The Banking Industry: A Moral Hazard

April 15, 2008
By

Global Credit Crunch
Those who know me know that I have a lot of vitriol for bankers. As an industry, they have their “New World Order” in the palm of their hands….or if you look at it from the working man’s perspective…our democracies by the gonads!

Through hedge funds and lending to Ninja (no income no job no asset) borrowers, which is highly irresponsible, they managed to make their banks billions of dollars which gave each “successful” banker a million dollar bonus or more.

Banks have historically been in a great position. Countries compete for their services by promising them deregulation and tax cuts…or should I say “business welfare.” This push towards the far end of the neoliberal spectrum is taking its toll on the tax payer and it will eventually end in higher taxes and the selling of our countries as the banks need to be bailed out. In the UK we have socialized Northern Rock…a massive bank at a cost of £1800 ($3600) for every person in the UK. The UK is one of the most exposed countries to this crisis because of our record levels of debt.

We would never run our households this way…then why do our politicians allow it!!?? They know they have to have bankers on their side because they provide them with campaign funds…According to Carrol Quigley, bankers hold the power and have done since the days of Andrew Jackson. Jackson’s epitaph reads, “I killed the banks!” Ironic, isn’t it!

You can see my vitriol and anger! The rich will not be as affected by the financial mess as those who they have preyed upon. And it will be the responsible members of society who will have to bail out both the banks who are taking huge losses and the individuals who declare banckruptcy.


No other industry privatises the profits and socialises the losses as much as the banking industry

What we are seeing at the moment is socialism/fascism for the rich and free markets and coercion for the rest. Recent examples of this socio-fascism being; a centralised meeting last week between the G7 and world bankers, Gordon Brown having breakfast with Bankers, and Bernanke promising bankers that the US tax payer will take the bad loans off of their books. No other industry is socialized in such a way except maybe the “Defense industry”.

Greed and corruption are rampant in a sector that doesnt even produce anything except fiat currency!

Inspired men and Holy Books of the world might have some guidance on this subject.

Both Aristotle and Plato condemed Usury. 1 Timothy 6:9-10 reads:

People who want to get rich fall into temptation and a trap and into many foolish and harmful desires that plunge men into ruin and destruction. For the love of money is a root of all kinds of evil. Some people, eager for money, have wandered from the faith and pierced themselves with many griefs.

Why is it then that the rich who fall into temptation by their greed and prey on the poor and needy are bailed out by others which negates the natural consequences that should come according to this scripture?

In a world where our temporal and spiritual lives are interlinked and our ultimate goal is to have a society such as Christ instituted in the New Testament and Book of Mormon, a society where all things were in common and there were no poor among them…why are we so far off and what should we do to move in this direction?

Wikipedia defines Moral Hazard as:

the prospect that a party insulated from risk may behave differently from the way it would behave if it were fully exposed to the risk.

The behaviour of banks over the last few years, which I am sure would change if they knew the government wouldnt bail them out everytime their greed got the better of them, has been “morally hazardous”. The government and the “private” banking industry are so tightly interconnected that I do not see our “democractically elected” (please sense my extreme sarcasm) politicans ever changing this relationship of convenience.

I wonder if the City of Enoch had similar challenges? ;-)

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32 Responses to The Banking Industry: A Moral Hazard

  1. April 15, 2008 at 6:13 am

    This is silly.

    Bankers are not evil and neither are banking or banks.

    And neither are butchers and bakers and candlestick makers. (Or plumbers, or lawyers.)

    I shudder to think of the economy that you would foist on the world if you were in charge!

  2. April 15, 2008 at 6:32 am

    John F. “is a corporate lawyer focusing his practice on cross-border transactions, finance and corporate law.”

    AH HA!!! I see we have an expert on why the global financial state is in such a mess… ;-)

    Perhaps you could tell us what you and your colleagues are doing to solve the situation they have created ;-)

    I also doubt that you have even read anything I have said considering your scant and derisive reply.

    I do not intend to “foist” any economy on anyone but would like to see the poor provided for and a more equitable distribution of wealth not the corporate “private tyrannies” we have today. I believe in voluntary cooperation and think that people should be responsible for their actions.

    I can honestly say that I do not work to directly perpetuate this socio-fascist system…something I am proud of and something that allows me to sleep at night.

    Please critique what I have said and add something substantial Johnf as I am sure you are more articulate then the first reply makes out.

  3. April 15, 2008 at 7:26 am

    You are misquoting me JohnF…I never said they were evil…

    I said that their current behaviour is morally hazardous.

    There is a difference.

  4. John Nilsson
    April 15, 2008 at 7:57 am

    Stephen,

    I agree with some of what you say, but I see banks as performing a different function than other for-profit corporations. Banks take everyone’s money and promise to make them more, as well as serving as creditor to those wanting to start businesses, etc. The riskiness of an investment decision is always a judgment call, not a science, although the Ninja loans are inexcusable and exploitative. The Federal Deposit Insurance Corporation was set up by FDR to prevent things like all of the bank failures which were one prime factor in throwing the U.S. into the Great Depression. Ordinary folks’ savings were wiped out.

    So how do we protect those that can’t protect themselves? Regulation of the industry, I suppose. Weren’t Ninja loans against internal banking policy in the first place?

  5. April 15, 2008 at 8:44 am

    Stephen,
    What both Johns said. There certainly are moral hazards associated with banking (as there are with blogging, with attorneying, with accountanting, with teaching, and with just about any other profession you can have).

    However, in your post you’re conflating a lot of unrelated concepts (for example, hedge funds have been helped, and even invested in, by investment banks, which are not the same as banks making loans to individuals, although hedge funds and investment banks both bought into the securitized loans as investments).

    Furthermore, and scripture notwithstanding, the modern economy wouldn’t work without banks or interest. Even practicing Muslims, who cannot pay or earn interest, are forced to use elaborate structures to replicate the returns of interest in order to, for example, purchase a house. And it’s really hard for them to go to college (there is apparently one Islamic banking association that has figured out a way to structure around school loans, but it’s not a widely accepted solution).

    There is plenty wrong with banking and bankers, but most of them (except for perhaps the CEOs) do internalize the economic risk inherent in risky business (as in, the many bankers I know who have lost their jobs or received low bonuses, where the bonus is the primary aspect of their yearly income). There is moral hazard, yes, but your vitriol against phantom bankers distracts from the real, and improvable, problems with the system.

  6. Dan
    April 15, 2008 at 8:54 am

    Bankers are still blind to the mess they created and are heading to Big Brother to drag them out of their own mess. Soooo ironic for the John Galt admirers. Atlas shrugged eh? It seems that that atlas is not really being held up by the big boys of capitalism, but instead by the state, as usual. Joe Taxpayer once again is the safety net for the rich boys.

  7. cadams
    April 15, 2008 at 10:14 am

    I see coming up a new fulfillment of the Book of Mormon prophecy of slippery treasures (Samuel the Lamanite). The imaginary fiat currency going down the tube, our financial Frankenstein.

  8. April 15, 2008 at 10:24 am

    #4 – John Nilsson..great reply. I am pretty sure NINJA loans were not illegal but a result of deregulation. The problem is that as soon as you put regulation on banks they find ways of getting around the system or move to another country that promises deregulation and offshore tax-free status.
    An example of bankers getting around the system are called Credit-Default Swaps which are also dangerous in this time of economic turmoil.

    As you know my hopes for the future are idealistic…I think regulation is a must have at the moment and in the future as a countervailing force to this excessive greed. When talking about regulation, it looks like Hedge Funds were the first on the radar here in the UK according to Martin Wolf at the Financial Times.

    #5 – Sam B….thanks so much for the comment. It is great to have someone who knows more about these things then myself discuss them and enlighten us.

    “Hedge funds are not out of my “vitriol” in this post. Hedge funds came under heightened scrutiny as a result of the failure of Long-Term Capital Management (LTCM) in 1998, which necessitated a bailout coordinated by the U.S. Federal Reserve. Critics have charged that hedge funds pose systemic risks highlighted by the LTCM disaster.” (Wikipedia) This is another example of the socialism for the rich which has angered me.

    And according to a recent BBC Documentary called “Super Rich:The Greed Game, Terry Smith, a borker for Tullet Prebon said, “They are not regulated and in offshore jurisidictions.”

    I completely agree that the modern economy would not work without interest rates…but lets not forget who wrote the rules of this game and who continues to write the rules of the game. The FSA (Financial Services Authority) in the UK, the very same people that are responsible for Northern Rock are being regulated by THEMSELVES…..masterstroke of genius.

    The rules need to be rewritten…

    Interestingly a cooperative bank in Sweden called JAK, feels that the economic instability is a result of the taking of interest.

    JAK operates under the following premises:

    -The taking of interest is inimical to a stable economy
    -Interest causes unemployment, inflation, and environmental destruction
    -Interest moves money from the poor to the rich
    -Interest favours projects which tend to yield high profits in the short-term

    As unrealistic as instigating anti-usury legislation might be at the moment considering the velocity of the current unsustainable system…it could be the purging that brings about a system that is founded on cooperation rather than greed.

    Thank you for correcting me Sam B. on focusing solely on bankers and lumping them all into one pot…I am just very angry at the moment considering the financial situation of things and the way no one at the top seems to be resonsible. I do disagree that this is just a fleeting apparition…it is something that plagues our society and needs to be scrutinized and solved. So on the conclusion that a solution must be found, I hope we can agree…though our means and end results might differ.

    #6. I concur wholeheartedly.

  9. April 15, 2008 at 10:25 am

    #7- Interesting point you raise…I have never looked at that passage from that angle.

  10. April 15, 2008 at 10:56 am

    Stephen,
    You’re right that hedge funds potentially pose a risk; if I remember right, LTCM was leveraged by a factor of 40 or 60 (meaning for every dollar the fund had from investors, it borrowed 40 or 60 dollars). Then it made a really bad bet. But that bailout, again, if I remember correctly, was actually funded by most of the big banks, probably with help from the fed, on the theory that, without a bailout of some sort, LTCM’s collapse would collapse world markets. (I was still in college when all of this happened, and I wasn’t at all interested in financial news at the time, so I don’t actually have any way to verify the fact or the impression.) It’s the same justification that the fed used to inject money into JPMorgan’s takeover bid for Bear Stearns, and the same justification it uses for subprime mortgage relief. I’m not convinced the fed is right about Bear or about mortgage relief, and I have no idea about LTCM.

    I’m actually all in favor of better (and maybe tighter) regulation, although what is currently on the table is worse and looser regulation. But most of the people who work as bankers are not worse people than those who don’t work as bankers; a good portion of them are graduates in English or Spanish or finance who discovered that there are limited numbers of jobs in the real world using their skills, who want to make a very comfortable living, and who need to do something before business school. There are, of course, bad people in banking, and banking can make otherwise good people bad. But I know a lot of really good people in banking (although I suspect they were good before they were bankers; while I don’t have any reason to doubt that banking can make an otherwise bad person good, I can’t say that I’ve seen that happen).

  11. April 15, 2008 at 10:59 am

    Oh, and a lot of hedge funds are organized offshore, often in tax haven jurisdictions, but a whole lot are also organized in Delaware and, I’m sure, other states as well (I’ve seen one organized in California, I know of one in Minnesota, and I’d be surprised if there weren’t any number in any given jurisdiction). Basically, a hedge fund is just a partnership or limited liability company through which people pool their money, which money an investment manager then invests. In and of themselves, they are neither good nor bad; they’re just an investment instrument, with both advantages and disadvantages as compared with mutual funds and direct ownership of stocks.

  12. April 15, 2008 at 11:13 am

    Sam B. You are very right in your correction of the title and content.

    My sister is a banker and I know she is not a bad person but the system that has been built over years needs strict regulation and equity just as, like you say, other industries seem to have…I just get so tired of this extralegal activity that seems to pervade through the defense industry and banking sector.

    Thanks for all the background…great stuff Sam B.

  13. April 15, 2008 at 11:41 am

    Actually, if you’re interested, Robert B. Reich’s book Supercapitalism discusses the rise in the monster capitalism we see today (he traces it largely to changes in technology starting in the mid-70s), and his suggestion for how to tame the beast (that is, not ask companies to play nice; he thinks that, in today’s world, the extraordinary pay of CEOs is both justified and necessary from a business perspective. Rather, he says, we need to separate the business from the political, and use the political realm to regulate). It’s a great book, and Reich was the Secretary of Labor under Pres. Clinton, and now teaches public policy at UC Berkeley.

  14. Jeff Spector
    April 15, 2008 at 12:12 pm

    The banking industry, like most in the US, is totally self-serving. They provide their services with one purpose in mind, maximize corporate profits and their own salaries. It is not a charity and does not have a charitable bone except to promote its agenda.

    They are capitalists when making money and keeping profit, but are socialist when hit with failure (can you say: Bailout?). They are in bed with government because government recruits them to run the monetary system.

    Economic laws of supply and demand and basic capitalistic principles (can you say capitalistic and principles in the same sentence?) cannot operate when so much regulation, manipulation and glad handing as an endemic part of the system.

    Tear the system down!!!!!!

  15. April 15, 2008 at 12:27 pm

    See, Jeff, Reich looks at the system in a similar manner as you do (sans the capitalist-socialist rhetoric), but his prescriptions may actually have real-world impact because he does an excellent job of describing, in value-neutral terms, and stating real and possible solutions, rather than making extreme claims that are both not terribly accurate and turn off both those invested in the system and those with knowledge of the system. “Tear the system down!!!!” not only will not, in fact, cause any change, but, if spoken loud enough, will tar the agenda of those who sincerely want to improve the system. Although I’m in favor of better regulation of the financial sector, if my two choices are the guy saying the system is evil and let’s destroy it or the person who says, it works, don’t touch it, I have to choose the latter, even though the best solution is somewhere in the middle.

    That is, you can be liberal and still in favor of constructive solutions. If being liberal means solely to tear down what is there, I can’t align myself with such liberality.

  16. Jeff Spector
    April 15, 2008 at 1:07 pm

    Sam B,

    “Tear the System Down” was merely a nod to Steve. I am realistic that that kind of change will not happen. However, when you have the fox guarding the hen house coupled with the apathy of the American voter and the headlock that the financial industry has on the US government and its politicians, it is hard to imagine a scenario where it gets fixed.

  17. April 15, 2008 at 1:39 pm

    lol…I acknowledged the nod Jeff. Made me laugh. Mike Gravel thought the same as you Jeff…whilst running for President he was honest and acknowledged that he didnt know how to decorporatise politics.

  18. Jeff Spector
    April 15, 2008 at 1:51 pm

    My run for President was equally short-lived :) :)

  19. drew terry
    April 16, 2008 at 12:33 am

    Back to December 3, 1907, when the New York Times ran this story: 
     
    BANKERS DISCUSS CAUSES OF FLURRY: Due To “To Great Expansion Of Enterprise” says Jacob H. Schiff 
     
    Nash Advocates A Central Bank – William A. Nash, President of the Corn Exchange Bank, New York City, said in part: “The fact that the Government bank was used by President Jackson for political purposes should not close our eyes to the importance of now re-establishing such a bank, purged of many of its then evil features, and surrounded by reasonable safeguards and legislation. I do not propose to enter any details as to the plan of a central bank and only give an outline. This central or Government bank should be owned JOINTLY by the Government and the National banks. The Secretary of the Treasury and the Controller of the Currency should be represented on its board. The Treasury funds should be deposited with the central bank and the Government bank should have power to issue NOTES in certain proportion to its gold reserves or capital.” 
     
    “As it is likely that the sole right of such NOTE issue would be opposed by our National banks, and any radical plan for a Government bank would probably not pass Congress at present, an alternative plan has been admirably developed in an article lately published by Mr. Paul M. Warburg, a banker in New York, under the title, ‘Plan of a Modified Central Bank.’ This appears to me the most practical of all plans yet suggested, as it provides for a Government bank limited chiefly to transactions with the Clearing Houses of the various cities. The bank is to deposit funds with the Clearing Houses and National banks against United States bonds and other approved security as well as commercial paper and bankers’ bills with proper margins.”

    http://www.greatreddragon.com/commentary/080329_1907191320072013.htm

  20. Dan
    April 16, 2008 at 4:11 am
  21. April 16, 2008 at 4:38 am

    Great article and analysis Drew. thanks for that.

    Dan….thanks for the heads up. It is obscene. Where does this money they make come from….tax payers? Other companies? Or is it the money that people made with the inflation in housing prices in the UK…some houses that were worth £200,000 10 years ago are now worth millions. I dont see where it can come from so quick…almost like monopoly money.

  22. Dan
    April 16, 2008 at 7:51 am

    Stephen,

    Most of that money comes from correctly predicting how the market was going to go. They were betting on futures and they won big. For example, one way to make a gazillion dollars is to have predicted that Bear Stearns was going to fall. You short their stock, say, 5,000,000 shares at $50 a share. That’s a hefty chunk of stock to have borrowed and sold hoping it would fall. But you bet that it would. And in this case it fell, to $3 a share at its lowest point. You sold 5,000,000 shares at $50 a share and now buy it back and give it back to Bear Stearns at only $3 a share, pocketing the difference. You sold it for $250,000,000, and you bought it back for $15,000,000. You just made $235,000,000 just like that.

  23. Peter Brown
    April 18, 2008 at 8:53 am

    Stephen, I came late to the game, but of the overarching problem I have with banks is that they are outside the purvey of regulation. Archtects, attorneys, doctors, butchers, etc. are in the system. The United States Constitution states that we the people have the power to print money. We gave that power away to the Federal Reserves in 1912, and correspondingly, our power. People who don’t realize this have their heads in the sand. The Fed chiefs all look innocent enough, but I believe they have institutional control over the Treasury and the IRS, both of which are traditionally above the law in the courts. If everyone wants a fascinating treatise on this, go see Aarron Russo’s From Freedom to Fascism. It’s a very convincing expose on the IRS and the Fed.

    I think bailouts make the problem worse. Markets should be allowed to fail, people should lose their homes. The market will correct itself. I’m an uber free market guy. I believe in it. What the “industry” does, however, is practice corporate socilism in order to be outside of the risks of the free market. The rest of us do not have the luxury. The manipulation of the rate by the FED right now will not help America, it will make us poorer as we inflate and fewer of our dollars will pay for goods (they will become slippery). The rates are meant to keep the money rolling into the investors so they won’t lose their investments, investments which were BAD, based on brokering and not on the fundamental soundness of the investment.

  24. Derek P. Moore
    April 18, 2008 at 12:41 pm

    “From Freedom to Fascism” is full of lies and false connotations. I cannot say that the filmmaker did this intentionally, he is probably just misled like so many others. But the movie does seem a lot like entrapment to me (if you follow some of the suggestions from this movie, and especially from the wider “show me the law” movement, you can no longer legally possess firearms, etc.).

    In this country we have case law, so even if there weren’t something in the U.S. Code which deems us culpable for our income taxes (which there is), then there is also case law and court rulings supporting the enforcement of IRS codes and the income tax and the IRS’ and the court’s definitions thereof.

  25. April 20, 2008 at 7:32 am

    #23 Peter…I really do empathize with you on this one. I agree with your second paragraph but the problem is that the poor people will suffer the most from the greed of the corporate intelligensia. But I see it as a purging process but it will need to change permanently and become regulated by the people. In my mind, corporate structures need to be replaced with more horizontal structures like cooperatives.

    #24 Derek…I have watched Freedom to Fascism many times and love it. I think the history it gives of the Federal Reserve system, the battle of Andrew Jackson with the banks, the Jekyl Island meetings etc are all historically essential for the working and middle class to know. These people really are “outside” the capitalist machine. Nonetheless I agree that there are inaccuracies in the film. The court case of Sullivan v. United States needs to be mentioned.

    My problem with income tax and other taxes is that it is complusory and that the tax system is not transparent with about 50% of US taxes going to the defense industry and the development of weapons which are sold to other countries to protect dictators and promote war. I enjoyed the recent story I read of a Methodist Preacher and his wife refusing to pay taxes because they knew their money was being used in an illegal war in Iraq. They didnt use public services to stay on the moral highground. I admire them and wish there were more people in the world who would unite to do this. This would be a huge wake up call to the fascist elite.

  26. Peter Brown
    April 20, 2008 at 11:16 am

    “I really do empathize with you on this one. I agree with your second paragraph but the problem is that the poor people will suffer the most from the greed of the corporate intelligensia. But I see it as a purging process but it will need to change permanently and become regulated by the people. In my mind, corporate structures need to be replaced with more horizontal structures like cooperatives.”

    Well, let me amend. I’m for free markets. but if we had coopertive safety nets, other than govenment ones, the free market failures (which there are many) would bypass the typically hazardess reasons why socialists showed up in the first place. To refine this principle, I’m for free markets, I’m against corporatism. The biggest problem I have is how to translate this into them modern political dialogue. Anti-coporatism that isn’t socialist is so outside the mainstream that it has no political voice. Maybe you can direct me in your anarco-syndicalist/libertarian thought streams to public figures that believe the same.

  27. Derek P. Moore
    April 20, 2008 at 11:47 am

    Stephen Wellington :—

    Yes, the history lesson in “From Freedom to Fascism” is pretty accurate and well taught. I did appreciate this part of the movie very much.

    The problem with it for me were all the ridiculous “show me the law” scenes. The movie just seems to break down at that point, and if people follow that train of thought and research it, they’re also going to find and become susceptible to the “statehood” movement (for lack of a better phrase), which advocates revoking your federal citizenship to “legally” take yourself out of the federal income tax system and to fall back on your de jure State citizenship (e.g., I would “become” a Missouri citizen instead of a U.S. citizen if I followed their advice). I wonder how many naive Internet wanderers have sent off their request for revocation of citizenship after watching and researching “From Freedom to Fascism”.

    Don’t get me wrong, I haven’t filed my taxes in over 10 years. ;)

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  31. October 6, 2009 at 3:36 pm

    Hey Stephen – long time an’ all that! How’s the fam? :)

    Since the crunch I’ve been trying to get my head around economics – and the more I do, the more scared I become! It’s also opened my eyes to the genius of the law of consecration. The best analogy I can think of for money is blood: We can’t imagine life without it, but ultimately it’s the death of us and the perfected form of economy does not require it. When it comes to banking though, our greatest problem is not finding a solution to the money supply problem (i.e how much money should there be in an economy at any given time). That’s currently determined by bank lending, which has been recently demonstrated to not be an ideal solution…

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