Winner of the New Statesman SPERI Prize in Political Economy 2016

Wednesday, 7 September 2016

Connecting the dots

John Harris has an excellent article in the Guardian, listing the number of politicians in the UK and EU who have retired to lucrative jobs, often in the financial sector. He links that directly to popular distrust of our ruling elite. I want to make the same connection, but via a slightly more elaborate but perhaps more worrying route.

First, let’s think about the financial crisis. The damage caused by that crisis has been huge, and not just because of the recession it caused. In many countries it seems to have permanently reduced the growth in productivity, meaning that compared to a world in which it did not happen we are permanently poorer by a large and growing amount.

Now as an economist I get a lot of stick about my profession failing to predict this crisis. But economists have not been reticent in thinking about how to prevent the next one. The fundamental weakness of the financial sector is the relative absence of capital (equity) compared to other companies. But the adjustments forced on banks since the crisis have been marginal, and certainly not enough to prevent another crisis.

It is natural to ask why. You might think that getting very tough with banks would have been politically popular? Measures could have been phased in to avoid any short term damage to lending. So why have politicians, and the senior civil servants who advise them, been so tentative? (For that matter, why don’t we change the way multinationals are taxed?)

Or if we go to the Eurozone, the decision to stop Greece defaulting in 2010 was the result of fear that the European banking system was too weak to cope. The consequence was crippling austerity for Greece, and bailing out European banks by the back door using Troika loans to Greece. You might think that European politicians would as a result be particularly keen to ensure that this kind of thing would never happen again, but there too action has been very limited.

If we were talking about the United States, the answer to why the financial sector is treated with kid gloves despite the problems it has caused would be obvious: the financial sector provides a huge amount of funding for politicians to spend getting elected/re-elected. In Europe that does not happen so much. But the expectation of financial reward for good behaviour in the form of employment after a politician retires may be just as effective an incentive. 

So any distrust that people have in our ruling elite and the political system that supports them is not some irrational form of envy. Politicians retiring to lucrative jobs is not inevitable and largely harmless. It is a form of corruption. It strikes at the heart of why we had a financial crisis which has made almost all of us a great deal poorer, and why little has been done to prevent another. The main beneficiaries of the public's reaction to economic hardship and elite corruption may be the likes of Donald Trump and Marine Le Pen.      


  1. I basically agree with the above article, except that I think there’s more to it than the corruption which SW-L refers to. The Vickers commission only proposed a minute increase in bank capital, but I don’t believe that was because commission members (certainly not Sir John Vickers or Martin Wolf) were looking for lucrative jobs at banks.

    Reason for that feeble increase in proposed bank capital was that the commission thought increased capital would increase bank funding costs and thus interest rates. That’s sloppy thinking, not corruption. Reason is thus.

    Bank shareholders demand a higher return than depositors because shareholders accept risk. But that leaves out the cost of deposit insurance which is nothing more than a charge for accepting risk. Total risks for a given bank which is funded entirely by shares ought to be exactly the same as where the same bank is funded entirely by depositors plus deposit insurance. Ergo increased capital ratios are costless.

    On a separate point, Martin Wolf recently echoed SW-L’s point about Trumpism being a reaction to bankster / politician corruption. Wolf said in a recent speech (in Iceland) that Trumpism would never have happened if a hundred bankers in the US had been jailed.

    1. Ralph, you seem to be over-looking maturity transformation as the "alchemy" in banking. If loans were all funded by equity (ie using a funding model much like Wonga uses) and savers held savings in the form of shares, then part of the risk would be due to the very long duration of those financial assets. Even if an asset has no default risk, if it has a very long duration, the price will bounce around. Just look at a chart of say 50year index linked gilt prices. They have no default risk but if you hold your savings in them, the value bounces about from one day to the next.

    2. Stone, Re “very long duration”, that rather implies shareholders are stuck with their investment for a long time. They aren’t: they can sell their shares whenever they want.

      Of course, as you also imply, they may have to sell at a loss, thus shares are certainly less liquid than deposits. But any loss of liquidity can be made up for by simply having the state print and spend more money into the economy, and doing so costs nothing in real terms. As Milton Friedman put it, "It need cost society essentially nothing in real resources to provide the individual with the current services of an additional dollar in cash balances."

      As for maturity transformation, I regard that as nonsense. Detailed reasons at the link below. But basically as I just pointed out, any lack of liquidity due to stricter bank regulations can be made good at zero cost.

    3. Ralph, I was meaning duration in the sense here:- "Modified duration is the name given to the price sensitivity and is the percentage change in price for a unit change in yield." It is all very well pointing out that the government can offer savers government securities (including cash) as a zero-duration alternative to commercial bank securities but that doesn't address the issue of banks getting low cost funding. Personally I'm all for reforming banks but we need to acknowledge what we will be doing.

  2. Superb deconstruction of the implicit/explicit quid pro quos in politics and the toxic effect on policy. In America, this reality taps into a deep vein of distrust of "eastern" (New York) bankers dating to the 19th century. Please elaborate on the dots theme in future, preferably as guest editorials in mainstream media.

  3. "Now as an economist I get a lot of stick about my profession failing to predict this crisis."

    I don't think it is the failure of the profession to predict it that upsets people as much as its response: all that needs to be done to understand what happened and why is to tweak Model.


  4. Somewhat lacking in evidence: that the dots (a few) exist does not help to join them up uniquely without an empirically based model. Could you give a few pointers as to your views on fractional reserve banking and the appropriate capital requirements. Good piece, nevertheless.

  5. In my view you're exaggerating the role of both political donations and the revolving door, SW-L. There is a more general phenomenon which is the conventional wisdom says doing much regulation makes you anti-business, politically, and inefficient, economically, and those things make politicians fear losing elections. You may laugh at this fear due to the rise of Trump and Le Pen, but understand that this has been the conventional wisdom even among left-wing and liberal parties since the 90s. They have been slow to change even in the face of electoral defeats, most spectacularly on the continent. They appear to think a complete recovery is just around the corner, and they have to sit tight til then, and not blow it by getting tough on the banks and suffer criticism over it from the rich and powerful through the media.


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