Bankers and Their Problems/Mistakes

November 2, 2012

In our previous post, we defended the integrity of the employees of banks, who in our opinion, are little different from those in the technology industry or elsewhere, in terms of their adherence to law and regulation, desire to do the right thing, or, on the other hand, in terms of the (small) percentage who are intentionally attempting to cheat in order to gain advantage.

We asked the question: “Is there a moral obligation that goes beyond the law and regulation?” E.g., if one is abiding by the law and regulation, in any industry, then is it fair, or is it reasonable, for us to expect behavior to adjust to an even higher “moral standard?”

Neoclassical economists (and most Republicans) would seem to answer that we have too much government (law) and regulation, in the first place, and self interest will provide the best results in the marketplace, assuming minimal government intervention. We don’t know of any prominent right wing writings that call for a higher moral standard than already exists as defined in the current law and regulation, which they regard as excessive.

We argued that Stiglitz unfairly vilifies bankers for behavior that was in the vast preponderance of cases, well within the law and regulation–otherwise, our system is well designed to punish, and, as he complains, there was relatively little malfeasance and punishment found and delivered. And, while none of the administrations across the last 30 years in the US or the UK has significantly increased regulation, it still is true that our two countries are two of the most regulated in the world, with the most stringent laws.

Should we say, then, that the biggest banks (investment banks included), with the greatest talent, should not create new innovative instruments, such as credit derivative products? These are products which are admittedly extremely complex, extremely hard to explain to unsophisticated investors. But these products, when successful, efficiently deliver great benefits to the market. Those who want to invest in high risk can buy a tranche of the high yield and high risk portions. Those who want little risk can buy the lower yield portions.  The combination of all this creates highly marketable instruments which deliver a lower overall yield in the market, and lower mortgage costs to the homebuyer. What’s wrong with that?

And, sometimes, in the ups and downs which are now characteristic of our financial markets since Reagan/Thatcher unleashed neoliberal economics, there will be market crashes, in which the best educated of the analysts were simply wrong–they underestimated the downside risk of the market collapse in their models. They didn’t do this intentionally–they simply tried to use a “reasonable range” from best to worst outcomes. If one uses the worst worst imaginable outcome in modeling any future scenario, one would never make any investment–isn’t that right? We assume examples are not needed–it’s so self evident to all when we think about it.

Is this any different, really, from what we might see, and defend as the nature of our wonderful “capitalism” in any other industry? Don’t we find that there is a continuous stream of failures in all industries as competitors fight for opportunities? Most of the startups fail, and we hope that the few which succeed will provided returns to more than make up for the losers. Blackberry devices may be failing, while iPhones may be succeeding. Investors in Research in Motion are losing money. Investors in Apple are making money. If Apple had used the worst possible scenario for various technology failures, their device would cost so much that no one would buy it. As it is, it’s the most expensive.

So, if the creators of credit derivatives, or many of them, with this new product, failed, why do we impose a different standard on them than we impose on Research in Motion? We certainly could argue that the management of that mobile device company misled us with promises of its overwhelming virtues. But, we don’t. Why?

Did the bankers make mistakes? Yes! Did the bankers benefit from largess of government? Yes, in at least three ways–regulation (and the process of poorly administering regulations) and law that was less than effective; and, by reason of the Federal Reserve’s providing such low cost money as to subsidize the banks through “rents,” as it is known in economics; and, by “bailing out” the big banks when their excesses brought them to near disaster. It’s also true that top management of the banks did not suffer enough in terms of their salaries/bonuses/jobs, but in our opinion, that’s more a characterization of our entire economy–all our public companies–not just banks. Auto companies were bailed out, too.

And, again, none of this was “illegal” or in violation of regulation. It was government (if we include the Fed, not free of government influence) that decided to do these things. So, why doesn’t Stiglitz focus more on the mistakes of improper governance, rather than piling criticism on the banks? Is it perhaps because he too falls into the camp of believing in small government and thus cannot stomach the thought of better regulation and stronger laws?  Admittedly, he does address the rent seeking of the banks through the Federal Reserve, so we gather he would like to change that. The bailouts were not the decision of the banks, well received by some troubled banks and resisted by stronger ones (JP Morgan and Wells Fargo, for example). That was the government. Should we criticize the bankers for that?

So, we can criticize the banks for making mistakes. We can criticize them for sending their lobbyists and their campaign contributions. We can criticize them for failing to predict the disastrous drop in the economy in 2007/8, and for aggressive risk taking which they undertook in the heyday of 2004-7, before the drop, underwritten, so to speak, the cheap money policy of the Fed (government). We can criticize them for straying away from their primary purpose of taking deposits and lending to the public. We can say their management profited too much. But, we can’t say they were generally operating outside law and regulation–that’s not proven and that’s not true. Arranging “robo-signing” of mortgage documents was not an attempt to deceive anyone–it was just a poorly executed attempt to deal with the overwhelming volume of requests for mortgages (resulting from the Fed driving down interest rates in its attempt to prioritize its focus on inflation over its responsibility for full employment). It was just another mistake, like any other in the capitalist economy.

Before concluding, let’s return to the question of morality–is Stiglitz making a plea for bankers to rise to a higher level of conduct than is required by law or regulation? Is he saying the credit derivative products are immoral–perhaps because they are too complex for many to understand, or because the risks of such instruments at times of cyclical crisis are high? We are arguing that the basic criticism should be in the absence of appropriate government (and Federal Reserve) action, which was driven by the growing influence of vested wealth interests in every segment of our society.  But, let’s agree on one final observation on human nature–given the nature of our capitalism, it is not likely that any call for a higher moral standard is really going to result in significant change, unless such calls are directed more critically toward changes in government and regulation.  Any other view of such a plea could only be interpreted as a call for something other than capitalism. This will be the subject of later posts.

Milankovic’s excellent book of 2011 (The Haves and the Have-Nots: A Brief and Idiosyncratic History of Global Inequality) puts it well: “The root cause of the crisis is not to be found in hedge funds and bankers who simply behaved with the greed to which they are accustomed (and for which economists used to praise them). The real cause of the crisis lies in huge inequalities in income distribution that generated much larger investable funds than could be profitably employed. The political problem of insufficient economic growth of the middle class was then “solved” by opening the floodgates of cheap credit.” P196

Most all of the failures of banking should be seen as failures of our brand of financial capitalism, and if we want to change it, that’s not going to happen by simply criticizing the banks. It has to happen at the level of how the government manages the economy–we are in need of an overhaul there!

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