NEARLY five years on from its great crash, some of the behemoths of boom-time banking are still wobbling. In Cyprus, the island’s second biggest bank is being closed down. The next eurozone crisis could hit that tiny Adriatic gem, Slovenia, where troubled banks and institutional corruption are proving a toxic mix. Or what of Malta, with a bigger banking exposure relative to national output than Cyprus? Or even Luxembourg, the wealthiest EU member state, but thanks to the secretive activities of German, French and other banks, hosting a financial sector a staggering 23 times the size of its GDP?
Here, we saw some of the first dominoes fall. And the focus now is on digging around in the foundations of the survivors to see if they are strong enough to withstand future shocks. This week the Bank of England’s Financial Policy Committee put the overall shortfall in capital in UK banks and building societies at £25 billion. It warned an additional buffer of that size must be added to existing reserves by the end of this year.
Markets seemed relieved. Last year the Financial Services Authority, which formally hands over regulatory control of our commercial banks to the Bank of England on Monday, had assessed that capital adequacy gap at £50bn. The FPC hasn’t revealed exposures for individual banks. But it’s widely believed that some £20bn of that £25bn is accounted for by the part-nationalised Scottish banks, RBS and Lloyds (owners of the Bank of Scotland brand).
Opinion is deeply divided over what banks like the Royal and Bank of Scotland will do to plug that shortfall. Departing Bank of England governor Sir Mervyn King promises not a penny more from taxpayers, but denies that imposing this additional layer of prudence will force banks to shrink their loan books even more. Business Secretary Vince Cable disagrees.
Andrew Bailey, the Bank deputy governor, who will head up its new Prudential Regulation Authority from Monday, says half the £25bn is already factored into existing capital-raising plans by the banks concerned. So the additional burden is around £12bn. Well on the right hand side of the decimal point, even in banks with crash-ravaged balance sheets. The implication seems to be that raising the rest shouldn’t prove too onerous and shouldn’t dampen lending or compromise recovery in the wider economy.
Everyone out there who can’t get a loan at all or is paying interest at a fat premium to rock-bottom bank rate must be thinking: pull the other one. But there’s a deeper concern. As politicians and central bankers wrestle over what degree of regulation might prevent future bank crashes, there’s still no clear-cut consensus on what causes these periodic financial earthquakes in the first place.
The public has already made up its mind. It’s all about greed. The culprit is a cult of casino capitalism. Fat-cat bankers are only in it for the millions they can get out of it. They’d sell you anything if they thought they could get away with it. Look at those nine executives from Barclays, news of whose latest collective £38.5m bonus pot was sneaked out on Budget day. Rich Ricci’s name is sufficient to clinch his role as yet another super villain in this story of how banks have betrayed their shareholders, their customers and the public at large.
Sadly for conspiracy theorists everywhere, some recent academic research in the United States paints a rather different, more nuanced picture of what triggered the 2008 banking crash. The prevailing narrative up until now has it being triggered by the subprime mortgage scandal in America. As the post-millennium real estate boom was peaking, millions of poorer US citizens were lured into home ownership on the back of easy-to-get, low-interest mortgages. Seemingly ever-rising house prices held out the promise of realising their own American dream.
These burgeoning subprime loans were then bundled together by cynical financial engineers, sliced and diced, and sold on as investment grade securities all around the world to anyone who would buy them. Sold knowing the mortgages were junk and the housing bubble would soon burst. Sold to make a quick buck. There were plenty of takers. But when American interest rates started rising again and mortgage defaults soared, the music suddenly stopped. The roof fell in. But, from amid the wreckage, most bankers got off scot-free.
Now, however, three economists – two at the University of Michigan, one at Princeton – have published research findings that challenge that prevailing narrative of why it all went wrong. The trio decided to explore just how cynical and self-interested the behaviour of the people at the heart of this subprime debacle had been. Cheng, Raina and Xiong drew their key sample from attendees at the 2006 American Securitisation Forum, the largest industry conference of its type in the US. These were vice-presidents, managing directors and other executives on both sides of the trade in securitised mortgage products at the heart of this story.
Using public databases covering such things as deed transfers and property tax assessments, the researchers were able to track the personal property transaction history of their entire sample. They also compared it with two other control samples, one of S&P 500 equity analysts who did not cover housebuilders, the other a random sample of lawyers who did not specialise in real estate law.
They found little evidence that their sample of securitisation agents knew the crash was coming. Typically they increased, rather than decreased, their own housing exposure as the boom peaked. Buying second homes. Upgrading main residences. Moving into frothy housing markets like Southern California. They were more caught up in grabbing their own slice of the housing action than either of the other two control samples. The homes they bought between 2004 and 2006 were among those most aggressively sold after the bubble burst. In terms of their own housing exposure, those on the sell side of securitisation plunged in deepest.
So, if it wasn’t all greed and cynicism, what else could have caused this monumental banking crash? Robert Schiller of Yale, one of the few economists to foresee disaster, blames groupthink. The willingness of most individuals to go along with conventional wisdom for fear of being marginalised or ridiculed. Back in the 1950s, lab psychology experiments showed individuals could be persuaded to give patently wrong answers about the comparative length of lines on a card, if others in the group (all in cahoots with the psychologist) were giving the same wrong answers.
As with lines on a card, so with the persistence of any market trend. Bankers, like the rest of us, can be persuaded that housing ladders have infinite rungs.
Even the people orchestrating the subprime boom apparently thought that and put their own money on the line. Yet the Westminster coalition, created to sort the last mess out, is now doing its damnedest to get a new housing boom going. £12bn to support its latest Help to Buy intervention!
Banks may still be wobbling. But are we already in the foothills of the next fiasco?