Banking Scandalz

Do you know what popped into my head as I read the latest blog-post by Philip Boucher-Hayes ("PBH")?

Of course you do: it was the argument that is always made when the pay and conditions of teachers comes up on talk-radio

They are all underworked and overpaid because I know a teacher who just reads the paper all day/can't control the class/never corrects homework/comes in drunk etc etc

Fire those teachers, I say ! And then discuss what teachers worthy of employment should be paid.

So, up rocks PBH - I am out on a linguistic limb here; it means "PBH comes along", I think - to suggest that all bankers are evil because ... well, he has a list of credible accusations against a number of banks and bankers around the world. He and I had a little back-and-forth about this on Twitter, in which I wondered if any of the stories came to more than a hill of beans. He answered that many actually involved regulators extorting extracting large amounts of money in penalties from banks.

Parenthetically, I often marvel at the respect that court decisions or regulatory actions attract when the results line up with the zeitgeist. Out-of-touch judges and clueless regulators magically, when criticising popular targets and/or imposing penalties upon them, become not just excellent but infallible.

The catalogue of scandalous conduct laid out by PBH is impressive, so much so that in several cases it seems to me that it would merit the loss of banking licences. Why hasn't it ?

I am much too modest to suggest that I know the answer, but it seems to me that there several fairly plausible possibilities.

1. The conduct alleged never took place, or was less serious than alleged
2. It may have indeed taken place, but the proof is unavailable
3. Credible scapegoats were found and dismissed e.g. Bob Diamond of Barclays. (Note that they may or may not have been the true culprits)
4. It may still happen

"Wait", you say. "Are you not forgetting that many banks have already been fined huge amounts ? This proves that the allegations are no mere flights of fancy; they have in fact been proved beyond reasonable doubt, as you lawyers say".

Well, I am not familiar with all the cases involved, but of course it is not my intention to suggest that no bank ever grossly misbehaves. The manipulation of LIBOR, even if the effect on any customer, when there has been any at all, has been exaggerated, was appalling, for example. But I do not accept that all of these allegations have been proven beyond reasonable doubt, or even to the less demanding standard of proof viz. on the balance of probabilities.

No "Free Lunch" in Banking Regulation

The Bankers' New Clothes:
What's Wrong with Banking and What to Do about It

by Anat Admati & Martin Hellwig.

Publisher: Princeton University Press

MY REVIEW

The ability of financial intermediaries, normally banks, to create money via the device called fractional reserve banking ("FRB") is capable of being both a boon and a bane.

When it works well, savings are mobilised, economic activity is facilitated, incomes increase, wealth accumulates and occasional set-backs are accommodated. It is a magical device without which the modern world could not exist.

In this, it resembles fire. Fire is essential to civilisation but is also extremely destructive when control of it is lost, Similarly,when money creation goes "bad", the consequences can be cataclysmic.

Some say that this is basically unavoidable, and that humanity is condemned to endure such disasters from time to time, just as we must expect another Ice Age sometime, no matter how well we restrain our pollutive natures. That may or may not be so, but I agree with the authors of this book that lessons can be learned and things can be done.

Admati & Hellwig are enthusiasts for the idea that Society can be spared future pain by a more conservative approach to one of the key fractions in FRB, the leverage ratio (often also called the capital ratio). "Whatever else we do, imposing significant restrictions on banks’ borrowing is a simple and highly cost-effective way to reduce risks to the economy without imposing any significant cost on society" is the message of this book, which also gives much space to rebuttal of many contrary arguments. It is a good book, and overall, I think that it makes its case well.

I really wasn't aware, before the book came to my notice, that the issue was so controversial, and I am still a little bemused at the pretty unanimous enthusiasm with which the book has been greeted by some. You can read The Grumpy Economist (No, John Cochrane - and he claims that he is "not really grumpy") and Patrick Honohan - who does admit to some "chafing", mind you - to get the full enthusiastic flavour, or just look at the reviews (including one by Ken Rogoff) summarised by the publishers here. Based on what I have seen myself, the selection appears, unusually for a publisher, to be quite representative. The Amazon ones are here.

My reason for buying the book, though, was because I was astonished by the authors' vehemence (visible in interviews and the Internet) on a point that I (still) think to be incorrect.

I agree that lower bank leverage will bring probably all the benefits that the authors say that it will. Furthermore, I note that they have wisely avoided pinning their colours to the mast of a specific figure, though it's clear that they have roughly 30% in mind (the current average figure is 3%, they say; others put it at nearer 11%). I also tend to side with them in the rebuttals of objections.

My problem is with their insistence that their plan is cost-free for the economy as a whole. I find it odd that there has been so little discussion or challenge of the view that higher bank capital requirements will not actually reduce the flow of loan finance out of the banks. Their approach to this in the book, in interviews and their website is not only wrong, in my view, but perverse.

It is perverse because it requires us to accept that banks' funding structure will have NO effect on banks' activities, whereas Admati & Hellwig spend quite a lot of space describing how the need to attract equity will improve lending standards. Better lending ceteris paribus pretty inevitably means less lending. Admati and Hellwig at different points appear to accept and also to deny this.

While one of the points well made in the book is that (non-bank) users of capital have become too fond of credit and too equity-averse, the authors appear to believe that this preference will frictionlessly pivot on both sides of the balance sheet i.e. depositors will voluntarily become more inclined to take an equity position in the institution where they keep their liquid savings, and borrowers will become more willing to pay in the form of a profit-share to lenders. If anyone doubted that before the Cyprus "bail-in", their fears will not have been assuaged by that fiasco.

I share Arnold Kling's view,

The non-financial sector wants to issue risky, long-term liabilities and to hold riskless, short-term assets. The financial sector accommodates this by doing the reverse.

.

Finally, though, I am dismayed by this book, and nearly all of its reviewers, because I see no appreciation of the multiplier effects of capital, and other ratios, on the dynamism of FRB. (Indeed, the words "multiplier", "fractional" and the phrases "fractional reserve banking" and "money-creation" are entirely absent from the text.) Central Banks wishing to dramatically slow down over-heating economies or sectoral markets always could (but very rarely did) increase the minimum ratios.

Raising the capital ratio, which is another way of saying "reducing the leverage ratio" even from 11% to 25% will drastically cut the money supply, even if the appetite for bank equity increases a lot. Raising equity capital may not be as difficult as it once was, but it is still and will always be slower than borrowing from money markets. For Klingian reasons, I doubt that bank balance sheets will, following such a change, end up as big as they were. This will have effects in the real economy.

But, even if this is, improbably, insufficiently optimistic, consider what the position will be going forward with a ratio of 25 instead of 11. Where before the multiplier was 9, now it is 4. For every extra million in deposits, 4 million can be injected as new credit, instead of 9 million. That is a formidably less dynamic monetary environment.

Of course, there will be positive aspects to this: less inflationary pressure and less reckless lending, to name but two benefits well worth having. And as we have painfully re-discovered, excessive dynamism is undesirable. However, as the authors say in another context, "it is impossible to discuss coherently the need for anything without considering its cost". The flow of credit will be reduced, and money creation will be suppressed considerably if we do, as we probably should, adopt Admati & Hellwig's proposal either in whole or in part. Those are significant costs. We should not pretend that they do not arise, even if we think that they are exceeded by the benefits.

Update on Friday, July 12, 2013 at 11:15AM by Fergus O'Rourke

Whoops ! Nearly forgot to mention this by Arnold Kling on the book, in which he adopts, unsurprisingly, a Klingian perspective. My own review was drafted before I discovered this article.

Update on Friday, July 12, 2013 at 11:19AM by Fergus O'Rourke

It's not explicit above, so let me make it so: the authors' repeated claim that they will show, and then that they have shown, that there is no cost to be paid for what they propose is, I say, not sustained in the book, or in the subsequent responses to its critics.

Resumption of My Arrested Series

Readers will recall that the next, ninth, part of the series was to address the question

so, do they just get away with it, then ?

I was not very happy with the answers that I was getting to my own question, but patience has proved worthwhile, at least to me. While I was contemplating and researching the question, a number of things happened that affect things a little bit:

• Eugene Sheehy, CEO of AIB when "the ship hit the rocks", agreed to forgo part of his pension
• The rump of Anglo Irish Bank and Irish Nationwide Building Society, which had been consolidated as Irish Banking Resolution Corporation ("IBRC") was put into liquidation by the Government.
• The Liquidators quickly moved to sue Fingleton and others
• Seán Fitzpatrick and two of his former co-directors of Anglo have been formally charged with criminal offences. The charges relate to illegal concealment of loans to directors and to provision of loans by Anglo for the purchase of the Quinn stake in Anglo itself
• Ex-CEO Jim Lacey and some other former directors of NIB (now Danske Bank (Ireland)) were disqualified as directors

As I have previously observed, the crimes on which the Anglo Three will face jury verdicts are not of any real consequence as causes of the Collapse. It is matter of great regret as far as I am concerned that almost all of the time and other resources of the Office of the Director of Corporate Enforcement("ODCE") were diverted into the project of prosecuting these matters.

The other developments listed above are more significant, in my view. Together, they point the way to how, where the will is present, it is possible for the law to do something in recognition of relevant personal failures on the part of individuals even if, as it appears, no crimes of significance were committed and arrests are therefore ruled out.

Over the next few days, I will be sharing my conclusions in this regard.

Do remember, though: I am, I hope, not indulging in vindictiveness and my use of the phrase "getting away with it" must not be understood as suggesting that any crimes contributed to the Collapse, or that anyone guilty of a criminal offence connected to the Collapse is going unpunished. I cannot guarantee, of course, that the latter is not happening: all I can say is that I am aware of no evidence that it is, and everything that I have seen over the last five years suggests that such evidence is lacking.

Thoughts on an Arrested Series

In the old, originally French (I think), sense of "halted", my 10-part series (the first 8 parts are here) has itself been arrested for some time now.

I will explain why in due course, but some interim observations may be of interest

Yes, Irish bankers are just as liable to commit criminal offences as any other occupational group, and I have no reason to suppose that they are more virtuous than, say, journalists,lawyers, politicians, priests or academics. However, once again, I must emphasise that in this series I am looking only at the issue of crimes which may have been causative of the collapse of the Irish banking system.

Greed - which many see as the fundamental cause - is not in itself a crime, and I cannot see any workable manner in which it, simply as such, could be made one.

Fraud and insider trading are crimes, and their incidence increased in the period up to the Collapse, but they neither caused the Crash nor significantly contributed to the cost of it in Ireland (it may have been otherwise elsewhere e.g. in Iceland).

There is no evidence - that I have seen - of involvement in such nefarious activity by prominent individuals in the Irish financial institutions, civil service, regulatory establishment or politics, with the possible exception of the Anglo/Quinn debacle. (And in that sub-story, most of the credible allegations relate to what was effectively an increasingly desperate and always futile campaign to prevent the Collapse which had already become inevitable, probably from the beginning of 2007 or even earlier).

Journalists such as Matt Cooper (in many ways otherwise admirable) react by saying that if we cannot prosecute them, then "we" must excoriate them using "our" ability to "name and shame". What is meant is not even "trial by media" - trials have rules - but more or less ignorant demagoguery, which tells us more about the moral standards of those engaging in it than about the guilt of its targets.

More serious commentators, in particular Colm McCarthy, refer constantly to "lack of clear answers" and, while acknowledging the possible lack of criminal behaviour, persist in suggesting that there must have been an original "sin", committed by an individual or by a small number of people, which drove the banks "onto the rocks". They say that the Nyberg and its preliminaries dodged this question and point to the Bankruptcy Examiner's Report into Lehman Brothers in the U.S. as a model.

Let me (again) make a few additional pertinent points:

1. As the regular visits to Gárda stations by Mr FitzPatrick and a few others demonstrate, arresting is, among other things, in itself an idle recourse.
2. Charging and then bringing to trial are what matters.
3. I am not opposed to imprisoning bankers if they are convicted of serious crimes.
4. There is little reason to believe that the Irish banking disaster was caused by any Irish banker committing a serious crime known to Irish law.
5. Note that this does not equate to saying that no Irish banker has committed a crime known to Irish law. It also does not, of course, mean that Irish law may not have been lamentably lacking
6. As to whether breaches of the law were serious or otherwise, most were not, as far as I can see. The evidence on serious alleged crimes is not yet in the public domain (leaks do not count: they are usually inaccurate). My guess – not all that educated – is that at least one Irish banker is guilty of at least one of the serious alleged crimes. But the crimes in question did not contribute to the occurrence of the banking catastrophe for which we are all paying.
7. I believe that we need to legislate for more banking crimes, but we cannot in 2013 make something that happened in 2008 (or before it) into a crime now if it was not one at the time. The argument that the "common law" would have always regarded some relevant behaviour as criminal has proven impossible to sustain.
8. Furthermore, I am sympathetic - just a little - to Nassim Nicholas Taleb’s idea that we should perhaps reconsider the virtues of the death penalty, as in China, for disastrous errors of bank management.
9. There is no need for you - I am addressing the vocally impatient among us - to wait for the Director of Public Prosecutions, if you think – understandably – that she is too slow. The option of private prosecution, though of limited utility, is available if anyone thinks that there is enough available to proceed against anyone.(Read the recent English case of Gujra which includes a discussion of the merits of this procedure. The position in Irish law is very similar.)
10. But the truth, which those who shout loudest on this will not admit, is that you don’t have such a basis. Or else, you’re too lazy and prefer to shout than to do something useful, while complaining that others owe you a duty to do what you will not do yourself.
11. You are not alone. For years now, I have been offering to help anyone who wants to do something about it. Want to guess how many have even enquired about the possibility ?
12. The answer is: 1. No, not one hundred or one thousand. Yes, I mean the number between 0 and 2. I have had a single enquiry.
13. More correctly, the answer is still: zero, because that query – which only came in a few months ago – turned out to be from a bank shareholder who wanted to seek personal compensation from a former bank director.

On "Getting Away With It"

Any resemblance of any hypothetical characters mentioned hereinafter to real persons, living or dead, is purely coincidental.

Consider this scenario:

It is a "stark and dormy" night. (Who said Bulwer-Lytton is forgotten ?) On an unlit road, a tanker's valve somehow spontaneously opens - nobody ever provides a satisfactory explanation as to how or why - and the road surface is soon covered in a black-ish, smelly, viscous liquid. Some minutes later, a motor-car encounters the liquid, the driver - whom I shall call Mr Cooper - loses control and a very nasty accident happens, resulting in several deaths.

Cooper survives, however.

Is he jailed ? Prosecuted ? Arrested, even ?

No. Instead, he lives on, a free man "without a (legal) stain on his character". As Pat Rabbitte once asked, though, is he happy ?

Many people consider this to be outrageous. Four years later, some - and not just the predictably ignorant or intemperate - still mutter about how "the crook got away with it" (and believe it).

Now, unless you are new here, you will not be surprised to learn that my natural inclination is to resist such talk. I will ask to know which crime the unfortunate Cooper is supposed to have committed, why his broken tail-light or out-of-date driving licence had anything to do with the tragedy, even though they were criminal offences - albeit very minor - and so on.

My guess is that, even if you did not "buy" similar arguments already made by me in this series, you might see some value in them in the context of the hypothetical Mr Cooper.

It's an interesting exercise to discuss - as I have done with some people - why "the Coopers" are likely to get more sympathy (and, in my view, more justice) than "the bankers". Let us not detain ourselves with that discussion now. (We can return to it if there is a desire to do so).

However, in this article, I am going to explore the other side of that argument.

Let's go back to Cooper, and make the picture painted of him a little less straightforward, and thus, arguably, more realistic.

Breathalysed at the scene, he tested positive and while the subsequent blood test showed the alcohol in his blood was well below illegal levels, it also showed traces of psychotropic substances. At the time, however, the law did not specifically make it a criminal offence to drive in this condition.

Police investigation also revealed that Cooper's vehicle had at least two tyres marginally "bald", and that he had almost certainly been both driving too fast for the conditions and, worse, had been doing so with a telephone clamped to an ear with one hand.

All that said, the police had no doubt that none of these circumstances contributed to the tragedy, in which Cooper lost not only his only two children but several close friends who happened to be on the road at the unfortunate time. Even if Cooper's vehicle had been in perfect condition, even if he had had no alcohol or other intoxicants in his blood, had had his licence up to date, and had been driving with perfect care and attention, the people would have all died anyway.

Despite these circumstances, should the police charge Cooper with DDCD ("dangerous driving causing death") or less serious offences under the Road Traffic Acts because, otherwise, he will "get away with it" ?

Am I alone in wondering how a man involved in such a horrific scenario will ever get over it ? To me, the question of him getting away with it is out of place.

I would like to hear from those with a contrary view.

(We are not going to detain ourselves at this point with exploration of the culpability of Lehman Brothers, the haulage firm which owned the oil-tanker - imagine that ! - or of any other dei ex this particular machina. But don't forget the disclaimer above.)

Why They Should Not Be Arrested - Pt 8

This post is one of a 10-part series of posts, the rest of which can be seen here.

In this post, I shall address some issues which have been raised by comments made (on this site, Twitter and elsewhere) querying my overall thesis.

Common-Law Crimes

A "common-law crime" is one which was not voted into existence by the legislature. Many things have been recognised to be criminal for thousands of years. For example, murder, rape and theft were all recognised by the police and by the courts as crimes, even before statute law (that is, laws enacted by our elected representatives) defined and refined the details.

It has been suggested by Fintan O'Toole of The Irish Times, for one, that what caused the insolvency of our banks was the commission of common-law crimes by bankers. He refers favourably to what happened in the case of The City of Glasgow Bank, implicitly suggesting that that case showed "just how it should be done" if our justice system would only work as well as did, notoriously, that of 19th century Scotland, oh yeah !

Well, I have seen no evidence that similar behaviour occurred in our own recent disaster, but if it had, the perpetrators could be charged, not with such common-law crimes, but with crimes which have now, like murder, been defined by the legislature.

In any case, the City of Glasgow situation was in hardly any way comparable: only the shareholders lost money.

Finally, I know of no (other) common-law crime which applies to the behaviour of those who are responsible for our banks' failures.

Unjust Enrichment

There is no crime of "unjust enrichment" known to Irish Law. I am not even aware of it being a crime in other jurisdictions.

There is a tort (meaning a civil wrong) of that name. It describes the situation where, for example, you give me a €50 note thinking it to be €20. I do not notice, but may have been "unjustly enriched" by €30. You may be able to sue me for the return of the €30 - good luck with that ! - but there is no question of my being punished for what happened.

It might just be possible that some of those responsible for the banking mess might need to be nervous about this. To be clear, though, they may worry about having to return money received, not about being arrested or imprisoned.

"General Criminality"

This is the most common objection to my thesis, if hardly the most compelling.

What is said is that our "top bankers" were all obviously up to their necks in "blatant criminality", by which it is meant that they disregarded all constraints of law to indulge their greed. I have even been assured, by intelligent people educated to third level, that said bankers knew what they were doing and were determined to ruin their banks and the Irish economy so that their own wealth would be maximised.

Challenged to justify this belief, they will cite the revelations about the behaviour inside Anglo-Irish Bank during 2008, but are unable to explain why, if both Seán FitzPatrick and David Drumm are now bankrupt, wealth maximisation was going on.

I see no evidence of this alleged "widespread criminality". Greed is not a crime.

What happened during 2008 was not a cause of the crash, but a desperate attempt to avoid it.

Recklessness

Almost as common as the last, this concept is mentioned often, and appropriately so, in my opinion.

There is no general crime of recklessness, or even of gross negligence, in Irish Law. (There are road traffic offences which amount to the same thing, but prosecuting for lending "carelessly" "without due care and attention" or "dangerously" under the Road Traffic Acts are not viable options).

Now, Irish law does recognise a crime of "reckless trading" (Companies Acts, section 297A). Prosecutions of this can only take place if the accused was a director of a failed company (meaning one in examinership, or liquidation).

Because of the way in which the failure of the Irish banks has been handled (even Anglo is not a "failed company" in the above sense), technically the crime does not apply. I will discuss this further in the next part of this series of articles. For now, I will say two things about it.

First, I do not believe that the authorities had that legal position in mind when they chose to proceed as they did, but anyone of another mind is welcome to try to change mine.

Secondly, I cannot resist reminding you that I asked for a mandate from the electorate last year to make "reckless lending" a crime in itself, but there was little interest from voters and none from commentators.

Coming Soon

Part 9, in which I (attempt to) answer the question

So, they just get away with it, do they ?