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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The decline of the north's sporting powerhouse

Yorkshire historically acted as a counterweight to the dominance of southern elites, in sport as in politics and culture. Now, things are different.

On a drive between Sheffield and Barnsley, I spotted a striking painting of the Kes poster. Billy Casper’s two-fingered salute covered the wall of a once-popular pub that is now boarded up.

It is almost 50 years since the late Barry Hines wrote A Kestrel for a Knave, the novel that inspired Ken Loach’s 1969 film, and it seems that the defiant, us-against-the-world, stick-it-to-the-man Yorkshireness he commemorated still resonates here. Almost two-thirds of the people of south Yorkshire voted to leave the EU, flicking two fingers up at what they saw as a London-based establishment, detached from life beyond the capital.

But whatever happened to Billy the unlikely lad, and the myriad other northern characters who were once the stars of stage and screen? Like the pitheads that dominated Casper’s tightly knit neighbourhood, they have disappeared from the landscape. The rot set in during the 1980s, when industries were destroyed and communities collapsed, a point eloquently made in Melvyn Bragg’s excellent radio series The Matter of the North.

Yorkshire historically acted as a counterweight to the dominance of southern elites, in sport as in politics and culture. Yet today, we rarely get to hear the voices of Barnsley, Sheffield, Doncaster and Rotherham. And the Yorkshire sporting powerhouse is no more – at least, not as we once knew it.

This should be a matter of national concern. The White Rose county is, after all, the home of the world’s oldest registered football club – Sheffield FC, formed in 1857 – and the first English team to win three successive League titles, Huddersfield Town, in the mid-1920s. Hull City are now Yorkshire’s lone representative in the Premier League.

Howard Wilkinson, the manager of Leeds United when they were crowned champions in 1992, the season before the Premier League was founded, lamented the passing of a less money-obsessed era. “My dad worked at Orgreave,” he said, “the scene of Mrs Thatcher’s greatest hour, bless her. You paid for putting an axe through what is a very strong culture of community and joint responsibility.”

The best-known scene in Loach’s film shows a football match in which Mr Sugden, the PE teacher, played by Brian Glover, comically assumes the role of Bobby Charlton. It was played out on the muddy school fields of Barnsley’s run-down Athersley estate. On a visit to his alma mater a few years ago, David Bradley, who played the scrawny 15-year-old Billy, showed me the goalposts that he had swung from as a reluctant goalkeeper. “You can still see the dint in the crossbar,” he said. When I spoke to him recently, Bradley enthused about his lifelong support for Barnsley FC. “But I’ve not been to the ground over the last season and a half,” he said. “I can’t afford it.”

Bradley is not alone. Many long-standing fans have been priced out. Barnsley is only a Championship side, but for their home encounter with Newcastle last October, their fans had to pay £30 for a ticket.

The English game is rooted in the northern, working-class communities that have borne the brunt of austerity over the past six years. The top leagues – like the EU – are perceived to be out of touch and skewed in favour of the moneyed elites.

Bradley, an ardent Remainer, despaired after the Brexit vote. “They did not know what they were doing. But I can understand why. There’s still a lot of neglect, a lot of deprivation in parts of Barnsley. They feel left behind because they have been left behind.”

It is true that there has been a feel-good factor in Yorkshire following the Rio Olympics; if the county were a country, it would have finished 17th in the international medals table. Yet while millions have been invested in “podium-level athletes”, in the team games that are most relevant to the lives of most Yorkshire folk – football, cricket and rugby league – there is a clear division between sport’s elites and its grass roots. While lucrative TV deals have enriched ruling bodies and top clubs, there has been a large decrease in the number of adults playing any sport in the four years since London staged the Games.

According to figures from Sport England, there are now 67,000 fewer people in Yorkshire involved in sport than there were in 2012. In Doncaster, to take a typical post-industrial White Rose town, there has been a 13 per cent drop in participation – compared with a 0.4 per cent decline nationally.

Attendances at rugby league, the region’s “national sport”, are falling. But cricket, in theory, is thriving, with Yorkshire winning the County Championship in 2014 and 2015. Yet Joe Root, the batsman and poster boy for this renaissance, plays far more games for his country than for his county and was rested from Yorkshire’s 2016 title decider against Middlesex.

“Root’s almost not a Yorkshire player nowadays,” said Stuart Rayner, whose book The War of the White Roses chronicles the club’s fortunes between 1968 and 1986. As a fan back then, I frequently watched Geoffrey Boycott and other local stars at Headingley. My favourite was the England bowler Chris Old, a gritty, defiant, unsung anti-hero in the Billy Casper mould.

When Old made his debut, 13 of the 17-strong Yorkshire squad were registered as working-class professionals. Half a century later, three of the five Yorkshiremen selec­ted for the last Ashes series – Root, Jonny Bairstow and Gary Ballance – were privately educated. “The game of cricket now is played in public schools,” Old told me. “Top players are getting huge amounts of money, but the grass-roots game doesn’t seem to have benefited in any way.”

“In ten years’ time you won’t get a Joe Root,” Rayner said. “If you haven’t seen these top Yorkshire cricketers playing in your backyard and you haven’t got Sky, it will be difficult to get the whole cricket bug. So where is the next generation of Roots going to come from?” Or the next generation of Jessica Ennis-Hills? Three years ago, the Sheffield stadium where she trained and first discovered athletics was closed after cuts to local services.

This article first appeared in the 19 January 2017 issue of the New Statesman, The Trump era