Banks are like students in an examination room

by R. T. Luke V. Browne Fri, Oct 26, 2012

The economic historians say that financial crises have occurred at roughly ten-year intervals for the last four hundred years. You may know that Japan recently endured a decade of slow economic growth as a result of a real estate crash. Norway, Sweden and Finland experienced — in the late 1980s and early 1990s — banking crises created by problems in their respective real estate markets.{{more}} There was a time, remember, when slaves were “property” or “real estate” and we are told by Eric Williams in Capitalism and Slavery that the rise of banking in Glasgow (or London or Liverpool or Bristol or New York or New England for that matter) was intimately connected with the slave trade. Alexander Houston was one of the greatest West Indian merchants during the late eighteenth century in the city of Glasgow and a banker whose firm at one time prematurely anticipated the abolition of the slave trade (which is different from the abolition of slavery) and therefore “speculated on a grand scale in the purchase of slaves.” The abolition bill failed to pass at that time and the large number of slaves Houston owned “had to be fed and clothed, their price fell heavily, [and] disease carried them off by the hundreds.” Houston’s firm crashed in 1795 as a result and the crash was regarded as the greatest financial disaster Glasgow had ever seen.

Then there is, of course, the world financial crisis that began in 2008, which is now known in some quarters as the Great Recession, and which resulted from the bursting of the housing bubble in the USA. A housing bubble is akin to what we might call the “slave bubble” which was just described. Americans for some reason expected house prices to keep rising forever and built up their financial system on that belief. The tremendous 62 per cent increase in home prices between 1999 and 2005 reinforced the belief. The idea of ever-increasing house prices meant that bankers were more willing to provide mortgages for the purchase of homes to even high risk borrowers and to supply home-equity loans which were the basis of the debt-financed consumption binge that sustained the American economy. The banks abandoned lending to small and medium-sized businesses, which are the basis of job creation in any economy, and rushed into the mortgage market where they expected to reap above-normal returns.

The bankers apparently didn’t pay attention to the fact that notwithstanding the dramatic rise in house prices, (which should have meant that the value of a property would have always been higher than the value of the its mortgage), household income-which is what really dictates an individual’s ability to service a loan–in 2005 was significantly lower than household income in 1999.

Americans were encouraged to take mortgages that they basically could not afford by financial agents whose compensation packages depended only on the number, and not on the quality, of mortgages they sold. These financial agents, in many instances, pressured appraisers to over-value properties to justify bad loans. Some mortgages had temporarily low repayment rates which suddenly spiked. Other mortgages required periodic refinancing with a new set of fees at each refinancing. There were even mortgage arrangements that resulted in borrowers owing more at the end of a year than they owed when the year began. All was well once house prices continued to rise.

The banks and related financial institutions financed the mortgages and home-equity loans with money from the Federal Reserve and overseas investors. These financial institutions generally paid for their investments with heavy borrowing (high leverage) which carried significant risks but developed accounting innovations to hide this fact. The banks sometimes sold mortgages to investors who were often misled by the inaccurate safety certification given to the mortgages by rating agencies that were paid agents of the bank. The bank was principally concerned with the maximization of short term returns (as reflected in stock market prices), and to which the salaries of executives were tied, even if it meant the imposition of arbitrary fees on borrowers or circumventing regulations, accounting standards and tax rules.

The price of houses finally plummeted, against the national expectations, just like the price of Alexander Houston’s slaves. Mortgages went underwater (which is where the homeowner owes the bank more than the value of the house) and there were serious economic consequences.

The financial system was obviously poorly regulated, largely as a result of the actions of the banking industry lobbyists and their friends in high places who campaigned ceaselessly for deregulation with what Bill Clinton called a baseless “30-year anti-government rant”. These lobbyists won a lax regulatory environment that allowed the banks to get away with the sorts of transgressions already outlined. There was a deficient regulatory framework to begin with and the few “regulators” that were appointed were often former heads of the institutions they overlooked, and this gave rise to the perception that the bank was regulated by the bank.

America should have paid closer attention to the exemplary mortgage system of Denmark which has withstood the test of time. The world should have learnt an important economic lesson from the quarter century which started at the end of World War II. There was a twenty-five year period of relative global financial stability between 1945 and 1971 when there were strong regulations that were effectively enforced. Brazil was the only country to experience a banking crisis in that period. Spain’s comparatively strong financial regulations helped to prevent a total economic calamity in that country after its own real estate crash of 2008. Canada and Australia are so well regulated that they have never experienced a crash in the first place. A principal lesson from economic theory and world history is that banks need regulators, just like students in an examination room need invigilators and our nation needs law enforcement officers.

Mr Jomo Thomas pointed out the anti-working people nature of the American government’s response to the financial crisis (its bailout policy) in one of his Plain Talk columns. There was no rescue plan for the homeowners who fell into trouble as a result of the crisis or for individuals who became unemployed. The “Occupy Wall Street” protesters put it aptly: “The banks got bailed out, we got sold out.” Corporations and their top executives, and not the poor and indigent, are the greatest welfare recipients in the United States of America.

JP Morgan Chase, a company that has been tied to the financing of slavery in the United States, was a major beneficiary of the Federal Reserve Bank’s generous bailout help. Citibank, America’s largest bank before the financial crisis (with assets of nearly $2.36 trillion in 2007), and which was a proud supporter of apartheid in South Africa, was saved time and time again.

The bankers are like the “overgrown West Indians”, or wealthy planters, who were pleading distress and throwing themselves on the mercy of Parliament in the eighteenth century, so that they could continue to “roll in their gilded equipages through the streets of London” at the expense of less fortunate people in the Americas (see Capitalism and Slavery). “What would we say to a man who should ask our charity in an embroider’d coat?” What would we say of a world in which the social and economic inequality that characterized slavery and apartheid has not disappeared? What would we say of a people who have not learnt the importance of financial system regulation from international economic history?