Basil Fawlty is now the bank manager

The
Money
Men II
Alan McIntyre on the roots of the crisis

This man is responsible for our economic collapse

There are two competing views of human nature. One is that human nature is fundamentally good. This optimism finds expression in the classical liberal view that if the government just got out of the way then everyone would be richer and happier as a result. The alternative view is that human nature is fundamentally flawed. This pessimism (traditionally associated with the utopian left in politics and the Roman Catholic Church in religion), finds expression in the paternalistic view that we need to be protected from ourselves. The broad role of government is to make us play nice for the common good – or in the case of the Vatican to save our eternal souls.
     The bankers of the world are now Exhibit A for the prosecution in the case against the traditional liberal viewpoint. Over the last 20 years we deregulated and globalised the financial services industry and apparently ended up breeding a generation of arrogant bankers who thought they were infallible. The direct consequence has been a financial services industry that has gone to hell in a hand basket, closely followed by the rest of the global economy.

So whose fault was it? By all means take Sir Fred's pension away. Good economic incentives like any good religious morality require heaven and hell to be truly effective. But let's not kid ourselves that we're surprised by the bankers' behaviour. Economic history provides absolute clarity that if you offer most people the opportunity to lawfully accumulate vast wealth, then they are going to jump at the chance. Indeed, if we accept that we want to live in a broadly capitalist economy, then this is exactly what we want them to do. Capitalism relies on profit signals to guide behaviour and as Gordon Gekko famously put it in the movie 'Wall Street', 'greed for want of a better word is good' because it helps ensure efficient resource allocation. The bankers of the last 20 years have simply been lab rats in the maze that governments and regulators have designed for them, figuring out the best way to maximise their personal income and amass power and status.
     That selfishness, while maybe distasteful to some, was at least predictable. The true scandal is that banking regulators (and the politicians who appointed them) allowed themselves to be seduced by the liberal view of human nature without realising that in the process they were taking the safety catch off weapons of economic mass destruction. When it comes to banking (and a small number of other pastimes such as nuclear energy generation) we forgot that the default setting must be to assume human frailty. This isn't because bankers are any more flawed than the rest of us, but instead because the banking industry itself is special and that uniqueness demands a different and more cautious approach to oversight and regulation.
     Banking is different from other businesses in at least three ways. First, it relies on huge amounts of trust and confidence to function effectively. As a depositor you give the bank your money and trust they will pay it back when you need it. As a banker, you trust that the vast majority of those you then lend that money to will also pay it back. If you want to understand the role of trust and confidence in banking just watch Jimmy Stewart as George Bailey in 'It's A Wonderful Life'. He stands behind the savings and loan counter in Bedford Falls stopping a run on the bank by patiently explaining that the angry depositors' money isn't in the vault, instead its in Bob's house, and Frank's house. Unfortunately, there was no George Bailey to stand behind the counter in every Northern Rock branch, only Alistair Darling standing behind the dispatch box like King Canute.
     The second unique aspect of banking is leverage. Banking has historically been about borrowing money to make safe bets. If you had £1 to put on an even-money sure thing in the Grand National you'd double your money if it won. If you instead borrowed £10 from your friend in the pub and added it to your £1 bet then you'd make £11, even after paying the £10 back. The problem is of course if you don't win, then you can't expect to have a drink with your friend without the question of the borrowed money coming up. The change over the last 20 years in banking is that rather than borrowing £10 for every £1 of their own money and backing sure things, many of the world's bankers were borrowing anything up to £50 at a time to bet on rank outsiders with a tendency to fall at the first fence.
     The final unique and dangerous aspect of banking is its interconnectedness. Money is not only a stand-alone business; it's also the lubricant that greases the wheels of the rest of the economy. Over time the world of finance has also become far more interconnected as capital flows have become global. The consequence has been that if one bank catches a cold, the rest of the financial industry sneezes and the 'real' economy can end up with pneumonia as the supply of credit dries up and the bankers try to save themselves.

What happened over the last 20 years is that regulators and politicians forgot that banking is special and started to treat it like any other industry. Through their tolerance for loose lending practices, higher and higher leverage, and a reliance on caveat emptor instead of active regulation, they allowed the whole system to over-extend itself to the point where one tug on a loose thread (in this case the US mortgage market) caused an evaporation of trust, a seizing up of the global financial markets and economic collateral damage from Beijing to Reykjavik. In the process, the banker as Captain Mainwaring from Dad's Army – pompous but ultimately conservative – has morphed into the banker as Basil Fawlty. The centuries-old reputation of Scottish bankers as canny risk managers has also been destroyed. Only HSBC, a Scottish bank in all but name, will survive this crisis with any semblance of dignity.
     The pendulum will now swing back. We'll relearn that banking is special and that it really isn't the right place to be experimenting with unfettered capitalism. But as we reregulate it's critical that we do so with intelligence and insight and try and avoid cheap political grandstanding. If you just redesign the maze the rats will figure it out pretty quickly. We need oversight that keeps pace with financial innovation and recognises systemic risk when it starts to appear. Specifically we need to accept that – as much as it goes against free market sensibilities – we need to be able to prick asset bubbles like the housing market before they get out of control. We also need to put in effective firewalls that prevent the propagation of the type of panic we've seen over the last couple of years when even the smart regulators miss something (as they inevitably will).
     Were the senior bankers of the last 20 years generally arrogant, over compensated, and deluded that their alchemy was creating real wealth? Absolutely. Were they malicious robbers of widows and orphans? Bernie Madoff aside, generally not. They were simply acting rationally and lawfully within the boundaries that had been set for them. The real blame lies with the governments and regulators who forgot that the rules of the game in banking need to be very different and – like the Vatican – the most prudent course is to assume the worst about human nature and act accordingly.

Alan McIntyre is a Scottish-born partner in a New York-based financial services company