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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Rarely has it mattered so little if Manchester United won; rarely has it been so special they did

Team's Europa League victory offers chance for sorely needed celebration of a city's spirit.

Carlo Ancelotti, the Bayern Munich manager, memorably once said that football is “the most important of the least important things”, but he was only partly right. While it is absolutely the case that a bunch of people chasing around a field is insignificant, a bunch of people chasing around a field is not really what football is about.

At a football match can you set aside the strictures that govern real life and freely scream, shout and cuddle strangers. Football tracks life with such unfailing omnipresence, garnishing the mundane with regular doses of drama and suspense; football is amazing, and even when it isn’t there’s always the possibility that it’s about to be.

Football bestows primal paroxysms of intense, transcendent ecstasy, shared both with people who mean everything and people who mean nothing. Football carves out time for people it's important to see and delivers people it becomes important to see. Football is a structure with folklore, mythology, language and symbols; being part of football is being part of something big, special, and eternal. Football is the best thing in the world when things go well, and still the best thing in the world when they don’t. There is nothing remotely like it. Nothing.

Football is about community and identity, friends and family; football is about expression and abandon, laughter and song; football is about love and pride. Football is about all the beauty in the world.

And the world is a beautiful place, even though it doesn’t always seem that way – now especially. But in the horror of terror we’ve seen amazing kindness, uplifting unity and awesome dignity which is the absolute point of everything.

In Stockholm last night, 50,000 or so people gathered for a football match, trying to find a way of celebrating all of these things. Around town before the game the atmosphere was not as boisterous as usual, but in the ground the old conviction gradually returned. The PA played Bob Marley’s Three Little Birds, an Ajax staple with lyrics not entirely appropriate: there is plenty about which to worry, and for some every little thing is never going to be alright.

But somehow the sentiment felt right and the Mancunian contingent joined in with gusto, following it up with “We’ll never die,” – a song of defiance born from the ashes of the Munich air disaster and generally aired at the end of games, often when defeat is imminent. Last night it was needed from the outset, though this time its final line – “we’ll keep the red flag flying high, coz Man United will never die" – was not about a football team but a city, a spirit, and a way of life. 

Over the course of the night, every burst of song and even the minute's silence chorused with that theme: “Manchester, Manchester, Manchester”; “Manchester la la la”; “Oh Manchester is wonderful”. Sparse and simple words, layered and complex meanings.

The match itself was a curious affair. Rarely has it mattered so little whether or not United won; rarely has it been so special that they did. Manchester United do not represent or appeal to everyone in Manchester but they epitomise a similar brilliance to Manchester, brilliance which they take to the world. Brilliance like youthfulness, toughness, swagger and zest; brilliance which has been to the fore these last three days, despite it all.

Last night they drew upon their most prosaic aspects, outfighting and outrunning a willing but callow opponent to win the only trophy to have eluded them. They did not make things better, but they did bring happiness and positivity at a time when happiness and positivity needed to be brought; football is not “the most important of the least important things,” it is the least important of the most important things.

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