Banking reform – time to stop privatising the profits and socialising the losses

FOR the past four months I have been serving on the Parliamentary Commission on Banking Standards. It was set up in July in response to the Libor and other scandals and at first tasked with looking at culture and behaviour. However in recent weeks it has concentrated more on the issue of structure – whether investment banking and retail banking should be split. Sir John Vickers reported on this question last year arguing that there should be a ring fence placed around retail banking, but against a full split. The Commission has been asked to do the job of pre-legislative scrutiny of the Bill to implement the Vickers Report.

 

Amid this focus on the structure of banking, there is a danger that another question gets overlooked – who should bear the losses in the event of another banking crisis? One of the things that most angered the public about the recent crisis was that when times were good, the profits were private (and huge) but that when the crisis came, the losses (also huge) were borne not by those who had lent money to the banks but by taxpayers.

 

All across Europe, austerity measures have been imposed on electorates to pay for the cost of bailing out banks. And the banks were bailed out because the social and economic cost of allowing them to collapse was deemed too great. Yet, apart from some exceptions in Greece, for the most part the bondholders who lent to the banks have not had to take haircuts on their investments. They have been paid while the taxpayer swallows job losses, pension cuts and cuts to services. No wonder people are angry.

 

A lesser known part of the post crisis reform plan is for bail in debt – the idea that in future, if banks fail, it is the bondholders who should pay, not the public. This is what would happen in the event of a normal insolvency, but banks are not normal businesses. Because of the economic necessity of the payments service and the social necessity of protecting savers, they usually have to be kept going in some form. In 2008 this was by means of a huge taxpayer injection of capital. The idea is that in future, the debts to the bondholders should be turned into shares so that in the event of a crisis, the investment houses come to own the bank to which they lent money.

 

Will this work? Some who have given evidence to the Banking Commission doubt it. They say that investors would “run for the door” in the event of a crisis rather than owning shares in a damaged bank. Others say you have to ban other banks from owning such debt or in a crisis all the damaged banks would own one another and we’d be no better off. But other witnesses such as RBS boss Stephen Hester have said that in future all bank debt should be “bail-inable” to remove the implicit taxpayer subsidy from banks and to ensure that those who lend money to banks pay more attention to how they are run.

 

Bail in has been mandated by the international Financial Stability Board. The leader of that body has just been announced as the new Bank of England Governor. Bail in is supposed to be taken forward in Europe through the Resolution and Recovery Directive. And Paul Tucker, the Deputy Governor of the Bank of England, told the Parliamentary Banking Commission last week that if agreement could not be secured on this in Europe, he believed the UK should go ahead anyway.

 

Amid the sometimes quasi-theological discussion of ring fencing and separation it can be easy to lose sight of what reform is really aimed at. Reform is, at least in large part, to ensure that bank failures are less likely and that if they do happen, it is not the taxpayer who is left on the hook for businesses deemed “too big to fail”. There is more of course like lending to the real economy but a fairer distribution of losses is an essential change if we are to deal with the morally and economically wrong position of profits being privatised and losses being socialised.

 

 

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2 Responses to “Banking reform – time to stop privatising the profits and socialising the losses”

  1. John Stott says:

    Isn’t it bizarre how people change their tune when in opposition? In 2008, I used to work for a company whose Chief Executive stole a week’s worth of staff wages across the company, a months worth of trade union subscriptions and a month’s worth of credit union and pension contributions. He sent the administrators in and used the money he had stolen to help buy back certain parts of the business he liked and then consigned well over a thousand people to the dole. The taxpayer had to pick up the tab in terms of redundancy payments and a protective payment award for those who lost their jobs, whilst the company directors crowed to the local press about how the ‘new’ company was now making a profit. It even turned out that the company had been planning this some three years prior and had been given advice at that by the same administrators, who then facilitated the closure of the business. The whole thing was rotten to the core.
    The trade union I belong to, in addition to a clutch of MPs attended Westminster to meet with Mr McFadden, who was a government minister at the time. We informed him of all of this and asked for a government inquiry into the conduct of the employer. We also lobbied Mr McFadden to bring about a change in the law regarding company director responsibility. Despite all the evidence we laid out before him, he didn’t want to know. He even went as far as to applaud the employer for the jobs he had ‘saved’ within the business. The taxpayer wasn’t his concern back in 2008. He didn’t give a damn that they were footing the bill for corporate theft and irresponsibility.
    Curious how he’s concerned about the taxpayer having to pay for bank bailouts and job losses, now that he’s in opposition.

  2. Pat McFadden says:

    Thanks for your comment John though I believe you have misunderstood the point I am making in the article. This is not a conversion of view between Government and opposition. the point is that banking insolvency is treated completely differently from insolvency in other companies. If memory serves me right the meeting we had was Sayers the bakers. It was a “pre pack” administration. You’re right that these can be controversial because they involve some kind of management takeover but the judgement in an insolvency is always what can preserve the most jobs. I reject your charge that I was dismissive of the anguish caused by job losses in this or any other closure and asked officials if the insolvency laws had been broken in this case – their answer was they had not. The issue in banking is different precisely because normal insolvency rules don’t apply to banks. People’s savings, current accounts and the payments system are all deemed so crucial that takeover over the course of a weekend or taxpayer bail out have traditionally been the only policy options available. The point about bail in debt is to try to make bank insolvency more like insolvency in other industries. And that would mean debt holders bearing their share of the burden. The point about privatising profits and socialising losses is not just my view or a change of heart in opposition. It is an important part of the Vickers Report into banking failure, is part of the Liikanen report into the same issues in Europe and indeed Mark Carney, they newly appointed Governor of the Bank of England said recently in a speech that “we must address, once and for all, the unfairness of a system that privatises gains and socialises losses.” That is precisely the aim of treating bank insolvency more like insolvency in other businesses.

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