More than three years into the most significant structural crisis of modern history, the flaws that caused it are still looming around like the strokes of midnight in a horror movie.
A main problem is Moral Hazard. Some banks have reached such a big size that their failure would jeopardise society. Thus, these Banks enjoy an implicit rescue guarantee from governments that are ready to intervene to prevent failures with public money.
The largest ever rescue has already taken place. As Dr. Mervyn King stated, “Never, in the field of financial endeavour, has so much money been owed by so few to so many”. Without that and a promise of an unlimited guarantee, no bank on this planet would have survived.
As we predicted, (Why Banks Should Clean up their House and Take Advantage of the Opportunity of Modern Times), the controversy over bankers’ bonuses is getting greater. Bankers are seen by the general public as the “tourists of capitalism”, who cause the world to collapse; socialize their losses and privatize the profits. All of this bailed out on the back of genuine hard work, economic and social activity of the public.
The situation is now worsened by widespread public spending cuts imposed in most of Europe, affecting those who underwrote the rescue of the banks. This goes to further depress consumer spending which could otherwise ignite the possibility of recovery. In the absence of a systemic plan, these “austerity” measures appear to be socially immoral and technically depressing. So, these “fortune bonuses” appear to add insult to injury.
Yet, just focusing on bonuses is misleading because it looks at the issue ex-post, not ex-ante, and it forces payments of a different nature into the same category. Most bonuses come from banks that are still too big to fail: there the risk return is distorted. Asymmetry over who enjoys the profits and who instead suffers the losses is the problem. This creates further confusion and uncertainty, let alone political unrest. Did we hear correctly that in the UK negotiations are under way in the so called “Merlin Deal”, whereby banks would “commit” to lend more to small and medium size firms in exchange for no further crackdown on bonuses by the Treasury?
Horses trading will not help; “pay as you go politics” are a shambles. We should not be in psychological denial and still pretend that the “efficient markets forces” will magically appear to fix things.
We need courage and leadership, new real economic thinking, an original and systemic approach to repair the system’s faults and forward a sustainable recovery, as we outlined in our plan: “Operation Direct Growth”.
Regarding the matter of billions in bonuses, while the number of unemployed increases, Moral Hazard is the real cause of the problem. The debate should only and simply focus on the need to re-establish a level playing field. These individuals that are enjoying billions have not invested, let alone risked, their own capital but de facto public money. They enjoy an unlimited upside and do not face any downside.
Action should be taken to promote the unbundling of oligopolistic concentrations; a proliferation of players should be favoured, re-establishing partnerships, allowing managers to become real owners, best reward of all; de facto breaking up the banking activities. This would follow the wise recommendations of Dr. Paul Volcker; it would separate banking functions, deposit taking and lending from riskier trading, and keep individually separate the variety of other more sophisticated financial activities.
The break up of oligopolies is not a novelty; it happened already in the past in the oil, railroads, and more recently the telephone industry. Enterprise size matters; and an oligopolistic totalitarian world brings distortions and misery; (Time Horizon and Capital Flows Redirection for Growth). There are no economies of scale that justify such dimensions and concentration of layers of functions and risks.
A proliferation of players would unleash huge value. In fact, it can easily be demonstrated that the individual businesses of any of the top largest banks are now worth much more than the whole bank together.
Governments would grant incentives and award tax breaks if current management, or those executives who walked away with fortune payouts, were to reinvest them back into the industry. Tax advantages should be open to capital to invest in the long term; recreating direct ownership and focus on specialty areas.
This would represent the real Bonus, the concrete incentive for change and the proper reward for the financial industry and its participants, reopening healthy competition and establishing a higher level of industry specialization now needed in the western economy in its current transition.
The systemic hazard would be resolved and the risk diversification achieved would keep things under control. This new level of ownership would bring back that famous “skin in the game element”, that responsibility that is so healthy in any human activity and endeavour. It would make taking calculated risks and receiving proper rewards sound and possible.
No regulation, or capital requirements by themselves, could manage the Moral Hazard problem. Financial Institutions’ size and the necessary division in specific sectors of activity must be properly addressed.
This would also stimulate the recovery of pivotal medium size firms and generate a virtuous cycle in terms of consumer spending and rebalancing of public finances.
How else would those huge public deficits be repaid?
How else would the Euro be saved?
Big dangers are still looming over the horizon, but I remain optimistic: where there is life, there is hope!