Carry on banking: Stanford professor laments post-crisis approach to bank regulation

Regulators and politicians ‘coddle’ banks in the mistaken belief they are friends, a leading authority on global financial regulation told a Bayes Business School seminar last week.

Stanford University academic Professor Anat Admati argued that financial institutions have played a central – but largely ignored – role in the decline of democratic governance and accountability that has spurred populism across much of the western world in the last 25 years. Distorted incentives and weak oversight mechanisms, she said, allow key players in finance to undermine the rule of law, fuel public disillusionment and deepen the governance failures that sparked the 2008 global financial crisis. Little has changed since, she warned.

Professor Admati, who Time magazine named one of the 100 most influential people in 2014 after she co-authored the hugely respected book, The Banker’s New Clothes, said: “Banks are the most powerful lobby in Washingaton. Banking is political. You do not understand outcomes in banking without understanding the politics.

Politicians are always saying that banks have always been friends. No. The entire problem in banking is bad governance – including bad rules. That's why banking is problematic. It has very distorted incentives and very bad rules, and they persist. That’s the bottom line. Banks are special because of the privileges they’re afforded. They're very coddled, to the point that they don't even know how much they are (coddled).

Her presentation wrapped up a political economy research conference, which Bayes hosted in partnership with the School of Policy and Global Affairs at City St George’s, University of London, and the London School of Economics.

The safety net of support for banks, Professor Admati said, began with the Federal Deposit Insurance Corporation’s (FDIC) guarantee of bank deposits, a key part of President Franklin Roosevelt’s strategy to haul the United States out of the Great Depression.

“Since 1933 deposit insurance has provided an explicit guarantee so that depositors don’t have to worry (about banks’ risk-taking behaviour or corporate governance issues). However, the FDIC sometimes guarantees non-deposits too as the safety net is expanded. Sometimes that happens in a crisis with the Treasury coming in and acting as a sort of contingency fund that backs up risky investments by the Federal Reserve or other banks.

“If there's a risk and something does goes wrong, the government would pay. Of course, the government, the Treasury and the central bank are joined at the hip. Central banks are the power behind the throne. Normally, they're the lender of last resort. They give ‘liquidity’. This is a word that they love in banking. ‘It's all plumbing,’ they say. The government provides support. So there's a whole system that prevents default. Preventing default is a bailout. It's a bailout of the creditor.”

International agreements establishing banking rules, including those of the Basel Committee, proved “spectacularly bad” and actually increased the financial system’s frailty after Lehman Brothers collapsed, Professor Admati said. The committee’s work on new guidance in the years after the crisis has been little better, she added.

The sedating power of the 'stuff happens' approach

The Greek fiscal crisis of 2015 illustrated the ongoing failure of national and international regulators, governments and banks to learn the lessons of the global financial crisis seven years earlier.

“Most people involved (in the run-up to the global financial crisis) did not want to rethink. They just wanted to say ‘oh, stuff happens’ and pretty much move on,” she said.

Faced with the prospect of a second mega-bailout within a few years, the German and French governments pressured their counterparts in Athens to avoid defaulting on loans to their banks. The banks were exposed, she said, because international rules had accorded Greek government bonds a risk-free status.

Illustrating the banking sector’s enduring influence, Professor Admati pointed to the US government’s criminal investigation into HSBC’s money laundering and sanctions-busting activities on behalf of a drug cartel and others. In 2012 the then UK Chancellor, George Osborne, cautioned the DoJ against an excessive fine that could destabilise the financial system. Announcing the settlement a few months later, senior DoJ figures confirmed that such concerns had limited the size of the fine.

Professor Admati said: “The drug cartel was murderous: these were really, really awful people. Yet HSBC laundered their money for years. This was not a one-off mistake: the bank had a whole system in place. But we're powerless. We can't do anything."

"The banks break the law, and there's nothing we can do. It was supposedly a big fine but it was actually a few weeks of profits.”

Admitting her campaign is now personal, she said: “I spent years of my life lobbying in the public interest, and I didn't get anywhere. It’s frustrating but we must keep doing it. As academics we are very privileged. It is the duty of scholars to be sceptical and not to accept what people say at face value.”

Too many academics, she said, are instead thinking about getting their next paper accepted by a top tier journal. Professor Admati recalled an observation from ‘someone within the system’ after he shared quotes from several academic papers about banking.

“With friends such as academics, who needs lobbyists?”