What can stop the ‘too big to fail’ bankers from terrorising the world?

Irene Madsen, Team leader at the European Court of Auditors, Milan Martin Cvikl, and Angela Hodar McCann, Head of Unit at the European Court of Auditors (from left to right). Cvikl gave a press conference following the publication of the special report n° 5/2014 entitled "European banking supervision taking shape - EBA and its changing context" in which the European Court of Auditors assessed whether the Commission and the European Banking Authority (EBA) had satisfactorily carried out their responsibilities in setting up the new arrangements for the regulation and supervision system of the banking sector and to examine how successfully those new arrangements were functioning. The report found shortcomings in cross-border banking supervision, the assessment of the resilience of EU banks, and the promotion of consumer protection. (EC Audiovisual services, 2/7/2014).

Irene Madsen, Team leader at the European Court of Auditors, Milan Martin Cvikl, and Angela Hodar McCann, Head of Unit at the European Court of Auditors (from left to right). Cvikl gave a press conference following the publication of the special report n° 5/2014 entitled “European banking supervision taking shape – EBA and its changing context” in which the European Court of Auditors assessed whether the Commission and the European Banking Authority (EBA) had satisfactorily carried out their responsibilities in setting up the new arrangements for the regulation and supervision system of the banking sector. The report found shortcomings in cross-border banking supervision, the assessment of the resilience of EU banks, and the promotion of consumer protection. (EC Audiovisual services, 2/7/2014).

Last Monday 10 November the Financial Stability Board, an international non-binding body based in Basel which comprises government and central bank officials from G20 countries had a bright idea for the lenders. They admitted that the 30 “too big to fail” major world banks should retain at least 20% of their risky assets in own capital in order to save taxpayers the onerous burden of bailing them out when needed. FSB’s noble target is that those lenders should be able to go bankrupt without causing a global disaster, as Lehman Brothers did in 2008, nor counting on taxpayers to pay for their uncovered obligations, when they fail.

Obviously the FSB officials must have in the back of their minds the terrible thought that those banks are currently able to blackmail entire countries if not whole continents. There is no other way to explain why the major lenders are presently able to pocket the gains of their wild bets in all and every possible market, but hand the losses to taxpayers when the bubble busts.

Reckoning the unthinkable

In reality, the Board by recommending the retention of such massive bank reserves, indirectly recognises that for the time being and in the foreseeable future, taxpayers will continue to be held responsible or rather hostages being obliged to bail out the ‘systemic’ banks when they go bankrupt. It’s a fact then that the 2008-2010 credit melt down created not only a new kind of financial crisis, but also a powerful weapon in the hands of the major banks. The “too big to fail” lenders are nowadays quasi reassured that the governments will use taxpayers’ money to save them, if the real economy is to avoid the worst.

In real terms, taxpayers are offering free insurance to banks. There is a more to that though. Apart from governments who use taxpayers’ money, central banks come to the picture and engage in the rescuing of lenders and actually help them with subsidies to recapitalise and continue playing their unholy game. We saw it clearly happening before our eyes during the past six years. After the American, the European and other governments gave trillions to sustain the failing banks during the 2008-2010 crisis, the central banks took the relay and started refinancing them with even more trillions free of charge or at interest rates too close to zero.

Recapitalised for free

The banks use all that money and bet it in derivatives, third world risky financing and other obscure business usurping an important annual return on all that money. A rough estimate is that the major American banks got around $4 trillion from the US central bank, the Fed, at zero interest rate. Exploiting this bonanza for four years must have left them a net 20% to 25% or up to one trillion dollars. Then it was easy for them to buy back the shares the government had acquired, when it directly subsidized them at the peak of the 2008-2010 crisis. Apart from Lehman Brothers no other major bank shareholder or management team suffered any loss and they all kept their clout on their bankrupt institutions

FSB tells the truth

Now let’s return to Basel and the FSB’s idea for the restoration of adequate capital cushions in the balance sheets of banks. Mind you that until 1992 the banks were very closely monitored by regulators and draconian rules were applied in order to protect people’s savings. The first Bill Clinton administration started to seriously dismantle the up to then solid regulatory environment for the banking industry, a global policy line that freed completely the banks from any prudency control and rule by the turn of the millennium.

The 2008-2010 crisis awoke everybody and proved that the banks had been taking full advantage of their newly acquired freedoms and started creating their own money. They kept spinning their equity capital by tens of times and arrived at being leveraged by depositors and investors to up 30 to 70 times their own capital, according to the appetite of their shareholders and management team for risks. They didn’t discover anything new. From Adam Smith’s times, bankers tended to create their own money. That’s why the prophet of free market economics, when writing about banks he demanded tough controls and recommended even ethical scrutiny of bankers. He concluded that this profession tends to attracts villains and tends to turn honest businessmen into crooks.

Back to reality

Returning to current developments, the truth is that regulators on both sides of the Atlantic Ocean the closest they have come now to make the “too big to fail” banks responsible for their own bail-in, is the EU’s Banking Union. Still, this new European institution is based on the rather shadowy universe of the usual Brussels complex environment of regulations. Today’s Eurozone financial setting is built upon the Recovery and Resolution Directive, the Capital Adequacy Regulation and the peculiar Single Supervisory Mechanism. Even in this case though, five to eight years have to pass (not earlier than 2020) in order the Eurozone banks to be mutually resolved or rescued when failing, with Brussels jointly using member states resources.

As a result the lender of last resort remains the…taxpayer and the central bank. As for the US nothing that matters has changed there concerning bank prudency rules. US banks are practically operating in the same regulatory environment that led to crisis. No western government dared touch the critical issue of reserves. FSB is the first body to talk about 20% or even 25% prudency reserves. However, such an obligation will turn again bankers into blue-collar workers, miles apart from today’s Lamborghini addicts. As a matter of fact, the FSB demands that the banks should hold one fifth of their risk weighted assets as equity or debt held by investors who can take losses. This will change everything in the banking industry.

All that will force the bankers to either secure new huge equity and uncovered debt inscriptions or realize sizeable reductions of their investments/assets side of balance sheets or do both. The concomitant result will be an enormous reduction in profits and bonuses. And the question is if the banking sector can accept this prospect, even as a vague eventuality to start being negotiated in 2019, as the FSB proposes. Unquestionably, there is no other way than the return to mandatory and sizeable reserves/equity to make the banks again lenders of the real economy. Otherwise they will continue to terrorise us all…

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