Opinion

Edward Hadas

The ongoing ethics struggle of banks

Edward Hadas
Mar 5, 2014 15:58 UTC

The Swiss Bank Employees Association has told an uncomfortable truth: it was “generally known” that for many years some of their employers profited from customers’ “tax evasion.” That is incontestable, as many of the banks’ managers concede. But the practice, supposedly now ended, raises an important question about ethics and business. Why were neither the managers of the Swiss banks nor their employees worried by this business model?

The hardly hidden truth was included in an Association press release which called on Brady Dougan, the chief executive of Credit Suisse, to apologize for insulting the Swiss bank’s employees.

Dougan, who was trying to explain to U.S. legislators how Credit Suisse had stopped helping Americans escape taxes, said that “some Swiss-based private bankers went to great lengths to disguise their bad conduct from Credit Suisse executive management.” The claim, said the employees’ group, slighted the professionalism of the workforce. Besides, it was “hardly credible.”

That last statement is a little unfair. It makes excellent sense that some eager employees, anxious to bring in new business, and well aware that there was an official policy against aiding tax evasion, hid certain salient facts from their bosses. They knew that full disclosure would just get them into trouble, while bringing in new business would be rewarded, with few questions asked.

But if Dougan is right that the managers were totally ignorant, they hardly look good. After all, the commitment to change the old Swiss banking culture – which asked so few questions that accounts bore numbers rather than names – had started well before 2001, when Credit Suisse seriously began its efforts to clean up its relatively small U.S. private banking operations.

Madoff/subprime – spot the difference

Edward Hadas
Jan 15, 2014 15:36 UTC

Bernard Madoff still has some magic. The public finds anything connected to the fraudster’s case fascinating, from a prison interview to JPMorgan’s agreement last week to pay $2.3 billion for Madoff-related sins. And why not? Madoff was a grandmaster of the confidence trick. But there is more to it than that. His way of doing business was alarmingly close to the perfectly legal practices which brought down the financial system in 2008.

To see that, compare Madoff to a hypothetical pre-crisis hedge fund manager – one with a special interest in U.S. subprime residential mortgage securities. The common tale starts with a commitment to provide higher returns than the economy can safely offer to financial investors. Both Madoff and the hedgie took in funds without making any specific promises, but their investors’ expectations were lofty.

Madoff, of course, knew that he could not live up to those expectations. That makes him smarter than the hedgie, who was either foolish, if he thought American house prices would keep rising for many years; or arrogant, if he was confident that he could sell out before the losses hit.

Imagine a world without debt

Edward Hadas
Aug 7, 2013 09:32 UTC

I have a dream: a world without debt, and with much more equity. It’s not just that summer holidays are a good time for fantasising. The fifth anniversary of Lehman Brothers’ bankruptcy is a month away, and regulators have recently forced both Deutsche Bank and Barclays to issue more shares.

Some regulators’ beach thoughts may drift to the magic numbers of bank capital ratios. My approach is less technical and more philosophical. I wonder why the financial system relies so much on debt. Loans and bonds are poorly designed for their primary economic purpose – investment.

This observation may sound shocking. Interest-bearing debt is considered totally normal. Financial theory unquestioningly treats risk-free debt as the standard instrument. Savers usually compare all investments to a similar standard: safe bank accounts which pay a steady interest rate.

Fear, greed and bank capital

Edward Hadas
Jul 17, 2013 14:27 UTC

Buildings should be strong enough to withstand storms and earthquakes. Similarly, banks should be able to remain upright after massive waves of losses. Engineers have a pretty good idea of how to make skyscrapers strong. The regulators and lawmakers who set the rules for big banks are still struggling, five years after the government rescue of many American and European banks.

Bankers and their defenders say that the struggle is over. The financial structures have been reinforced: deeper capital foundations, new supports added and weak materials removed. But many critics point out that the banks have not done the one thing necessary – to double or triple the ratio of shareholders’ equity to total assets. That is the only sure way, they say, to guarantee that large losses on loans do not threaten the ability of the institution to remain standing.

I think the critics are largely right. As economists Anat Admati and Martin Hellwig explain in their book, The Bankers’ New Clothes, the bankers’ almost instinctive aversion to equity protects bonuses and shareholders at the expense of the general public. Still, in my view banks have a more fundamental problem than poor capital structures. It is society’s unreasonable expectations of what they can accomplish.

Rate rigging costs more than money

Edward Hadas
Jun 19, 2013 14:41 UTC

Here are some depressing figures: 133, 20, 4, 3 and 1. They are the most recent key counts in what might be the most alarming of all the financial scandals since the 2008 crisis, the sometimes successful efforts of traders to rig benchmark rates.

The first four numbers come from Singapore; they count up, respectively the traders, institutions, years and rates involved in attempted manipulation in the city-state. The one is for Tom Hayes, the first and so far only trader to face criminal charges for messing with the Libor interest rate. Investigations of possible unfair play in energy-price benchmarks are continuing, but it is already clear that too many traders in too many markets tried too often to profit by manipulating supposedly objective readings of market conditions.

In cash terms, the machinations are hardly a problem. In comparison to the hundreds of billions lost and the score of institutions capsized by reckless speculation made before the 2008 financial crisis, any losses – the Singapore authorities say that rates there stayed honest – were microscopic. While the distortions of one-hundredth of a percent were large enough to enrich a few traders, they were too small to make anyone else noticeably poorer, or to add much to the profits of the banks which employed the crooked traders.

The dangerous aristocrats of finance

Edward Hadas
May 29, 2013 14:21 UTC

In many ways, the financial world has changed remarkably little in the five years since the 2008 financial crisis. Yes, banks, brokers and other intermediaries are neither as profitable nor as popular as in the pre-crisis years. However, the industry is still arrogant, isolated and ridiculously lucrative. Leading financiers look more like pre-revolutionary aristocrats than normal businessmen.

Pay is the most obvious sign of this privileged social position. Consider JPMorgan, a fairly typical financial firm in terms of remuneration. Last year, the annual compensation per employee was $192,000.

That already seems high, but the measure includes the majority of employees whose pay is bunched around the $45,000 average for non-supervisory U.S. workers in finance. Assume that two-thirds of Morgan’s employees were in that group. For the rest, the people at the top and upper middle of the company, that leaves an average pretax reward of $485,000 – more than 10 times the norm of the lower orders.

Cyprus and the danger of promises

Edward Hadas
Mar 19, 2013 14:42 UTC

Don’t make promises you can’t keep. Wise parents tell small children that, and wary lovers use that command as a taunt. But in the world of finance, unrealistic promises are the norm, and they are too often broken. Depositors in the banks of Cyprus may be learning that lesson.

True, the government of the Mediterranean island may retreat from its first plan, and in any case the accounts are to be taxed, not written down, so the terms of the deposit insurance will be technically kept. And strictly speaking, deposit guarantees are not being breached in the United States and other countries with an inflation rate higher than the interest rate paid on savings accounts, even though that inflation-tax steadily erodes the accounts’ real value. But in fact, governments – both small and suspect like Cyprus, and large and respectable like the United States – have failed the lovers’ test. They have made promises to savers which they either cannot or will not keep.

These trust-breaking governments can resort to the errant lover’s usual excuse: we could not have known what the future would bring. Just as bitter experience somehow invalidates a promise of undying love, an impossible-to-predict avalanche of bad loans might erase the obligations of Cypriot banks and the equally unpredictable financial crisis could exculpate monetary authorities in the United States and elsewhere. Such events, they can say, are like the acts of God which invalidate insurance policies.

Morality and monetary policy

Edward Hadas
Mar 6, 2013 13:22 UTC

Monetary policy these days is complicated, ineffective, and quite possibly immoral. The complexity is inevitable; there is no simple way to ensure that the supply of money and credit is appropriate in a large modern economy. The ineffectiveness is evident: central bankers let that supply grow too fast before the 2008 financial crisis, and have unable to return monetary conditions to normal since then.

The moral lapses may be subtle, but I believe the lack of attention to the common good in the management of interest rates and the monetary system causes three serious problems.

 1) Dangerous freedom

Imagine a world in which anyone can use anything as a currency. This perfect monetary freedom would be a disaster. With strangers, I would only be willing to deal in gold, or some other scarce substance that could be carefully measured, because I would have no way of evaluating verbal or written promises to deal fairly. I might be able to trust members of my social group in economic transactions, but only because our monetary freedom was balanced by strong social constraints; they would be punished if they tried to cheat me.

Bad ideas spawn Lesser Depression

Edward Hadas
May 16, 2012 14:18 UTC

On September 15, 2008 Lehman Brothers collapsed in a heap, a bankruptcy that was followed by a recession in most rich countries. As time goes on, the severity of the disruption becomes both more apparent and more puzzling.

When Lehman failed, it was reasonable to expect the pain to be brief and concentrated. While too many houses had been built in the United States, most of the world’s real economy (comprising factories, offices, retail outlets, construction projects) was doing well. The global financial sector was more distorted, even before investors took fright at the decision to let Lehman go under. But by the middle of 2009, governments and central bankers had agreed to provide bankers and brokers with anything needed to keep them healthy.

Optimism was not justified. Although the countermeasures stopped the deterioration, the rich world now seems stuck in a Lesser Depression – many years of poor economic results and a series of financial crises. In the United States, the euro zone, Japan and the UK, real GDP per person is still lower now than it was four years ago. In all of them, GDP growth is currently either slow or non-existent.

Mr. Fine Suit visits Europe

Edward Hadas
Nov 30, 2011 06:00 UTC

Once upon a time there were 11 prosperous merchants who lived in a land of peace and plenty. They decided to form a league that would work together for everyone’s greater good. But then a charming man in a fine suit came around with a tempting speech: “I love your project and trust your businesses. I will lend you money at a very attractive interest rate”. How nice, thought the merchants. Our customers will love us if we use the money we borrow to give them better deals.

All went so well that six other merchants were proud to join the league. Mr. Fine Suit seemed pleased. He reduced the already low interest rate on the loans. The merchants all planned to repay, but today was never quite right. Today, in fact, was always a good day to borrow more, while tomorrow always looked like a better day to raise prices.

Then one day Mr. Fine Suit changed his tune. “You know, you have a mighty nice little enterprise going here. But business is business, my friends. Interest rates are going to rise for some of you.” The merchants were angry, but what could they do? They promised to be more frugal, but still had to pay up. As the months went by, Mr. Fine Suit became more hostile. Just last week he came to the G-store, the most prosperous and prudent of all the merchants, with a really nasty threat. “You know, between us, I’ve never liked your stupid league. You’re much smarter than the rest. Leave the league and I’ll keep on lending you money at a low rate. If not, well, here’s a little reminder of what I can do.” He increased the interest rate by two notches before leaving the room with a menacing smirk.

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