pass the costs on to users and pocket the rent.


I am not alleging such matters are ever openly discussed or even mentioned. That does not mean they do not play a decisive role in decision-making.


So it is no surprise when we read reports of JP Morgan Chase and the like offering juicy jobs to members of China’s elite. On the contrary  it is entirely rational behaviour and seems bound to spread.


I am amused when commentators such as Mr Blanchard of the IMF contrast the “quick” way that the US recapitalised and cleaned up its banks with the “slow” Japanese and European way. But the US did so only by folding the commercial banks into the central bank! Don’t take my word for it – no less authorities than Paul Volcker and Alan Greenspan share such a view. Mr Volcker could barely conceal his dismay when the business model of the pre-emnent investment banks failed and both Goldman Sachs and Morgan Stanley were provided with the cloak of Federal reserve  protection, notably access to the discount window, in 2008; Alan Greenspan believes the banks have become extensions of the state.


I am glad to note that academics are catching on , as this new paper by Mark Roe, a noted legal scholar, shows:


“The recent travails of JPMorgan Chase — including its now well-known $6 billion trading loss after the financial crisis — fit well with this analytic. Analysts initially viewed the trading debacle as cautionary, not one fundamentally implicating regulatory policy. After all, the losses were only a fraction of JPMorgan’s $20 billion annual earnings. The setback in much of the conventional wisdom was one for the bank’s shareholders and managers and, hence, in one view, an issue for ordinary corporate governance. But by systematically examining the incentives, we can see how such missteps can link to, and follow from, a too-big-to-fail boost from the realities of government financial policy. It’s not just that some firms are too-big-to-fail, some are too-big-to-manage, and some are both, but that the two characteristics link together, with any implicit too-big-to-fail subsidy pushing firms to be too-big-to-manage.”


Consider next the incentives to so-called “challenger banks” – and other, smaller firms that we are supposed to be encouraging to provide greater competition and diversity. Their strategy, if rational, will also be distorted by such effects. They will aim not at serving customers but to become potentially an attractive acquisitions for TBTF banks -i.e. bringing larger benefits perhaps than some existing parts of their corporate empires. Thus TBTF banks will gather together a growing concentration of activities representing a real threat to society if they go wrong. This will make it unthinkable to break them up.


Big financial groups and national states are locked in a deathly embrace.


it is often stated that higher capital ratios have made banking much safer. Why? So long as you are guaranteed against failure, as you are if you are an organ of the State, the more capital you have, the greater the incentive to take risks and leverage and play any trick you can to exploit the guarantee. This explains the return of excessive risk-taking in the financial world, as observers such as Mr El-Erian have noted – and as Ben Bernanke has already warned about.


My guess is that it will take another two or three crises to drive these points home, by which time the big states and big groups will have exhausted themselves – as well as the patience of taxpayers.


That will open the way to realising the forecast of The Money Trap that we shall in the long run witness the elimination of current large financial groups and the acceptance by states of constitutional limits on their monetary policies. These two steps are critical in making progress towards a new global financial system. Not yet, not yet, but what matters is the direction of travel.


Can we short-cut this process? In Europe nobody at the Commission or national governments is thinking about the long-term future of European finance. they just want to get through the next few months without another crisis. What Europe needs is a bank reform agency that will force the gradual winding down of its TBTF entities, even at the cost of raising the cost of financial intermediation. At present it is impossible to know which institution would survive without the public subsidy. The ECB should insist on a rationalisation of EU banks as a condition for its liquidity support.