Reviewed: The Bankers’ New Clothes by Anat Admati and Martin Hellwig

Profits of doom.

The Bankers’ New Clothes: What’s Wrong with Banking and What to Do About It
Anat Admati and Martin Hellwig
Princeton University Press, 392pp, £19.95

The Federal Reserve and the Financial Crisis
Ben S Bernanke
Princeton University Press, 144pp, £13.95

Historians will not be forgiving of the past 30 years. Western governments, with Britain in the vanguard, indulged an explosion in bank balance sheets supported by declining levels of equity and by borrowing that ran into many trillions of dollars, euros and pounds. This created a long and apparently impregnable private-sector-led boom; but it was a mountain of lending underwritten by a molehill of equity. Bankers claimed that they had invented new tools to handle what previous generations would have regarded as impossible risks. They were wrong. The inevitable exposure of the system’s fragility has left the world – and Britain in particular – saddled with a combination of private debt and crippled banks that, even if policy were clever and well resourced, which it is not, would take years to restore to something like normality. Instead, we have austerity and a long, barely contained depression. Never have so few lent so much to so many so recklessly, escaping the consequences while imposing hardship on others.

This raises fundamental questions about the sheer unfairness of capitalism and its vulnerability to those at the top creating dynastic personal fortunes. Nor could bankers and the high priests of modern finance – hedge-fund managers and private equity partners – ever have pulled this off without an accompanying ideology that vaunted the efficiency of private markets animated by personal selfishness and was self-serving nonsense. This was propagated by powerful, privately owned media cheerleaders, feeding off well-financed neoconservative think tanks, which persuaded the gullible public that this was the only way that wealth and jobs could be generated.

Given the scale of what has happened, the response from civil society and the left has been feeble. True, there have been groups such as UK Uncut and the Occupy movement. But even now, the left continues to take aim at the wrong targets. As I was writing this review, Cypriot banks, vastly overborrowed (mainly from the Russian superrich, allegedly laundering their money) and supported by minimal amounts of equity, were repeating the drama of RBS and Lehman Brothers. If anything was to go wrong with the assets against which they had directly or indirectly lent the borrowed money, there was too little equity to absorb the impact. Greece’s partial write-down of its debts in which Cyprus’s banks had invested was such an event, and inevitably a crisis ensued.

Yet, with dismal regularity, leading left-of-centre commentators – indistinguishable in their analysis from their counterparts on the right – decided that the culprit was not the structure of modern banking but the euro, austerity and the flint-eyed German government. In an alternative world of floating exchange rates and governments with an unfettered capacity to borrow and print money, they argued, the crisis would have passed fairly painlessly. This is yet more self-serving tosh. It is the bastardisation of Keynesian economics and the infantilisation of liberal-left thinking – a refusal to think hard about capitalism in favour of taking refuge in anti-austerity slogans and Ukip-style populism. With floating exchange rates, Cyprus, given the epic mistakes of its banks, would now be confronting hyperinflation as its currency collapsed, or else the takeover and rundown of its banks by the IMF. Rants about the euro or the reluctance of German taxpayers to foot the bill for the crisis dodge the issue. The pressing question is how western banking is to be reinvented and restored to health – in Cyprus, Britain and elsewhere – so as to relieve economies of the crushing legacy of private debt.

One of the most important contributions to answering these questions is a new book co-written by the leading German economist Martin Hellwig and his US counterpart Anat Admati. The Bankers’ New Clothes is a lucid exposition of the intellectual falsehoods deployed by banks to justify the ways in which they went about growing their business beyond any reasonable assessment of risk in the run-up to the crisis of 2008 and which they continue to peddle today.

Admati and Hellwig cut through the debates about whether it was too little or too much regulation that was to blame, whether central banks could and should have acted faster, and the rights and wrongs of securitisation or separating commercial and investment banking, and go to the heart of the matter. Western banks, they argue, borrowed far too much with far too little equity in their balance sheets to act as a buffer if things went wrong in any part of their business, from trading on their own account in the multitrillion-dollar derivatives markets to extravagant and reckless lending on real estate.

Less than 70 years ago, banks operated with between 20 and 30 per cent of their liabilities as equity; by 2008, that had shrunk to just 3 per cent. They believed that they had invented instruments that removed the risk, allowing them to run their banks with a tenth of the buffer they had before. It could only lead to disaster.

Admati’s and Hellwig’s constant refrain is that banks are no different from any other organisation or individual. In effect, managements and shareholders elected to run banks as if they were homeowners with mortgages worth 97 per cent of the value of their home, with only 3 per cent of equity. This makes sense when house prices are rising but it will only take a 3 per cent fall in house prices to wipe out your stake. Homeowners might take the risk once in their lives and hope as they steadily pay off the mortgage that any fall in house prices could be ridden out. However, banks adopted this as their standard approach, running their affairs on the finest of margins. British banks’ total liabilities are worth just less than five times our GDP – but supported by tiny amounts of equity.

Admati and Hellwig challenge all the bankers’ justifications for their behaviour. Having more equity is neither more expensive nor a deterrent to new lending. It has only been possible to grow balance sheets to such a gargantuan size with so little equity because banks have known that, in extremis, the risks would be underwritten by the state – either directly by insuring our deposits with them, or indirectly by bailing them out.

Having little equity is at the core of the one-way bet that the bankers have made: when times are good, they make fabulous profits and bonuses; when times are bad, the state picks up the pieces. As a result of this explicit subsidy and the state’s promise of underwriting the banks’ risks, banks never had to worry about their solvency: that was guaranteed. All they had to concern themselves with was their liquidity – that come what may they have enough cash to give depositors if they withdrew it. Here, central banks, with their capacity to print legal tender, enter the picture. As long as they are proactive enough to generate the cash that banks need in a crisis and at sufficient scale, through being the lender of last resort, then, with solvency underwritten and liquidity on tap, even the worst banking crisis can be managed.

Admati and Hellwig think that this is economically inefficient and unfair. After all, it is not as though periodic financial crises don’t impose huge costs on society. One could go further still. If banking relies entirely on having the state as a backstop, then society can reasonably ask for some quid pro quo in return.

One of the bitterest aspects of the lending boom of the past 30 years is that Britain has so little to show for it. We don’t have great industries or great infrastructure. Instead, we have loaded households and many firms with insupportable levels of debt. Even in good times, the banks have been unable or unwilling to support innovation, business-building and investment.

Instead, their focus has been on property lending or funding takeovers by private equity partners of perfectly good companies that did not need to be overwhelmed with debt to enrich their new owners. If more people understood what has happened and why, the outrage and clamour for change would be irresistible.

The trouble is that too few make the effort to understand and those who do are deterred by the apparent complexity of modern finance, or the unwillingness of so many practitioners and top officials to be honest about its deficiencies. In this respect, a collection of Ben Bernanke’s lectures on the role of the US Federal Reserve in the financial crisis is a classic of the genre – uninquiring, complacent and, unless you are fascinated by the minutiae of central banking, unilluminating.

Yet he is the chairman of the Federal Reserve, the most powerful central bank in the world. For Bernanke, financial crises are like hurricanes: they are just part of the climate of capitalism. If that is right, then it is imperative to have a watchful central bank led by a resourceful chairman such as Bernanke; someone who is ready to pump trillions of dollars into the system when the hurricanes occur, in order to provide crucial liquidity. And with that, the hurricane should pass.

In fairness to Bernanke, he operates in an intellectual and political environment in which suspicion of the state is so endemic that some on the Republican right want to abolish the central bank altogether. His lectures were, in part, a response to that crazed tendency, explaining in simple language why central banks’ capacity to provide the system with cash when it is in crisis is so crucial – and how the Fed set about doing that in the most recent crisis.

Bernanke skirts around the issues raised by Admati and Hellwig. Yet they are fundamental – not just to the stability of the financial system but for the question of how capitalism is to be better organised (which is surely the issue, more than any other, that the New Statesman needs to address in its centenary year).

We need banks to be run with more equity. We need them to accept that their decisions about how much they lend, to whom and on what terms have profound implications for our economy and society. That needs to be part of a wider reframing of the principles on which firms are constituted. Remuneration needs to return to earth. We need careful economic policies that offer the prospect of a sustained increase in demand and prices over time, gradually inflating away the real value of debt. Excessive private debt does not just imprison economies – it suffocates personal lives.

All of this should be part of a wider debate about what constitutes a good society. If a potential Labour government is to be successful, it will be because it is riding an intellectual tide that answers these questions. The New Statesman is one of the few catalysts for developing ideas that we have. The next two years are arguably the most important in its history: I hope it rises to the task.

Will Hutton’s most recent book is “Them and Us: Changing Britain –Why We Need a Fair Society” (Abacus, £10.99)

Photograph: Getty Images

This article first appeared in the 12 April 2013 issue of the New Statesman, Centenary Special Issue

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Is defeat in Stoke the beginning of the end for Paul Nuttall?

The Ukip leader was his party's unity candidate. But after his defeat in Stoke, the old divisions are beginning to show again

In a speech to Ukip’s spring conference in Bolton on February 17, the party’s once and probably future leader Nigel Farage laid down the gauntlet for his successor, Paul Nuttall. Stoke’s by-election was “fundamental” to the future of the party – and Nuttall had to win.
 
One week on, Nuttall has failed that test miserably and thrown the fundamental questions hanging over Ukip’s future into harsh relief. 

For all his bullish talk of supplanting Labour in its industrial heartlands, the Ukip leader only managed to increase the party’s vote share by 2.2 percentage points on 2015. This paltry increase came despite Stoke’s 70 per cent Brexit majority, and a media narrative that was, until the revelations around Nuttall and Hillsborough, talking the party’s chances up.
 
So what now for Nuttall? There is, for the time being, little chance of him resigning – and, in truth, few inside Ukip expected him to win. Nuttall was relying on two well-rehearsed lines as get-out-of-jail free cards very early on in the campaign. 

The first was that the seat was a lowly 72 on Ukip’s target list. The second was that he had been leader of party whose image had been tarnished by infighting both figurative and literal for all of 12 weeks – the real work of his project had yet to begin. 

The chances of that project ever succeeding were modest at the very best. After yesterday’s defeat, it looks even more unlikely. Nuttall had originally stated his intention to run in the likely by-election in Leigh, Greater Manchester, when Andy Burnham wins the Greater Manchester metro mayoralty as is expected in May (Wigan, the borough of which Leigh is part, voted 64 per cent for Brexit).

If he goes ahead and stands – which he may well do – he will have to overturn a Labour majority of over 14,000. That, even before the unedifying row over the veracity of his Hillsborough recollections, was always going to be a big challenge. If he goes for it and loses, his leadership – predicated as it is on his supposed ability to win votes in the north - will be dead in the water. 

Nuttall is not entirely to blame, but he is a big part of Ukip’s problem. I visited Stoke the day before The Guardian published its initial report on Nuttall’s Hillsborough claims, and even then Nuttall’s campaign manager admitted that he was unlikely to convince the “hard core” of Conservative voters to back him. 

There are manifold reasons for this, but chief among them is that Nuttall, despite his newfound love of tweed, is no Nigel Farage. Not only does he lack his name recognition and box office appeal, but the sad truth is that the Tory voters Ukip need to attract are much less likely to vote for a party led by a Scouser whose platform consists of reassuring working-class voters their NHS and benefits are safe.
 
It is Farage and his allies – most notably the party’s main donor Arron Banks – who hold the most power over Nuttall’s future. Banks, who Nuttall publicly disowned as a non-member after he said he was “sick to death” of people “milking” the Hillsborough disaster, said on the eve of the Stoke poll that Ukip had to “remain radical” if it wanted to keep receiving his money. Farage himself has said the party’s campaign ought to have been “clearer” on immigration. 

Senior party figures are already briefing against Nuttall and his team in the Telegraph, whose proprietors are chummy with the beer-swilling Farage-Banks axis. They deride him for his efforts to turn Ukip into “NiceKip” or “Nukip” in order to appeal to more women voters, and for the heavy-handedness of his pitch to Labour voters (“There were times when I wondered whether I’ve got a purple rosette or a red one on”, one told the paper). 

It is Nuttall’s policy advisers - the anti-Farage awkward squad of Suzanne Evans, MEP Patrick O’Flynn (who famously branded Farage "snarling, thin-skinned and aggressive") and former leadership candidate Lisa Duffy – come in for the harshest criticism. Herein lies the leader's almost impossible task. Despite having pitched to members as a unity candidate, the two sides’ visions for Ukip are irreconcilable – one urges him to emulate Trump (who Nuttall says he would not have voted for), and the other urges a more moderate tack. 

Endorsing his leader on Question Time last night, Ukip’s sole MP Douglas Carswell blamed the legacy of the party’s Tea Party-inspired 2015 general election campaign, which saw Farage complain about foreigners with HIV using the NHS in ITV’s leaders debate, for the party’s poor performance in Stoke. Others, such as MEP Bill Etheridge, say precisely the opposite – that Nuttall must be more like Farage. 

Neither side has yet called for Nuttall’s head. He insists he is “not going anywhere”. With his febrile party no stranger to abortive coup and counter-coup, he is unlikely to be the one who has the final say.