Leiden, a.d. X Kal. Oct. MMDCCLXVIII A.U.C.,
Let’s start on a cheerful note:
Because I will continue on a less cheerful one. This post is about Ewald Engelen’s ‘The Shadow Elite: Before and After the Crisis, Nothing Learned, Nothing Forgotten’ (De Schaduwelite, Ewald Engelen). (Sadly the book is only available in Dutch, but its message is worth taking note of, as post-crisis events in the Netherlands have been rather similar to what happened in, for example, the UK and the USA.) In ‘The Shadow Elite’ Engelen argues that our financial system is still fundamentally the same as when the financial crisis hit us, because financial elites have effectively lobbied political elites. This means that bankers can still take high risks and earn a lot of money while doing so, until things go wrong and taxpayers need to save these banks in order to prevent the break down of the financial system. Its message, if true, is a rather worrisome one, one that should unite liberals and socialists alike to resist a system which perpetually transfers money from the 99% to the 1%.
To start Engelen gives an overview of which explanations for the financial crisis of 2007/2008. Some have blamed a lack of regulation, which allowed banks to take too much risk through ‘securitization’ (pooling several mortgages together, thus making a default of one family less painful for the creditor). Others have argued that governments were too involved in financial markets, banks knew they were ‘too-big-to-fail’, so they could safely bet on bail outs. Also, governments had subsidized, and to some degree still are subsidizing, house ownership, creating a housing bubble. Some blamed the low interest rates, which created several asset bubbles in the (Green)span of a few years (sorry, bad pun). Moreover, investment banks and commercial banks have been merged in a lot of countries. Commercial banks are banks where ‘ordinary citizens’ save relatively small amounts of money, and which generally should take lower risks. Investment banks are banks where people with a lot more money can speculate, and they generally can take higher risks. If a commercial bank crashes, a lot of people on ‘normal’ incomes lose all their money and pension, which would justify government intervention in the form of a bail out or deposit guarantee. If an investment bank crashes, a lot of millionaires and billionaires lose some of their money, which would be a result of the higher risks they were willing to take. This clearly does not deserve government intervention. However, after commercial banks and investment banks were allowed to merge in the 1990’s, like Postbank and ING Bank (1991) in the Netherlands or J.P. Morgan and Chase in the USA (2000), governments had to bail out banks that went bankrupt because they had taken very risky actions with their investment branch, to save their commercial branch.
It was the particular combination of all these factors that caused the financial crisis. Without the low interest rate, the securitization would not have mattered so much, without the implicit pledge to bail out banks, they would not have been so eager to help creating a housing bubble. Without regulation international financial markets were less transparent than they could have been. The financial system is an extremely complex system, and there is not one single event or factor which led to the crash of this system. The combination of actions of a lot of actors, who had imperfect foresight, with at times the true intention to help society, at other times only their immediate self-interest in mind, caused this crisis.
The most surprising thing about The Shadow Elite is that it does not blame either government or the private sector, it blames both for what went wrong. The basic argument of the book could be summarized as: ‘Sure, it was a combination of things going wrong which causes the financial crisis, however, whatever governments and central banks did wrong, they were urged on by banks and multinationals to do so.’ The technical term for this is ‘regulatory capture.’ It cannot be denied that governments made mistakes which led to the crisis, but the government, to a large degree, was only acting on behalf of actors in society. The agreement between business advocates, the labour unions and the government to keep wages relatively low, incentivized people to take on more debt, which led to a housing bubble and an unnecessarily large banking sector. Moreover, there was a general belief that big banks and low wages were good for ‘The Netherlands Inc.’ and thus for the Dutch population. Of course, it turned out there were wrong, but it is certain that before 2008 there was a wide consensus that everything really seemed to run along fine, if indeed Dutch citizens were led to believe so by the banking sector and the ‘captured’ Dutch Central Bank (DNB). So, the combination of factors which caused the financial crisis to hit the Netherlands particularly hard was caused by bad public policy and ‘greedy bankers,’ not by just one of both.
But the past is the past, mistakes were made, we should be working on fixing the system, to prevent these mistakes from being made again. It is here that The Shadow Elite touches on a particularly worrisome issue: Engelen argues we have hardly changed anything since the financial crisis. Banks have resisted every attempt to effectively regulate their sector, ironically lobbying for thousand paper laws or directives, which are so vague that banks can easily circumvent the rules in these documents. Moreover, the difficult rules prevent potential entrants from competing against traditional banks. These documents are paper tigers for the large actors, but prevent competition by hindering entry to the market. So, while complaining that regulation stifles innovation and profitability, it is actually the banks themselves that lobby for confusing and long, and thus ineffective, regulation.
Meanwhile only symbolic measures have been taken in the Netherlands. Bonuses may not be more than 20% of the constant wage, bankers need to promise to not take high risks and banks can no longer sell products which are not in the interest of the customer. The first does nothing more than change the way bankers are rewarded, the latter two are nothing but symbolic measures: risks will only turn out to be too high after something goes wrong, and the best interest of the consumer is a rather vague term.
Moreover, the Basel III Rules have only marginally increased the capital buffers banks need to have, and have hardly forced Dutch banks to own more liquid assets to prevent illiquidity, which is a situation in which even though on the long term you own more than you are due, on the short term you do not have the money to pay for things. For instance, you need to buy your groceries tomorrow, but you do not have any cash on your bank account. You can sell your house, but that will take a while, so you cannot buy your groceries tomorrow. Usually the less risky, the more liquid an asset is. Forcing banks to own a certain amount of low risk assets makes them safer, because others will be more likely to buy low risk assets in case of a crisis. Thus, banks will be able to get the cash they need to pay their ‘bills’. However, banks are of course unhappy to own low risk assets, because they are usually less profitable. The Basel III rules allow Dutch banks to count securitized Dutch mortgages as such low risk assets, which means that effectively nothing changed compared to before the financial crisis. In other words, banks are still allowed to play with other people’s money, backed by governments that need to bail them out if they fail.
So, Engelen argues, what we really need is more elegant regulation, one of the best pieces of regulation in the banking sector was only 37 pages (Glass-Steagall Act). This law effectively separated commercial banks from investment banks from 1933 until 1999, thus to a large degree preventing spill overs from the risky investment bank sector to the commercial banks. It thus effectively protected the tax payer from having to save those who took a lot of risk to earn more money. Compared to the thousands of pages of the Basel III Agreement this is extremely short, which shows that effective regulation does not have to be terribly difficult. We need to separate investment banks from commercial banks again. We need lower limits on how much people can borrow for their mortgage, like we used to have before. We need higher wages, so people do not need a huge mortgage to buy a house or can afford to rent a house, so they do not need to buy a house. So we need to stop wage moderation, after all, what are we supposed to do with a €85billion trade surplus (Central Bureau for Statistics on Trade Surplus)!? We need banks to retain higher capital buffers, to prevent bankruptcies when banks lose a lot of money.
So, the reason that the financial sector has not been reformed in a meaningful sense, Engelen argues, is that bankers, lobbyists and politicians have worked together to perpetuate the financial sector’s money making machine of creating more and more debt, on which banks earn nice interests as long as the economy is doing well, but the high risks of which they never have to face. I do agree with Engelen that the reforms which have been undertaken are not sufficient, and his analysis of why reforms have not been undertaken sounds plausible at least. The main issue for me is not that banks take risks, that is what they are supposed to do, that is how capitalism creates economic growth. The issue is that banks benefit when things go well, but do not ‘have to sit on the blisters’ when things go wrong. Just like I discussed earlier, it is outrageous that taxpayers have to bail out multimillionaires. So we need a system in which this is no longer necessary to prevent the collapse of the entire economy. Moreover, this is an issue on which right and left wing politicians should agree, the former because they should support free markets, the latter because they should oppose wealth transfers from the 99% to the 1%.
Bottom Line: Not much has changed since 2008, the Dutch banking system is still as fragile as before and banks continue to bet on taxpayer support if, or when, markets turn sour. Meanwhile, bankers keep singing the Money Song, something which, as such, I do not mind. However, you would wish fair competition, a level playing field and smart regulation would allow everyone to join the choir.