Banker-think in welcome retreat

By Edward Hadas
March 27, 2013

For once, investors have got it right. In 2008, their panic turned a financial crisis into a long multinational recession, but they have mostly yawned right through the drama in Nicosia. They hardly twitched at a stream of warnings from investment banks and pundits: bank deposits are no longer sacrosanct; the European Union has been exposed as despotic and incompetent; the Russians are coming; the Russians are going; capital controls will destroy everything; “bail in” (taking losses on loans that cannot be repaid) is the end of the world as we once knew it.

Such talk was out of proportion. Cyprus is a small country – its GDP would put it at 116 on the Fortune 500 list of the largest quoted U.S. companies – with a financial sector that had expanded excessively for two decades, almost entirely by attracting flight capital from Russia. A national financial collapse was both insignificant and merited. Besides, the EU and the International Monetary Fund had a plan to deal with the collapse: a combination of financial help from other countries and managed pain for depositors in Cypriot banks.

Alarmists could not deny all this, but they invoked the great demons of financial crises: precedent and contagion. That was silly. Cyprus was obviously a special case, and the European Central Bank was clearly determined, and able, to keep its problems from spreading. Even if Cyprus had left the euro zone, there would have been no dangerous precedents or grim effects, just a demonstration of a bizarre desire for economic self-harm. For everyone else, Cyprus would still be like a flea-bite – scratch for a minute and forget about it.

Why then have so many distinguished economists made so many dire predictions? I believe the answer is that they overestimate the current power of finance.

Recent history is on their side. For more than three decades, financiers almost always prevailed over political authorities. In the 1980s, they bamboozled politicians with spurious arguments for financial deregulation. In the 1990s, banks trampled over their regulators. In the early 2000s, central bankers became votaries at the altar of finance. They treated rising asset prices as signs of divine favour.

The 2008 financial crisis didn’t end the sway of bank-think. Banks forced governments to rescue them, but bail-ins were treated as anathema and calls for radical changes were ignored. The largest banks became ever larger, top bankers’ pay remained extraordinarily high and monetary policy was designed to make life easier for banks. In the euro zone, investors gave politicians orders on fiscal policy. The desires of the financial sector had to be met and their fears, however irrational, had to be calmed.

Very gradually, however, finance has lost ground. Regulators and public opinion are forcing pay cuts and capital additions. Governments plan to tax some economically pointless trading. And now, the people who put money into reckless Cypriot banks are being punished rather than rescued. It’s a big change from 2008, when foolish Irish banks managed to dump almost all the cost of their mistakes onto taxpayers.

Some of the alarming talk about Cyprus comes from apologists, sometimes unwitting, for the forces of finance. Their claim, that economic health is harmed when governments refuse to support troubled banks and to fully guarantee depositors and bondholders, makes sense for the industry. For society, such deference to narrow financial concerns is corrosive; it encourages bad behaviour from banks and high pay for bankers.

Other pessimistic experts are simply behind the times. They don’t realise that investors are now less in awe of finance and sufficiently trustful of the authorities to foreswear the emotional excesses which wreaked such havoc while finance’s power was unchecked. Investors are slowly learning, with some difficulty, that banks will neither be allowed to fail disastrously nor rescued painlessly. The lesson has been sufficiently assimilated to allow them to ignore the Cyprus-alarmism.

That is good news, but banker-think still remains too powerful. It still shapes monetary policy, poisons the debate over fiscal policy and slows down institutional reform. There is still too much credit outstanding in rich countries. Too many people still believe that rising house prices and bull markets in shares are unconditional goods.

Finance needs to be restrained, but it should not be crushed. While power so corrupted financiers that they often lost sight of their economic responsibilities, the industry has a valuable role to play in modern economies. It should protect savings, and both gather and allocate funds for investment.

Finance and government ought to help each other. Governments can restrain bankers’ greed and foolishness. Bankers can keep governments from spending more than they can afford, and can encourage a just and responsible monetary policy. There is much work to be done.

4 comments

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excellent observations

Posted by rational44 | Report as abusive

Mr. Hadas,

Once again, you ignore the trees and see the forest.

In many, many ways, life is a game all must play. Our path through it is more enjoyable and less taxing when players accept that each bring something necessary to the party, and when both greed and envy are properly harnessed it benefits the common good.

Posted by OneOfTheSheep | Report as abusive

EH

You seem to forget that capitalism is founded on sheer human greed. There is nothing wrong with that; everyone is greedy. However, whether one is a banker, an investor or a depositor in a bank, Principles of Investment 101 informs us that there are 3 types of investments – high risk, medium risk and low risk. In the final instance, one has to live by one’s own choice of risky ventures when things go wrong. Take your pick on who has to pick up the tab – all taxpayers, all depositors big and small, or mostly well-to-do depositors (among them, many money launderers) who can afford to lose 30-40% of one of a certain high risk investment? I think the third option that was eventually chosen is still the most reasonable and just one. Yes, bankers and financiers should be restrained… but how? As long as there is a demand for high risk investments in society, unrestrained capitalism will continue on its destructive course… unless of course you think you can change human nature.

Posted by penalng_lang | Report as abusive

I rather disagree. The Troika have just shown what they are prepared to do to keep the ludicrous Euro project going. They lie, then some of them tell the truth, then they are forced to back-pedal then someone else confirms that it’s true. You just can’t trust the Eurocrats. That’s one of the things destroyed by the Cyprus debacle – credibility. I have moved my money (such as it was) out of the Euro zone periphery and I would urge anyone with deposits there to do the same. The next bail-in will be much bigger and somewhere that will have a much bigger impact than Cyprus.

Posted by paulos | Report as abusive