A grizzled American academic visited us last week to deliver some telling insights on the state of high finance to the banking inquiry currently taking place in the Oireachtas.
Professor Ed Kane of Boston College originally coined the term ‘zombie banks’, but it is pretty clear that he regards much of the current regulatory system as more than a little inert. Prof Kane, with his flat, unvarnished accent, could have stepped straight out of the set of the 1950s film On the Waterfront. The film, starring Marlon Brando, dealt with the thuggish practices of criminal types controlling the docks. Prof Kane had the somewhat weary look of an overworked, chain-smoking union official, but there was nothing tired, or tiring, about his testimony.
The expert witness drew an analogy between the financial markets and the roads. In his view, our bankers ignore the financial rules of the road, leaving chaos in their wake.
As he put it, “something must be done to sanction the reckless pursuit of subsidies in ‘too big to fail’ firms. It is a form of criminal theft.”
We may believe that we are simply dealing with the wreckage left over from the sub-prime excesses and the property and loan bubbles of the noughties. Prof Kane’s view, however, is that new fires are being lit beneath the façades of our current financial system. “People are still figuring out how to fleece the taxpayer,” he says.
His particular target are those ‘too big to fail’ institutions which, if anything, have become even more powerful in the wake of a crisis which has resulted in the consolidation of institutions.
These are the organisations which, by dint of size or sheer complexity, cannot be let go because to do so would cause so much disruption to the wider system. In Ireland, we have been left with a Big Two, considered essential to the running of the economy, enjoying the lion’s share of whatever banking is being carried out across the State.
Prof Kane is interested in the Irish experience, one where the taxpayer bailout has broken records, but he is inevitably a little sketchy on the detail. To the embarrassed amusement of the gathered pols, he repeatedly referred to Anglo Irish Bank as ‘AIB’. The ghostly shadows of Seán FitzPatrick and David Drumm could loom over AIB Group when attempts are made to bring this particular banking piggy to market — the Irish taxpayer will be counting on a particularly energetic exercise in selling as he or she sets out to recover their multibillion-euro enforced investment.
Prof Kane warns of a “continued corruption of the culture of regulation in the US and Europe”. The ‘big guns’ are being given the benefit of the doubt when it comes to calculations as to their solvency.
“Regulators are afraid to be accused of escalating a bad situation so instead, they cover it up,” says Prof Kane.
The suggestion is that what has occurred is a form of ‘regulatory capture’ where implicit guarantees regarding funding structure are being provided.
“A passive policy of forbearance is allowing these institutions to roll over exposures,” he says, citing the 2008 example of the US-based AIG — “the closest parallel to Anglo, except that it was never nationalised”.
By and large, those financiers running huge risks and exposing taxpayers to huge losses have not been punished, but rather, are “treated as a kind of high priest where merely being shamed is punishment enough”.
Prof Kane has a number of concerns about the system as it currently stands. Activities in the swaps markets make him very worried. Financial institutions are subject to capital requirements, but accounts are subject to ongoing manipulation.
“Troubled banks tend to bring gains forward and push recognised profits out into the future while the value of things is overstated,” he says. “By and large, when a firm is recognised [by the external auditors] as insolvent, it has been insolvent for a long time. The basic problem about regulatory culture is that banks are given benefit of the doubt.”
Prof Kane is associated with the Institute of New Economic Thinking. In a recent interview on its website, he also points to the dangers posed by the rise of so-called shadow banking, where substitutes have been created for products and activities carried out in the traditional banking sector. In other words, where regulators threaten to be effective, the players retreat into the shadows.
In this interview, he concludes that, in practice, in supervisory terms, we are back to where we were before the collapse of Lehman Bank in 2008. In his view, the 2010 Dodd Frank Act, passed by the US legislators, lacks real bite and cannot be compared with the Glass Steagall Act which transformed regulation during the Great Depression. The change compared with 2007/8 is that the procedures are different. The system, however, remains intact. US taxpayers are still at risk while bankers engage in profitable, but risky, activity in the swaps markets.
He goes as far as to suggest that the Federal Reserve is lending indirectly to dodgy institutions via the swaps market. In his view, the US taxpayer will end up as the ultimate guarantor of the system, being the only country with the necessary resources in a crisis. He is sceptical about the ability of the ECB to come up trumps in a crisis.
“The ability of the ECB to absorb losses is limited by its ability to recapitalise itself,” he says. “The aspiration of European unity has run ahead of the institutions which are supposed to embody it.”
Prof Kane has a number of remedies for this fraught situation.
Returning to his traffic law analogy, he is keen that risk-taking bankers be treated in the same way as those who repeatedly infringe the rules of the road, with the application of a series of penalty points resulting in a removal of the licence once a particular points level has been reached. “The idea is to persuade bankers from driving at excessive speeds and engaging in dangerous turns,” he says.
In response to a question from senator Marc MacSharry about the separation of functions as between a central bank and specialist reguialtory body, Prof Kane favours such separation on the basis that central banks can never be single-minded regulators. However, he recommends the appointment of outside private trustees to the boards of a regulatory body.
Of particular concern is the fact that regulation on a cross-country basis remains quite incomplete, leading to risks of the sort taken by AIG where the US taxpayers were left exposed by the activities of a French subsidiary operating in London.