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

Matthew Lewis/Getty
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120 years on, and rugby league is still patronised as “parochial”

Even as Leeds and Hull Kingston Rovers do battle in the 2015 Challenge Cup final, the century-old conflict between rugby league and rugby union isn’t over.

When Leeds and Hull Kingston Rovers step out onto the hallowed Wembley turf on Saturday afternoon it will be a celebration, regardless of the result. The final of rugby league’s oldest competition is expected to be watched by over 85,000 fans, with countless more watching on the BBC. And the reason for celebration? This year’s Challenge Cup final falls on rugby league’s 120th birthday. 

Saturday will mark exactly 120 years to the day that the custodians of 22 clubs rendez-voused at the George Hotel in Huddersfield to split from the amateur Rugby Football Union (RFU). The teams who formed the guerrilla organisation were dependent on millworkers, miners and dockers who unlike their more affluent and privately-educated southern counterparts, could ill-afford to miss work to play rugby. As such, the Northern Football Union (which later changed its name to the Rugby Football League) announced its separation from the RFU and immediately accepted the principal of receiving payment for playing. Taking the schism as a declaration of war, the RFU struck back by issuing lifetime bans to any player associated with its northern kin. 

Neither league’s revolutionary spirit nor the promise of a pay cheque lead to a change in fortunes, though. It remains, according to one journalist, a “prisoner of geography”, ensnared by its older kin. Wembley is its parole, the chains are off, for but a short while, as league earns a pass out of its Northern confinement. Union, on the other hand, is the dominant code in terms of finances, participation numbers and global reach, while league is still viewed as a “parochial” sport. 

To understand why league is viewed as parochial, and union global, the writings of the Italian Marxist Antonio Gramsci on cultural hegemony are particularly useful. Union embodies the resource-rich and powerful historic bloc, institutionalised through its strong standing within public-schools and its big-business connections. League, on the other hand represents the downtrodden and plucky subaltern. Its agency has only stretched so far as to command superior TV figures perhaps a ringing endorsement from the masses.

In order to quell its fellow oval-chasing brethren there are examples of union shockingly suppressing the spread of league. In France the 13-a-side code had overthrown union’s dominance as hundreds of clubs switched to le treize towards the end of the 1930s. As the Second World War divided France, union bigwigs held office with members of the Nazi-collaborating Vichy government who were persuaded to outlaw rugby league once and for all. 

On 19 December 1941 a decree forced league clubs to hand over kit, stadia and funds to their union counterparts. The game has never fully recovered in France, although two Frenchman are in contention to play for Rovers on Saturday – Kevin Larroyer and John Boudebza, testament to the art of treizistance.

There are other instances of union dignitaries stifling league’s growth in places as wide-ranging as Japan, Serbia, South Africa and Italy. Examples exist in the United Kingdom too. Cambridge student Ady Spencer was banned by the RFU from playing in the Varsity Rugby Union match having enjoyed the rigours of league as a youngster in his native Warrington. The incident was subject to a parliamentary motion in 1995 being condemned as an “injustice and interference with human rights”.

But even as rugby union followed its heretic sibling into professionalism a century after the split there’s little to suggest the relationship has changed, highlighted this year through the case of Sol Mokdad. A Lebanese national, Mokdad will be watching the final in Beirut with friends, but it’s a far cry from where he was just a few months ago – locked up in a jail cell in Dubai at the behest of UAE Rugby Union (UAERU). 

“I moved to the UAE in 2006 and set up rugby league there a year later. I was arrested for fraud and for setting up a competition without the UAERU’s permission,” he tells me. “I was baffled as they’re a completely different body. It’s like the Cricket Federation demanding that they control all baseball matches. We’d just got a huge deal with Nissan to sponsor our competition which the UAERU weren’t happy about. They said I’d impersonated their president in order to get the money which was a complete lie. They weren’t too happy that we were getting a lot of exposure in western media outlets too, because I’d suggested that the UAE would be a good place to host the World Cup, that’s where it all started to go wrong.”

“I was at a corporate event when I got a phone call to say that UAERU had ordered my arrest. I tried ringing my mate George Yiasemides who was the COO of UAE Rugby League. He’d promised to help me out, but he didn’t want anything to do with me. He sold me down the river. I was chucked into a cockroach-infested cell. The bathrooms were covered in s**t  and I was locked up for 14 days with no contact with the outside world.” 

Eventually an agreement was reached and all Mokdad had to do was sign a document which would guarantee his release, subject to conditions. Easy enough right? But as he explains it wasn’t. 

“They sent me to the wrong police station and when I eventually got hold of the document they’d added conditions I hadn’t agreed too. I had to make a public apology on all of our social media, destroy all documentation and was told that I was financially liable for any damages or legal fees that may come up in the future. Any monies gained from our sponsorship was to be handed over to the UAERU, as well as having to agree to never participate in any rugby activity in the UAE again.”

Homeless, broke and jobless, Mokdad returned to his native Lebanon and he is unsure of where his future lies. “I definitely want to stay in the sport however I can. It was incredibly hard to leave what I’d created in Dubai.” he says. “I still think about it now. It was so surreal.” 

He’s backing Leeds in the final, in case you were wondering. Although it all makes Saturday’s game seem rather irrelevant if in 2015 you can be jailed for establishing a sport. Perhaps it shows more than ever, that after 120 years of separation, rugby league is still trying to shake off the shackles of its older brother.