Banking, morality, theology and superstition.

I will not be signing any petition calling for any kind of enquiry, public, private, judicial or parliamentary into the moral uprightness and other behaviour of bankers. I might even sign a petition opposing such an enquiry were I given a chance. My reasons for this inaction (and somewhat improbable counter action) are both practical and moral-theological and derive from my conviction that the very serious problems in the global banking crisis have little or nothing to do with the moral turpitude of many bankers (of which I have no doubt) or of the moral uprightness of others (of which I have equally little).

To begin a process of searching out the moral failures of those who work in banks is at best a nasty irrelevance (rather like the witch-hunting associated with MPs expenses) and at worst a dangerous distraction from the real difficulties we face. Those difficulties have their origins in a serious systemic weakness in banks’ balance sheets (which I’ll try to explain shortly) and a consequent lack of liquidity in the system (ditto) which between them are causing a credit squeeze. If all those in charge of banks were the most ethically well-meaning and lowest paid people it is possible to conceive this would help not one jot in guiding them in resolving these problems.

To suggest that the cause is moral failure is to succumb, it seems to me, to some theological temptations made more beguiling because their theological nature is most often disguised as some sort of common sense. This temptation is to believe that bad things only happen because of bad behaviour, that anything that goes wrong must be  a response to or punishment of sin. Any suffering is to be looked on as being caused by somebody’s transgressions and the response is to seek the guilty party and punish them in the hope that this will restore order and well being. The analysis and rejection of this scheme is the main thrust of the Biblical Book of Job and is reprised in the Gospels.

In the case of the current woes of the banking system this means that people lash out, identifying things about bankers they don’t like (mostly that they’re paid too much) and suggesting that this is what made things go wrong. Leaving aside whether high pay is a moral issue (I don’t think it is but that’s not what’s at stake here) this ignores certain features of how we got where we are. We are caught in the tail end of a credit cycle. These cycles are a recurrent feature of banking in capitalist economies and is more or less unavoidable.

There are a range of reasons why this cycle is so bad and I don’t believe anyone really understands it but some unarguable ones are: that the banking sector became concentrated in too few institutions which each individually acquired systemic importance; the credit flows were at a magnitude beyond what the system could safely sustain not least because of very large and prolonged imbalances in trade between creditor and lender countries;  banks’ balance sheets were allowed by regulators to inflate beyond the limits of real safety.

A bank’s balance sheet shows the relationships between its assets (mostly the money people owe it, its lending) and its liabilities (mostly the money it owes people, including both those who have made deposits with it and its borrowings from other institutions). It needs to lend sufficient money at interest for the incomings to cover its expenses and generate a profit but also to retain enough ready at hand to meet the demands of those who wish to make withdrawals. Balancing this is a constant effort and is the task of specialists in “Asset and Liability Management”.

Another task the bank has to undertake is taking account of the probability that some assets will turn out to be valueless because those who owe the bank money don’t repay it. If this happens too much the bank will find itself with less assets than liabilities (those who deposit can be relied on to want their money back) and will collapse into insolvency. To cover against this banks are required to retain some money that they don’t use for lending (“capital”) which can absorb the losses without leaving uncovered liabilities.

During the credit boom two things were allowed to happen. Huge volumes of assets were acquired (i.e. loans were made) using money borrowed from other institutions rather than from small scale depositors. In one regard this makes no difference, borrowing is borrowing whether its my savings account or a loan from Kuwait’s sovereign wealth fund or a Chines bank. However there is a real distinction and one that lead to the collapse of the Royal Bank of Scotland. These “wholesale” loans are much less “sticky”, especially the very short term lending typically made at LIBOR. When there seems to be trouble a “wholesale run” in which these funds become inaccessible can develop very quickly and this is what put an end to Fred Goodwin’s career (and also Northern Rock).

The other thing that happened was that over-optimistic estimates were made of how much would be repaid (this is what went wrong at Bank of Scotland and there some moral failure was definitely at work, but that’s another story). One example of this was US “sub-prime” lending but it was far more widespread than this. These mistakes about who was a good risk would have been alright if property prices didn’t fall (since much of it was secured against property) but they did. Because balance sheets were so swollen there wasn’t the capital to cover the losses.

Banks ran the risk of collapse and because most of the money in the economy exists through and in the banking system and because the banks were so big that their collapse would lead to a systemic collapse governments had no choice but to step in and take the banks over, putting money into them to “recapitalise” them to the point where they were able to continue operating.

However many of their remaining assets are not really worth what they say they are. It is not clear whether they additional capital they received has made them solvent. For this reason wholesale money is still largely unavailable to them, preventing them from acquiring new assets (lending more money). Until that problem is sorted out governments remain their only source of funding but that risks drawing states into insolvency too, if the assets they acquire by lending the banks money go bad. We’re in a terrible mess.

Blaming it on moral weakness and wrong doing is mere superstition. It is about as likely to make it go away as performing an exorcism on the Bank of England’s building in Threadneedle Street. We all need to grow up and realise that sometimes the world goes in ways we don’t like and we have to deal with it. If we have faith we have to trust that God knows what God is doing, if we don’t we have to make our own peace with death and suffering. In any case if we want the mess of the world economic system sorted out we have to look at it squarely and not distract ourselves by looking for scape goats.

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