Industry | 2010.03.15
The bankers' moral hazard | Paul Myners
Our goal is to restore discipline, and make sure financial markets punish as easily as they reward
In August 2007 a shock to global credit markets sparked the most severe financial crisis in a century. A crisis that saw world trade contract for the first time since the second world war and 200 million people around the world lose their jobs. The response from governments meant many millions of jobs have been protected – in the UK the number of repossessions and insolvencies is much lower than feared a year ago – but it has come at a heavy price and with significant controversy. With a difficult period of public spending consolidation ahead and relatively subdued economic and job growth, there has been anger as banks have rebounded from the crisis by paying huge bonuses, several posting record profits. There has been a widely held view that the crisis had negative consequences for everyone except those who caused it.
The failures have not been failures of the market economy. They have been failures of men and women who forgot that market discipline meant that they had to be disciplined in order to get results out of the market place. Too many people got complacent and lazy – and the market responded as we should have predicted, by extracting great costs from a great number of people. Some deserved it, but many did not.
An unswerving confidence in the efficiency of markets became an excuse for many to simply rest on their laurels. Making money is about hard work. It is about taking risks and just as importantly owning up to the fact that you are truly taking risks. And that means being smart, sceptical, and thinking through things before you do them. But for the market fundamentalists making money was about following formulas, plugging in the numbers, sitting back, and waiting for exactly what you predicted to happen, to happen.
The crisis of the last two years should be one unholy reality check for the fundamentalists. The market did not fail. People failed. Like an overconfident swimmer caught in a rip tide, they disrespected the power of the market and were pulled out to sea. But the financial industry did not get pulled out on its own. It dragged with it the savings of our families; the jobs of our workers; the viability of millions of small businesses. And faced then with unprecedented, sweeping, and irreparable damage to the real economy, governments around the world had no choice but to send out the most expensive flotilla of lifeboats ever assembled.
Saving the world\'s financial system was unquestionably the right thing to do. But in the process of saving it, we protected those very market fundamentalists whose actions caused the crisis.
The risk is now that their confidence has not been sufficiently dented; that they have not truly learned their lesson. And the danger with this moral hazard is that they could put us all at risk again.
This is why a central part of restoring true market discipline to the world financial system must be major reform globally to the way banks and financial firms are governed and regulated.
Our reforms must have three goals. First, we must make the system safer and stronger. We will introduce much more stringent capital and liquidity requirements in a co-ordinated global process. It\'s vital we do this in convoy – the UK cannot unilaterally adopt significantly more demanding standards than competitor countries. Incentives for bank staff must be aligned with the long-term health of their institutions.
Our second goal is to make the system fairer for everyday consumers with mortgages, pensions, savings and current accounts. Many are still faced with impenetrable language in mortgage and pension provisions. We have already proposed much greater transparency, mandatory income verification before the issuing of mortgages, and a full suite of reforms to make financial products work in the interest of their buyers.
The third aspect is perhaps the most important. It is the goal of this government to make sure financial markets can punish just as easily as they reward. A lot of people lost money in the financial sector over the last few years – bank shareholders in particular. But many have been protected. Creditors have been bailed out. Far too many bankers themselves have enjoyed massive awards during the crisis, even as their firms were rescued.
If we do not address this issue, we will have no hope in restoring true market discipline – the fundamentalists will get right back to business. We are serious about removing the safety net that has allowed those with blind faith in market efficiency to ignore the consequences of their lack of discipline. We are working with G20 countries and the IMF to assess the feasibility of an international levy on financial institutions . Any residual insurance banks are perceived to enjoy will not come for free.
In the past the implicit support of the financial industry has probably represented the most expensive public subsidy provided to any industry in any part of the British economy – vastly exceeding that paid to agriculture or the defence industry. There is no reason why taxpayers should continue to provide a free-at-the-source-of-delivery subsidy to the cost of capital for the banking system. We need to do everything we can to shrink the subsidy to zero.
Finally, it is also important to recognise what regulation can not do. The job of government is to protect ordinary people from the poor decisions of people working in the financial sector, and their failures to manage risk. But it is not to protect lazy or reckless investors and financiers from their own stupidity.
If we are going to fully overcome the anaesthetising effect of efficient market theories, the women and men who have money in the market are going to have to start behaving as if they have something to lose. It is time for real discipline from investors, from owners, and from anyone who has something to lose in the marketplace. And we should do everything we can to make sure failures of market discipline get the scrutiny and condemnation they deserve.
For more information, please visit
http://www.guardian.co.uk/commentisfree/[...]moral-hazard-discipline-punish
