Let’s level on leverage
George Osborne’s decision to mount a legal challenge to European proposals for a bankers’ bonus cap puts beyond doubt where this government’s priorities lie in the internecine conflict between bankers and society. While appearing to follow the advice of various commissions, on the issues that really matter he has consistently preferred to support the banks and their employees and to preserve business as usual by rejecting any effective break up of these institutions; by rejecting calls for sensible levels of leverage; by bringing forward legislation that advances banks’ claims in the winding up of failed institutions above the interests of depositors; and by pouring a great deal of our money into a system that shows little sign of effectively applying the funds for society’s benefit.
Europe should have targeted total compensation rather than a bonus ratio: but if ineffectiveness is the complaint, why litigate against it? In fact the cap offered an excellent opportunity to reduce the total costs in the interests of shareholders and society while avoiding the threat of defections to other EU countries. And for reasons I shall come to, for most bankers the threat of moving to tax havens in fruit-growing republics is idle: these economies can’t support parasitism on the scale required.
Government would have us believe that they want to remove the implicit support for too-big-to-fail banks. All these policies fight against that. The banking model they prop up is one that depends on institutionalised mispricing.
We should be quite clear about this. Leverage per se simply magnifies returns (profits or losses) and increases risk for one part of the bank’s capital structure. It doesn’t in itself create profits. And while zero-sum trading generates its ups and downs (and the optionality of bonuses allows employees to collect on the up without surrendering on the down), a banking industry that functions entirely on these ingredients would have to have too many institutions going bust too regularly for society not to notice.
The real key to leverage is often forgotten, though it was understood by Archimedes (Nogari’s fictional portrait is in Moscow: they (used to) do things differently there). δός μοι ποῦ στῶ, καὶ κινῶ τὴν γῆν he is reputed to have said (although probably in a local dialect): the point being that to move the earth, you need a fixed point against which to apply your lever. (A burglar’s jemmy works on the same principle.) Our government’s policies are that fixed point, providing the equal and opposite force which allows banks to continue to take deposits at close to zero interest rates when in fact these bear the risks of subordinated claims on businesses which have a high level of risk. Without that fixed point, market forces would require banks to pay the proper rate for each part of their capital – and that would bring their business model to an end. The industry would shrink to a far smaller size, consistent with the socially useful contribution to funding industry and individuals’ requirements.
The structural subordination arises from the willingness of government and regulators to allow banks to borrow among themselves on secured terms (with collateral being passed round like a nursery game, so that locating it when the music stops adds additional hazards for us all). It is now to be exacerbated by clause 9 of the so-called banking reform bill, which puts other banks before depositors in the creditors’ queue. Yet these deposit terms are accepted – by those who know that, for all its rhetoric, government cannot withdraw support from a failing bank without the whole system collapsing overnight.
So instead we not only lurch from one banking crisis to the next (in the knowledge that taxpayers will have to foot the bill again, on an even bigger scale), but in the meantime we continue, largely unnoticed and unremarked, to fuel the banks with no benefit to society.
I’m paying these bonuses.