Thursday, July 26, 2012

Betting the Bank

Are bankers just inherently evil?

It sure seems like it sometimes. Especially if you follow the news in Ireland and the UK. A few days ago Séan FitzPatrick, former chairman of Anglo Irish Bank was arrested and charged (finally) for activities in 2008, which involved a scheme to lend money to investors who, in turn, invested the money in Anglo Irish to artificially inflate its share price. Before that, Barclays (Britain’s second largest bank) admitted that it manipulated the interest rates at which banks lend money to each other (the London interbank offered rate, or Libor) to inflate its profits. And, of course, everyone knows about the dodgy mortgage practices that went on in both Ireland and the United States that led to housing bubbles in both countries and precipitated the financial crisis and resulting recession.

You probably don’t need to follow the news to have a low opinion of banks. Many of us have our personal experiences to draw on for that. Mine go back to the year I went to France as an exchange student and a local banker advised me to buy traveler’s checks denominated in Swiss francs. Needless to say, the U.S. dollar only went up in relation to the Swiss franc during that year. To add insult to injury, when I deposited the left-over un-cashed traveler’s checks in my account after returning home, the bank somehow managed to put the money in the wrong account. More recently, when I sold my condo after moving to Ireland, Washington Mutual (where I had gotten the mortgage) somehow managed to show a lien on it even though the mortgage had been paid off years before—nearly causing me to miss the deadline for closing the sale. I can forgive people making mistakes, but what I don’t forgive is an unwillingness to even sort out the problem. Washington Mutual had sold my mortgage on years before and had absolutely no interested in tracking down any records for me. I managed to solve the problem without their help, and I considered it karma when Washington Mutual became a casualty of the financial crisis.

The fact is, though, we need banks and that is why they exist and why almost all of us do business with them. They perform a necessary function in a modern economy by allowing the work done by people (and converted to currency through salary and profits) to be made available to other people (in the form of loans) for starting new businesses or making major purchases. When the financial crisis caused lending to freeze up, we saw what it did to the economy and just how much we needed the banks to be lending.

Let’s be adult about this and acknowledge that, of course, most bankers aren’t evil and that they provide a necessary service. At the same time, let’s be realistic and acknowledge that handling so much money is an irresistible temptation to some and there will always be some level of crooked activity.

How can we keep the crooked activity to a minimum? That’s a complicated question, but in general there are a couple of major things that seem obvious. For one, it was clearly a mistake to repeal the 1933 Glass-Steagall Act in 1999. That act was a firewall between commercial banking and investment banking. Personally, I don’t mind seeing investors losing their money. They accept that risk when they get into the game. But it is neither fair nor logical for investment losses to affect other bank customers, who only want a safe place to keep their money. For another thing, the government clearly got too lax about allowing bank mergers, and that needs to change. I don’t mind seeing banks fail if they are poorly managed. Deposits are insured, so at least regular customers are protected. But when banks become Too Big To Fail their collapses can affect the overall economy, forcing the government to bail them out which, in turn, only encourages more unhealthy risk on the part of large banks. Clearly, a lot of huge bad bets were made in the years leading up to 2007 out of a realistic expectation that there would be a bailout in a worse-case scenario.

Congress’s solution to problems like these is often to enact more regulation. Politicians do this so often that they actually seem to forget that it’s already been done before. I’m always amused when Democrats rail against the financial “deregulation” of the George W. Bush administration when one of the most onerous financial regulation laws, the Sarbanes-Oxley Act, was enacted in 2002. This was in reaction to the Enron scandal, and it clearly didn’t solve anything. If anything, it made things worse by adding more paperwork burdens to companies with no discernible benefit. Similarly, the Dodd-Frank Act of 2010 added yet more paperwork requirements. No one seems very happy with that bill, either because it was “watered down” by lobbyists or because it adds more costs to doing business. The fact is that large businesses don’t mind extra regulations because they have plenty of staff on hand to deal with it. It’s middle-sized and small businesses that go under or don’t expand because of regulatory burdens.

Having said that, make no mistake, financial regulation is extremely important and necessary. In the end, it is our only hope to avoid more economic messes like the one we are in now. But it is the quality of government oversight that matters, not the quantity. When politicians pile a new regulatory framework on top of already existing ones, there is a law of diminishing returns. If you have ever worked in a large organization, then you know that the more overlapping responsibilities people have, the more time they tend to spend making sure someone else gets blamed for a foul-up than they do trying to prevent the foul-up in the first place.

One of the most outrageous and criminal financial operations in recent times was the scheme operated by Bernie Madoff. His victims were not stupid or unsophisticated. They included banks and charities run by serious professionals. They also included such well-known individuals as Larry King, Jeffrey Katzenberg, Kevin Bacon, John Malkovich, Sandy Koufax and Zsa Zsa Gabor. Most of these people were not dumb by any stretch of the imagination, but somehow they missed the simple fact that Madoff’s numbers made no sense. I have to wonder if they were lulled into complacency by the belief that nothing improper could be going on because, surely, the government simply wouldn’t let it happen.

This may be the true downside of too much regulation. We all might do a better job of looking after ourselves (and doing our own math) if we don’t succumb to the false hope that the government is out there always looking out for our interests.

No comments:

Post a Comment