I have a confession to make - in my deep and distant past, I have an accountancy qualification - a legacy of a young man with too little focus about what he wanted to do in life and before it had occurred to him that someone might pay him to play with computers. Not that I think there’s anything particularly wrong with accountancy; in an island dominated by finance it was a safe bet for a mathematically / logically-minded individual with too many diverse interests and no particular clue which one to follow at the time - but I found out pretty quickly that it definitely wasn’t for me. I don’t regret having done it though, since the knowledge, fogged though it is due to time, does sometimes come in handy; in particular, the economics elements. I’m no Warren Buffet by any stretch of the imagination, but I do at least have some grounding in the subject, and I do at least try to stay roughly abreast of economic events. And certainly, it’s been one hell of a year for those.
We’re now in the situation where not one, but 3 banks have been bailed out globally by governments, effectively propping up an ailing business by stumping up taxpayers money as security - Northern Rock in the UK, Bear Stearns in the US, and IKB in Germany. All three were brought down because of their reliance on a system which had poor lending practices built into it, and a level of greed which was suppressing sensible risk analsis. In all 3 cases they themselves were not the bad lenders, but they either bought the repackaged ‘leveraged’ debt as high-risk, high-return (in theory) investments, or relied on other people continuously buying into those kinds of ‘products’ to keep the system sloshing about with fresh money they could borrow themselves. In all 3 cases it was entirely their own fault for taking on excessively risky positions in the pursuit of profit - of course there were environmental factors over which they had no direct control, but these happen from time to time and a good risk strategy should cope with that. Ultimately the cause of failure was that these banks gambled too hard and got caught with their pants down. They bet that the house of cards wouldn’t blow over on their watch, and they were wrong - and they didn’t have the resilience to weather that, because they bet big, because they wanted to win big. More risk equals more reward, except when you lose.
When considered in isolation, I find it utterly distasteful that these businesses should be bailed out by governments. Between them they have made many, many billions in the past, which has no doubt funded some pretty lavish lifestyles at one level or another in the company, but they got too greedy and theoretically should pay the price that comes with that, since they already reaped the successes. But they haven’t really; the taxpayer is now shouldering most of that, along with shareholders who have lost their investment. For Northern Rock the amount being covered is to the tune of the entire NHS budget for a year - a staggering amount of money. However, I do understand why the central banks & governments had to step in, in all practical terms - after all in the interests of all of us, the financial system has to be seen to be stable, and given that people’s savings and pension funds were in danger, letting these companies go to the wall would have had some really nasty knock-on effects. Nevertheless, it does set something of a precedent - that a regular business will just be allowed to go under if it doesn’t perform, but high-flying banking business can take a ton of risks, make a truckload of money in the good times that they can spend on private yachts and penthouse apartments, and then get bailed out when the tide turns and their extravagant risks catch up with them. It’s a skewing of the karmic system that doesn’t feel right at all, despite all the valid reasoning that underpins it in an imperfect world.
I only hope that when the good times roll around again, these banks pay back the favour, with considerable interest. And that maybe, just maybe, a better way will be found to regulate these banking practices - I totally agree that government should not get involved in regulating business any more than it absolutely has to, but if the bottom line is that the government picks up the tab for failure, then these principles are incompatible - you can’t have it both ways. Maybe banks of this size should be required to make large annual contributions to a ‘rescue fund’ to cover those in their number that need bailing out - an insurance policy of sorts?
March 20th, 2008 at 12:51 pm
I dont think banks will change their behavior themself. They know they are needed and if they really need money they will get some from the goverment, because the goverment cant let the finacial system be crushed. And i dont think anyone want the system crushed. So i think this is one part where the goverments need to control more, they have clean the broken pieces anyway, so why couldnt the profit if the business is good. I dont know exactly what should be done. But something like, pay X% of your income every year to the goverment and if you are in trouble they will help. And a bit of controll where the banks invest would be good. What is now happing could be seen for several years, but they kept investing to for the will of profit and im pretty sure the banks knew they dont have to pay the bill at the end of the day. But im not a expert, just a humble opinion from a bystander
March 20th, 2008 at 2:45 pm
“Maybe banks of this size should be required to make large annual contributions to a ‘rescue fund’ to cover those in their number that need bailing out - an insurance policy of sorts?”
They already do - at least it sounds to me like that …
Quoting:
”
Your bank is also required to carry government insurance on your deposits up to $100,000. The insurer is usually the Federal Deposit Insurance Corporation (FDIC).
“
March 20th, 2008 at 2:52 pm
@warmi: that’s deposit-taking, high-street style banks, not investment banks, and it only covers the depositors. What’s happened is that the government has needed to prop up the banks themselves to stop the whole system unravelling due to lack of confidence, and that is by no means covered by depositor insurance. The depositor insurance might be ok for small local savings banks, but what’s happened here is that the abject, unsupported failure of something as big as Bear Stearns in the current climate would send confidence-sapping shockwaves through everything else and destabilise the entire financial system - or at least that’s what the governments think, otherwise they would not have stumped up so much of taxpayers cash.
It’s an example of how poorly regulated capitalism can fail, because excessive greed is inherently self-serving and that the potential for collateral damage was not properly factored in. The public purse has had to absorb the mistakes this time, but you can bet your ass that there will be measures coming in after all the fallout has cleared to try to prevent a repetition. You have to be careful not to have the regulation leash too tight, but this is an example of what happens when you let it go too slack and let greed run too rampant. The theory of it is that if a business fails because of that kind of behaviour, it’s their own fault and it should be self-correcting, but clearly that’s an oversimplified view of how things actually work. In practice, everything is connected.
March 20th, 2008 at 5:09 pm
Steve, I have to fundamentally disagree with you. In fact, being as most of Europe is quite socialist, I would say these latest actions fall more in line with that style of thinking than our “hard-line capitalism”
(and let’s not get into political philosophy and how socialism can be seen as the ultimate case of no karma, government bailing you out. But I do agree with socialism, which is why I won’t go there even for the sake of debate
)
What you have to understand is that the US government did NOT bail out Bear Stearns. Bear Stearns is destroyed. One of my best friends from college works there, and it’s rats leaving a sinking ship - most by force. It is a wrecked shell. The company’s stock fell from $57 to around $3. Everyone- those who had invested in it, those who had options (read: spoiled execs) - everyone- suffered BIG time.
If the government had stepped in and said “Bear, we’ll float you a low interest loan to keep you going” I could partially see your point. But that’s not what they did.
What they *did* was secure JP Morgan’s purchase of these now tainted assets- they were willing to socialistically sponsor this bail out so *that* the pension funds, Bear Stearns name, associated mortgage-based devices, etc. remain intact. It’s to avoid a financial disaster. Not for Bear- for the many many people who used Bear. Bear is through. You say they “should pay the price that comes with that.” Believe me, they have. From every possible angle- financial, reputation, career, pride- nobody at Bear wins in this.
Bear had a large chunk of the nation’s finances tied up in it. As a parallel example, the government financially supports Amtrak, our train service, because they just can’t get profitable. It’s the same thing. The government stepped in to save those dependent on what is virtually a public utility. Not the utility itself- but those who utilize it.
The only people who will benefit from this are JP Morgan for purchasing bargain basement-level assets. And frankly, in line with your karmic arguments- they’re willing to take some risk, they should get the rewards.
March 21st, 2008 at 12:47 am
Not exactly. Bears Stearns was sold not declared bankrupt. Had the Fed decided to declare bankruptcy they still could have helped the depositors and let the execs sink but this is not what the Fed did.
If you want to understand how the execs are benefiting read this: http://dealbook.blogs.nytimes.com/2008/03/19/hedging-the-bear-stearns-deal/
Oh… btw it is even becoming better:
http://au.us.biz.yahoo.com/bw/080320/20080320005968.html?.v=1
By definition Capitalism is good… when you have capital
March 21st, 2008 at 7:27 am
Bear Sterns is being bought, and the Fed is guaranteeing that they will back any debt the buyer takes on from this sad sorry institution. You know why I have no sympathy for these people? Because as the ship was sinking, when they KNEW it was sinking, they kept giving record bonuses year after year. Now, they are saved from declaring bankruptcy these people are able to keep those bonuses. Literally BILLIONS of dollars were given by Bear Sterns in bonuses. It’s just retarded. And JP Morgan (if the acquisition goes through) is not really taking on any risk here. That’s the whole point of the Fed backing the debt. Any bank that isn’t going under is literally lining up for a chance at a deal like this one.
This all goes back to what Steve was saying: it’s all very self-serving, and in an industry where “experts” are serving a public who largely don’t understand the nuances it is easy for their greed to harm everyone (instead of the easier situation, where your greed harms only you).
March 21st, 2008 at 10:00 am
“I would say these latest actions fall more in line with that style of thinking than our “hard-line capitalism””
And therin lies the problem - you can’t have a situation where you give financial institutions free reign in the name of pure capitalism, allowing them to make a killing in the good times, only to have to sink public money into them when times go bad. Regardless of whether you consider it a bail-out or not (and personally, anything that costs public money and interferes with the outcome is a bail-out by any other name; were just arguing about the degree of it), the fact is that the principles are entirely at odds - that banks like Bear should be able to reap the good times, in a celebration of capitalistic self-interest, without any thought to the implications outside their company should they screw up, and yet it’s in the interest of everyone else to avert larger economic ramifications should they fail. Purist capitalism tends to claim that ‘the market will sort everything out’, and that’s regularly used as an argument against regulation, but anyone with any ounce of sense knows that’s a steaming pile of crap in practice, certainly when you get to a certain size of business. The fact that the wider economic environment required that these banks be given some kind of softish landing (albeit still a big fall from grace), funded by the public purse, shows that market forces aren’t the whole story (in the interests of stability of the macro economy), and that should be factored in during the good times, not just the bad.
I also seriously doubt that the top management of Bear Stearns will be hurting that much in the medium term. I feel sorry for investors and for most of their workforce, but not for the senior figures who set the strategy and targets that led to this.
As for the Amtrak example, I don’t see how you can compare them at all. Train services don’t make a killing in the good times, Bear Stearns did. Train services provide a vital public service (more environmentally friendly travel) that can’t be easily provided by someone else because of the huge logistical issues, Bear Stearns is just one of many investment banks, they just happened to run their business badly. Bear Stearns is far, far from qualifying as a public utility IMO. But hey, if they want to become one, then they should also submit to the same level of governance as utilities have to - Amtrak wouldn’t be allowed to run their trains twice as fast to make more money, and just hope that they didn’t come off the rails (because you know, they hadn’t so far, so why not push it a little more?). Bear may not have put physical lives literally at risk, but I think the analogy stands up - if the risks you take in your own business interests are going to affect more than just your own company should they fail, slacker regulation is not an option. Choose one or the other, but you can’t have both.
March 21st, 2008 at 3:57 pm
I think you’re taking something governments and banks do every day and calling it wrong because of the particular magnitude of this case.
The very core of banking is extending credit. Our banks are based almost entirely on speculation of future payments that *will* come in. Not the money currently in the economy, but the money that is loaned out and expected back over X years. I could go on about how these loans are reported as assets, but I’ll forgo the lesson in 1929 economics
The government insures every personal account for $100,000. This was established, in large part, to allow banks to continue to “gamble” as they do with people’s money, while allowing individuals to confidently let them do so. You have to realize that the case of the government insuring JP Morgan’s purchase is the very same thing on a much larger scale. Bear gambled, and Bear lost. If Bank of America made some vitally bad loans and people’s savings were at risk, you better believe the government would step in- and at probably much more money than they’ve put up now. I don’t see how a pension fund and an individual account are any different.
It all boils down to this- we, as a society, have decided to play the game of credit. Love it or hate it, a large majority of people have decided that the shiny things now are worth the payments later. This is all gambling, period. Unfortunately, it ties up people’s lives, homes, etc.. and the banks are the brokers that keep the machine running. For some it works great, for others, not so much.
The real culpability here, to be honest, lies with the people with bad credit who default on their loans, and fund managers (such as pension managers) who put their money with Bear. The former are guilty for just plain not holding up their end of the bargain in this grand game, and the latter for not managing the funds under them correctly (i.e. invest in something as risky as sub-prime mortgages via Bear.)
The problem is that Joe the retired steel worker has about zero control over how his pension’s manager allocates the funds. Sure, through voting, etc., but let’s be honest about how involved Joe would really be in this process. And *that’s* where the government needs to step in.
We’re in a hairy game with this credit structure, and it is subject to failure. But to say that now “the public’s money” is needed to bail it out as if it’s something wrong is hypocritical- the public’s money is so inextricably tied up in this system, by *their* agreement, that to try to separate the two (the honest people’s money vs. the greedy banks’ money) is patently wrong.
Do I think some execs will still make out well with this? Sure. And is that alright? Probably not. But I think this whole story can be summed up as the price the average person has to pay to have that shiny 52″ plasma screen. We can argue all day about whether credit is wrong (I think it is and it isn’t), but this is such a regulatory step to keep this questionable device running.
March 21st, 2008 at 4:01 pm
Oh, and as one last point- yes, this will probably lead to more regulation, as these thing almost always do. But that is no reason a large chunk of people’s assets should become unraveled as a result. And the “such” in my last sentence should have been a “just”
March 21st, 2008 at 4:24 pm
I agree with you on some points - but the notion that it’s all a collective responsibility anyway and thus it’s ok is wrong in my view. Taking that to its ultimate conclusion you’re really talking there being a social insurance scheme for finance - that we all pay for the ones that are less fortunate than ourselves, like Bear (!) - but this doesn’t pan out. We all pay social insurance when we earn more so that others can get unemployment / sickness benefits, but the banks do nothing of the sort, beyond the depositor insurance which doesn’t really cover this. You cannot have a system where failure is subsidised externally, it’s inherently unbalanced.
I also don’t agree that it’s the price every person has to pay for credit. The price people pay for credit is the interest they’re already charged. Banks, credit card companies etc make a ton of money from this already and it’s *that* money that should pay for defaults, not something else. If there was no risk of default in credit, interest rates would not be as high as they are on credit cards. And if the lender gets too greedy and negligent about risk, then it’s their own fault if they expose themselves. I wouldn’t expect to get a loan unless I had a good credit record and perhaps collatoral, and if a lender is willing to toss money around unsecured or secured on dubious assets then it’s their own damn fault for being too greedy. This whole idea of repackaging loans so that their origins and potential worth were difficult to ascertain is a banking system creation, designed precisely to milk more money out of a flawed system. I don’t think you can blame anyone but the people who came up with these financial instruments and employed them over and over again in what is essentially a chronically deceptive practice. Joe Average is always going to be prone to overextending themselves, that’s the consumer culture, but Joe Average is not supposed to be a financial whiz - it’s up to those who control the flow of money to be sensible about risk, and that clearly hasn’t happened.
March 21st, 2008 at 4:43 pm
Will continue over AIM!
March 22nd, 2008 at 11:06 am
Very well said, Steve. I totally agree.
p.s. the captcha thing is not so comfortable for non-native english speakers (kinda complex).
September 25th, 2008 at 2:35 pm
[...] blogged a few months ago about my concern regarding the precedents being set by the Northern Rock and Bear Stearns debacles [...]