Let’s get right to the heart of every banking crisis, including the current one of this week: the temptation of bankers–who are human like the rest of us–to be self-serving no matter the collateral damage. In short–to be evil.
In the next few weeks, or for however long this current banking news cycle lasts, every form of pundit will be offering technicalities for this week’s Silicon Valley Bank (SVB) implosion, the current closure of Signature Bank, the $30 billon industry rescue of First Republic Bank, and whatever else unfolds. We invite you to turn to those pundits if you’re interested in after-the-fact autopsies and forensics.
If, however, you’d like to work upstream and are curious why our nation continues to allow these banking catastrophes (yes, allow!), and you’d like to know how to dramatically reduce these risks going forward, then stay with me here. This won’t take long and will resonate.
Image Credit: Herrick Kimball | The Deliberate Agrarian
First, by way of quick historical review and reminder that there’s nothing new under the sun, let’s hit highlights from America’s history of bailing out bankers who over-reached in their pursuit of profits. Then we’ll have a better perspective when we get to the source and solution of bankers being evil.
To quell the Panic of 1907, the US Treasury infused various NY banks with $35 million (present value of $1.12 billion), but that amount wasn’t enough. So J.P. Morgan (the man himself) organized a private industry rescue akin to this week’s CPR of First Republic Bank. That early effort, though, didn’t address the industry’s moral weakness–lack of guardrails on bankers risking other peoples’ money.
In response to the Crash of 1929 and bank runs in the early 1930s, the Roosevelt administration enacted necessary guardrails, such as requiring banks to maintain certain reserves, insuring deposits, oversight to avoid bank failures, and, most notably the Glass-Stegall legislation that prohibited bankers from risking their depositors’ money in pursuit of profit. No more Wild West drama for banking was the goal, and commercial banking became safer for our predecessors. But the temptation of our cumulative dollars in all our little accounts was just too great, so bankers began working to dismantle their guardrails. They finally succeeded in 1999 when President Clinton repealed the last of Glass-Stegall.
We’re all likely old enough to have paid attention during the subsequent 2008 financial crisis and the Obama administration’s rescue of the financial institutions, so the only thing I’ll remind you of regarding that era of evil is what President Obama said to banking executives in March 2009, “My administration is the only thing between you and the pitchforks.” Whether that statement was theatrics or a genuine attempt at a wakeup call to the banking industry, Obama’s rescue and subsequent Dodd-Frank legislation, a woefully anemic version of Glass-Stegall, didn’t sufficiently restore the guardrails. To finish our history recap, remember that President Trump gutted Dodd-Frank in 2018.
Now, with at least some historical perspective of American bankers’ pattern of self-dealing that leads to implosions and our government’s pattern of rewarding the self-dealing by cleaning up the implosions, let’s turn to the source of the evil that enables this dysfunction. The language of economics is replete with the dense and arcane, and, occasionally, the insightful and useful. Turning to the latter, let’s look at the economic term “moral hazard.” The Economist's nifty The A to Z of economics reference guide defines moral hazard as:
The risk that providing insurance might alter the behavior of those being insured. Homeowners or car drivers may take more risks if they know that an insurance company will cover their losses. This is also a problem for central banks when they act as a lender of last resort for banks; knowing they will be rescued in a crisis, bank executives may take more risks, and investors may be less choosy about the banks with which they do business (emphasis added).
And therein is the evil, described in the concept of moral hazard. Our bank executives, knowing they and their compensation will be rescued in an industry crisis, have worked hard to dismantle guardrails, and in doing so have us all back in a 1907-era remake. Our government, at least since President Roosevelt’s administration, has not had the moral courage to exercise control over the banking industry’s self-dealing appetite for risks with other peoples’ money. It is not unlike a parent who continues to give yet another car to their reckless teenage driver who refuses driver’s ed. Until the governing authorities have the moral courage to re-establish and enforce guardrails like Glass-Stegall, you and I and our money are at unnecessary risk on banking’s highways.
The evil inherent in the concept of moral hazard, and freely exercised by many bank executives, can only be checked by a morally courageous government. If a morally courageous side of our government does not soon materialize and reinstall those banking guardrails, eventually some unfortunate President’s administration will not be able to protect banking industry executives from seas of angry pitchforks. Just examine the history of some other countries.
We’ll close with some Better Capitalism ethic of mutuality wisdom captured in a quote by Mervyn King when he served as the Deputy Governor of the Bank of England: “[O]ur ambition at the Bank of England is to be boring.” The US government needs to help US banking become boring again, and in doing so it can absolutely discount banking executives' foreseeable and entirely disingenuous arguments that banking regulation equates to socialism. That’s an argument that springs from a different evil.
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