Monday, August 9, 2010

Credit Crunch Short Report 3 Years on

plus ça change, plus c'est la même
Remember when markets were on the brink and banks had to be bailed out from imminent bankruptcy(credit crunch)? Remember when we could get joy from jokes like:
Q: What’s the difference between Investment Bankers and London Pigeons?
A: The Pigeons are still capable of making deposits on new BMW’s.

The credit crunch is getting bad isn’t it? I mean, I let my brother borrow £100 a couple of weeks back, it turns out I’m now UK’s third biggest lender.
It seemed the free market had finally hit its brick wall, requiring huge change. Step forward a few years and the major UK banks are back to what they are doing best at - making a hefty profit - a combined profit of £15bn hardly sounds like an industry in crisis - or an industry which needs bailing out by UK taxpayers.

There has been talk of regulatory reform along the lines suggested here - Free Market Fails - reforming financial sector. But, it has got bogged down in detail and the need for global co-operation. For example, the idea of tobin tax (tax on risky financial transactions) has been mooted, but, without strong international co-operation there is an incentive to switch business to those countries who opt out.


One legacy of the credit crunch is to knock off the excess arrogance of much bank lending. Gone are the days of lending huge sums without deposit or checks on income. Banks are being pretty strict about requiring deposits and proof of income. It is a return to the 'boring' banking of the post war period. But, it is this boring banking which is less likely to lead to a rash of sub-prime mortgage defaults from people who took out mortgages they could never repay. In a sense this was an essential if inconvenient change.

The irony is that by pursuing 'boring' banking the banks have been able to nicely improve their profit margins. Also, another cry is that banks are being too mean in not lending.

On the one hand, a restriction of bank lending threatens the recovery. On the other hand, banks need to avoid irresponsible lending they were making a few years ago.

Monopoly Power

One consequence of the banking crisis was the swift merger of Lloyds TSB / HBOS group. At the time, the government baulked at the idea of yet another nationalisation. The idea of a super bank with 30% of market share seemed the least worst option. At the time, it dealt with the crisis. But, the problem is that it led to an even more concentrated banking sector. (Monopoly Power banks) Banks have great power to set interest rates above the Bank of England base rate - another reason for their return to supernormal profits.

Moral Hazard

Another problem with the banking crisis and bailout is that the banks have not really suffered from their incompetence. In many cases, banks gambled. They lost. They got bailed out and they are back to making large profits. If banks are too big to fail where is the disincentive to try gambling on risky loans again? It seems if you are an investment banker, there is still a one way bet. In banking incompetence pays. Bailing out banks and moral hazard

Easy To Criticise - But, What to Do?

The lessons of the credit crisis is that you cannot trust banks to self-regulate. In the midst of a recession, it is not surprising banks return to better lending practises. But, people can have short memories. The shock of the credit crunch will wear off. Risky lending practises can easily make a return. There are still ways to avoid a boom and bust in asset prices / lending. Just because it is not straightforward doesn't mean that it shouldn't be attempted.


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