Burning Down The House Of Cards
Rachel Reeves has signalled that she is “open minded” about the banks lobbying her to repeal regulations that came in after the 2008 Financial Crash. If she does, she will be accepting responsibility for the next one the banks inevitably cause.
Image Credit: Dominic Alves
One of the most important films dealing with the financial sector since the 2008 Financial Crash was 2015’s The Big Short. Comedic, irreverent and outright scathing of those involved, yet it remains one of the most incisive explanations of the 2008 Financial Crash and it managed to make the intentionally obscure world of financial alchemy accessible to the lay person. I’d go as far to say that it did for the idea of ‘sustainable investment banking’ as the films Threads and The Day After did for the idea of a “survivable nuclear war”.
If you haven’t seen it, please do so and pay particular attention to the scene explaining the concept of “synthetic CDOs” – where investors could effectively gamble on the possibility of you defaulting on your mortgage, and other investors could gamble on whether or not those investors will win their bet, and more investors could gamble on the outcome of those bets...all without knowing anything at all about your finances and the state of your mortgage.
One of the things that made these ‘financial instruments’ so destructive was that the ‘investment’ side of the banking sector – the bit that involves people effectively gambling amongst themselves with money that maybe was theirs and maybe wasn’t – was entirely leveraged on the ‘retail’ side of the banking sector – that’s the bit where you put money in your savings account and ask the bank for a mortgage to buy a house – but was completely divorced from it to the point that one side didn’t understand what the other side was doing.
When the housing boom of the early 2000s came to an end in late 2007 and people started defaulting on mortgages, this would have normally been tragic for those losing their homes and a sign of a substantial economic recession but would have ultimately resulted in a bounce back. But all of those ‘investment firms’ sitting on top of the sector were gambling with money that they ‘knew’ was ‘safe’ (because ‘safe as houses’) despite the houses not being nearly as safe as people assumed.
Not just assumed. The way the CDOs were structured made it functionally impossible for anyone to actually assess the risk of their failure. Because it was impossible to work how and if they might fail, the credit agencies declared them to be safe (yes, really) which encouraged banks to pile money into them.
It got so bad that the investment sector was gambling with something like $20 for every $1 actually involved in the mortgages. The investment gambling sector was many times larger than the value of thing they were gambling on. The liabilities on the banks ‘if’ their sure bet failed reached the point of being larger than the GDP of the countries they were based in.
It would only take a small increase in the percentage of mortgage defaults to utterly bankrupt the banks. An increase that might be caused by investment bankers encouraging retails bankers to take on ever riskier mortgages (with ever higher profit margins), paying exorbitant bonuses to bankers who could sell larger and larger mortgages to people who couldn’t afford to pay them.
Which is what happened. And the backlash threatened to pull down other sectors of the economy because the bankers weren’t just gambling on mortgages but on everything just about up to and including whether or not the sky was blue and the fact that the investment wings were entwined with their retails wings meant that if their investment bank failed, the ATMs on the high streets could be shut down too (runs on banks like Northern Rock showed the visceral reality of people faced with losing their savings because of someone else’s mistakes).
“I said to him [Tom McKillop, Chairman of RBS], ‘We’re almost ready to go. How long can you last?’ I thought he might say maybe a couple of days, and what really shook me was that he said, ‘Well maybe two or three hours and that’s it.’”
Except, the banks turned to their pet politicians and begged for a bailout – and they got it. One that we’re still paying back today (the UK is just about to sell off its last few shares in some of the banks it nationalised in 2008 – at a loss compared to what it bought the shares for and without ever using its ownership stake to reform the banks or use them for the public good). Almost no individual banker was held personally responsible for the financial mismanagement that ended an economic era but ushered in a new one where you basically haven’t had a pay rise since then.
One of the concessions that came out of the Crash was a series of reforms to the regulations of the sector and one of the most important of those was to strictly separate the retail and investment sides of banks to avoid the kind of contagion that made the 2008 Crash so destructive. It meant that investors could keep gambling their money, but they wouldn’t be able to bring down your savings account if they failed.
Now, this has led them to move into other risky gambling activities and the next crash is likely to come out of that, but what it did mean was that when the 2019 Covid pandemic started, one of the few sectors that held up remarkably well was the banking sector (to the point that we argued at the time that people facing the loss of their home due to lockdown should get a “haircut” on their mortgage or rent as part of a Covid support package because the banks could afford to take the hit better than homeowners or landlords).
This week, Sky News has been reporting that all of this might end now that we’re far enough away from the Crash that the bankers think we’ve forgotten about it. They are currently lobbying Rachel Reeves to get her to repeal that firewall between investment and retail banking. Their reasoning: it’s holding them back from making lots of money. Reeves has responded saying that she’s “open-minded” on repealing the regulations and that she shares their view that recent attempts to weaken the regulations “have not gone far enough”.
Let’s be clear here. This is an exact repeat of the pre-Crash world where Gordon Brown similarly weakened banking regulations that subsequently exacerbated the crash. It plays into the model of the British economy that Thatcher created and every Prime Minister since – Labour and Conservative – has encouraged. Where basically nothing matters so long as The City is allowed to accumulate as large a pile of cash as they can and the bare minimum is allowed to ‘trickle down’ elsewhere (not that this works even on its own terms). ‘Regulations’ are anathema and the market must be ‘free’...until things go wrong, then the banks throw up their red flags and start begging for socialism-just-for-them.
The most disturbing part of the report is the implication that Reeves is inviting the banking sector to write their own regulations. Something that, again, Britain is rather fond of doing (see environmental regulators both north and south of the border). This is a recipe not just for disaster but for repeating the same disaster that the same people caused last time.
It’s easy to make money in finance. Economists like Mark Blyth have quipped about the “3-6-3 model” of banking. Borrow at 3%, lend at 6%, be on the golf course for 3pm. You can run a bank for centuries using that kind of ‘boring banking’.
It’s a bit more labour intensive to run a ‘relationship banking model’ where the local bank has a physical presence in a community, the bank manager knows how the local economy works and has an active hand in helping local businesses to find their niche and develop for the good of the area.
But neither of these banking models makes a lot of money. They don’t allow that bank manager to fly a different helicopter to work every day. They don’t allow groups of bank managers to compare themselves to each other by whipping their cheque books out and counting the zeroes. They don’t create the world of The Big Short.
To do that, you need to take risks. You need to gamble money in reckless ways that would get you thrown out of a casino (or bankrupt one). And, of course, if you want to do it, you need to take those risks in ways that mean that someone else pays when you lose.
That’s what the banks want to do here. They want to make that pile of money but have the rest of us pay when they fail again. And Reeves is playing right into their hands.
The saying goes that ‘every regulation is written in blood’, meaning that they usually come about because we don’t realise that we need a rule until someone gets hurt and we decide we don’t want it to happen again. I think the problem here is that when the 2008 Crash happened, a lot of companies got hurt, and a lot of people lost their homes and their jobs. But the people who got hurt and the people who made the money weren’t the same people. The bankers more or less got away with their losses and assume they can do so again. The regulations were written in blood, but not theirs.
Part of Common Weal’s motivation for setting up the Scottish National Investment Bank was to break us away from this idea of ‘hot money’ investing where gathering the largest pile of cash as quickly as possible was the only way to work. The ‘patient finance’ model of SNIB should be one that thinks in terms of years and decades, even centuries, of stable investment rather than the hours, minutes and even microseconds of the financial world.
Finance is an important part of the world’s economy. It’s vital to allow people to see their ideas come into the world. But The Big Short world of worshipping the banking set as they gamble with our lives cannot be allowed to return.
