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2015 | OriginalPaper | Buchkapitel

4. Why Taxpayers Need to Be on the Hook

The Financial System Cannot Insure Itself

verfasst von : Avinash D. Persaud

Erschienen in: Reinventing Financial Regulation

Verlag: Apress

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Abstract

The period immediately after a major financial crisis, such as the Global Financial Crisis that engulfed the industrialized economies since 2007, is one ripe for radical financial reform. Cries of “this time is different” heard during the boom are replaced with shouts of “never again” as the bust unfolds. Crises are the handmaidens of financial reform. For example, the requirement that a bank must publish an audited account of its assets and liabilities can be traced back to the collapse of Royal British Bank in 1856. The US Federal Reserve was created in 1913 as a direct response to the Panic of 1907. The 1929 stock market crash gave birth to the 1933 Glass-Steagall Act, which separated US commercial and investment banking for over 50 years. The 1974 establishment of the Basel Committee of G-10 Bank Supervisors followed the collapse of Germany’s Bankhaus Herstatt in June of that year and the subsequent liquidity crisis in New York. The list goes on.

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Vorheriges Kapitel What Causes Financial Crashes

Nächstes Kapitel How Should We Regulate the Financial System?

On January 20, 2010, President Obama introduced his proposals limiting the size and activities of the largest banks by saying, “Never again will the American taxpayer be held hostage by a bank that is too big to fail.”

Avinash Persaud, “Banks Put Themselves at Risk in Basle”, Financial Times, October 16, 2002.

See House of Lords and House of Commons, Changing Banking for Good: Report of the Parliamentary Commission on Banking Standards, www.parliament.uk/documents/banking-commission/Banking-final-report-volume-i.pdf, June 12, 2013.

Regulators, in response to money laundering allegations, triggered the 1991 collapse of the BCCI. They did not step in to mop up a collapse that had otherwise occurred. BCCI remains a mystery. It was implicated in the Iran-Contra affair and the CIA-supported funding of the Mujahideen’s resistance to the Soviet invasion of Afghanistan. Regulators raided BCCI just as the Mujahideen declared victory.

There are many examples and it is invidious to name names, but before history is airbrushed, it is helpful to reflect on the following quote from a highly intelligent central banker, no doubt consistent with the advice of his staff: “[It is] important [to ensure] that regulators keep enough distance from the markets to give financial innovations such as credit derivatives a chance to succeed. The new market for credit derivatives has grown largely outside of traditional regulatory oversight, and as I have described, evidence to date suggests that it has made an important contribution to financial stability.” Roger Ferguson Jr., Bank for International Settlements, Financial Engineering and Financial Stability, www.bis.org/review/r021122d.pdf, November 20, 2002.

At its peak, RBS had assets of approximately $3 trillion and 200,000 employees.

The case for the prosecution is best laid out in Ian Fraser’s book Shredded: Inside RBS, The Bank That Broke Britain (Edinburgh: Birlinn, 2014).

However, the relationship between size and average costs has been found “to be U-shaped, suggesting that small banks can benefit from economies of scale as they grow bigger, but that large banks seem to suffer from diseconomies of scale and higher average costs due to factors like complexity as they increase in size.” Ingo Walter, “Economic Drivers of Structural Change in the Global Financial Services Industry,” Long Range Planning 42, nos. 5–6 (2009), pp. 588–613.

The Financial Times quoted Mr. Prince in an interview on corporate buyouts done on July 9, 2007. Mr. Prince was still bullish even when it was clear enough that the music had stopped some time back.

See Carlota Perez “Unleashing A Golden Age After Financial Collapse; Drawing Lessons From History,” in Environmental Innovations and Societal Transitions, vol. 6, March pp. 9–23, (2013).

See James Surowiecki, The Wisdom of Crowds: Why the Many Are Smarter than the Few and How Collective Wisdom Shapes Business, Economics, Societies and Nations (London: Abacus, 2006).

See Carmen M. Reinhart and Kenneth Rogoff, This Time Is Different: Eight Centuries of Financial Folly (Princeton, NJ: Princeton University Press, 2011).

At a press conference held on May 19, 2014 announcing the criminal plea by Credit Suisse in a tax evasion case, US Attorney General Eric Holder said that “this case shows that no financial institution, no matter its size or global reach, is above the law.” This seems to be the right stuff. However, I can’t help noticing that the firms the United States has targeted for megafines—UBS, HSBC, Standard Chartered, Credit Suisse, and BNP Paribas—are all non-US firms. This may be either a reflection of a nationalist motivation for justice or a concern stemming from the collapse of Arthur Andersen in 2002, when it was found guilty of criminal obstruction, showing that criminal convictions can collapse financial institutions. I can see, if not agree with, the political logic that says that if actions taken on the banks could kill them, better to kill the foreign ones that have modest local business.

Under Basel III, CoCos could qualify as either additional tier-one or tier-two capital depending on the triggers.

$150bn is an estimate attributed to Hank Calenti, Head of Bank Credit Research at SocGen, and quoted in “S&P Warns of Higher Risk in Bank Bail-in Bonds,” Financial Times, February 6, 2014.

See Avinash Persaud, “Bail-Ins Are No Better than Fool’s Gold,” Financial Times, October 21, 2013, www.ft.com/intl/cms/s/0/686dfa94-27a7-11e3-8feb-00144feab7de.html#axzz3ADcuVPgd.

Avinash Persaud, “Banks Put Themselves At Risk In Basle,” Financial Times, October 16, 2002.

For a more detailed explanation, see, Avinash Persaud, “Why Bail-in Securities Are Fools’ Gold,” Policy Brief 14-23, Peterson Institute for International Economics, November 2014.

This is a critical, though complex, point that we shall return to in greater depth in Chapter 5.

But it doesn’t make for good politics when a bail-in actually takes place—witness Greece, Cyprus, and Ireland—as those bailed in seldom feel they have been reasonably compensated for, or sufficiently warned of the loss.

On March 25, 2013, the Eurogroup, (European Commission, European Central Bank and other EU agencies) and the International Monetary Fund announced a €10 billion injection of cash to Greece on the condition that Cyprus would bail in depositors. Deposits below €100,000 were saved in the final negotiations, but the accounts were frozen for deposits above this level as well as for other creditors. They were to be repaid based on the amount that the receivers could recover.

The logic was that because of the bank’s size, complexity, and interconnectedness, should it fail, there would be such severe, broad, and adverse consequences that the authorities would try to avoid failure by rescuing the bank.

Despite much heat and light about banks originating toxic instruments, when it came to rescuing the banks, many of the architects and traders of these instruments had to be retained, even lured by bonuses, so that regulators could understand, value, and unwind the offending instruments. The decision to retain them was not without anguish.

In my experience as a non-executive director of a few organizations, managements everywhere, not just in banking, assume that there are economies of scale and so growth will always improve the current financial position. Growth is then touted as the solution to financial vulnerability rather than a contributory cause. Instead, I have observed that organizations often exhibit unforeseen diseconomies of scale. After a period of growth, critical IT, HR, and accounting systems snap under the strain, requiring fast, unanticipated, and costly expenditures. This imperils the organization’s financial position, whereupon management touts the solution of more growth.

Allan H. Meltzer, “End Too-Big-to-Fail,” International Economy (2009), p. 49.

See: (1) Elena Carletti and Philipp Hartmann, “Competition and Financial Stability: What’s Special about Banking?,” in Monetary History, Exchange Rates and Financial Markets: Essays in Honour of Charles Goodhart, vol. 2, ed. Paul Mizen (Cheltenham, UK: Edward Elgar, 2003); and (2) Franklin Allen and Douglas Gale, “Competition and Financial Stability,” Journal of Money and Banking 36, no. 3 (June 2004).

See Mark Blyth, “The Political Power of Financial Ideas: Transparency, Risk, and Distribution in Global Finance,” in Monetary Orders: The Political Foundations of Twenty-First Century Money, ed. Jonathan Kirshner (New York: Cornell University Press, 2002).

This is not always the case. Some countries, especially those with a culture of local mutual-savings institutions, like Germany and previously the UK, convincingly argue that they speak with the powerful voice of “ordinary men and women.”

Avinash Persaud, “Sending the Herd Off the Cliff Edge: The Disturbing Interaction Between Herding and Market-Sensitive Risk Management Practices,” Journal of Risk Finance 2, no. 1, pp. 59–65.

In November 2013, the Financial Stability Board (FSB) updated the list of globally and systemically important banks to include: Bank of America, Bank of China, Bank of New York Mellon, Barclays, BBVA, BNP Paribas, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, Groupe BPCE, Group Crédit Agricole, HSBC, ING Bank, Industrial and Commercial Bank of China Limited, J. P. Morgan Chase, Mitsubishi UFJ FG, Mizuho FG, Morgan Stanley, Nordea, Royal Bank of Scotland, Santander, Société Générale, Standard Chartered, State Street, Sumitomo Mitsui FG, UBS, Unicredit Group, and Wells Fargo.

This idea is perhaps best articulated and argued in the 2011 Vickers Report written by the Independent Commission on Banking. Set up by the UK government in 2010, the commission was charged with proposing structural reforms that would promote stability in the UK banking system.

See John Nugee and Avinash D. Persaud, “Redesigning Regulation of Pensions and Other Financial Products,” Oxford Review of Economic Policy 22, no. 1, pp. 66–77.

Titel: Why Taxpayers Need to Be on the Hook
verfasst von: Avinash D. Persaud
Verlag: Apress
Buch: Reinventing Financial Regulation
Print ISBN: 978-1-4302-4557-5

Electronic ISBN: 978-1-4302-4558-2

Copyright-Jahr: 2015
DOI: https://doi.org/10.1007/978-1-4302-4558-2_4