Barclays’ Bob Diamond to Non-Bankers : Drop Dead

Barclays’ Bob Diamond to Non-Bankers: Drop Dead
Bob Diamond, Barclays’ chief executive officer, no more said something  
as inflammatory as “drop dead” to the UK Treasury select committee  
yesterday than Gerald Ford did in a 1975 speech refusing to extend  
financial assistance to save New York City from bankruptcy. But the  
substance was every bit as uncooperative.

Despite its artful packaging, Diamond’s presentation was yet another  
reminder of the banking industry’s continued extortion game, namely,  
that they can take outsized, leveraged risks and when they work out,  
pay themselves handsome rewards, and when they don’t, dump them on the  
taxpayer. And they’ve only been encouraged to up the ante. Not only  
did they get to keep their winnings from their last “wreck the  
economy” exercise, no senior executive was fired, no boards were  
replaced, and UBS was the only major bank required to give a detailed  
account of how its screwed up so badly as to need government support.  
And before you tell me Barclays was never bailed out, tell me exactly  
how well it would have fared had any other major UK or international  
bank failed, or had the officialdom not provided extraordinary  
liquidity support when interbank funding dried up.

As we have noted often in the past, the very idea that employees of  
major banks are entitled to even as much as average wages is a  
stretch. If the true cost of their operations was priced in, they’d  
all be out of business. By any standards, they should be paying all  
the rest of us to be allowed to do so much damage with so little  
interference.

Andrew Haldane of the Bank of England goes through the math. In a  
March 2010 paper, he compared the banking industry to the auto  
industry, in that they both produced pollutants: for cars, exhaust  
fumes; for bank, systemic risk. While economists were claiming that  
the losses to the US government on various rescues would be $100  
billion (ahem, must have left out Freddie and Fannie in that tally),  
it ignores the broader costs (unemployment, business failures, reduced  
government services, particularly at the state and municipal level).  
His calculation of the world wide costs:

….these losses are multiples of the static costs, lying anywhere  
between one and
five times annual GDP. Put in money terms, that is an output loss  
equivalent to between $60 trillion and $200 trillion for the world  
economy and between £1.8 trillion and £7.4 trillion for the UK. As  
Nobel-prize winning physicist Richard Feynman observed, to call these  
numbers “astronomical” would be to do astronomy a disservice: there  
are only hundreds of billions of stars in the galaxy. “Economical”  
might be a better description.

It is clear that banks would not have deep enough pockets to foot this  
bill. Assuming that a crisis occurs every 20 years, the systemic levy  
needed to recoup these crisis costs would be in excess of $1.5  
trillion per year. The total market capitalisation of the largest  
global banks is currently only around $1.2 trillion. Fully  
internalising the output costs of financial crises would risk putting  
banks on the same trajectory as the dinosaurs, with the levy playing  
the role of the meteorite.

Yves here. So a banking industry that creates global crises is  
negative value added from a societal standpoint. It is purely  
extractive.

The reality is that banks can no longer meaningfully be called private  
enterprises, yet no one in the media will challenge this fiction. And  
pointing out in a more direct manner that banks should not be  
considered capitalist ventures would also penetrate the dubious  
defenses of their need for lavish pay. Why should government-backed  
businesses run hedge funds or engage in high risk trading, or for that  
matter, be permitted to offer lucrative products that are valuable  
because they allow customers to engage in questionable activities,  
like regulatory arbitrage or tax evasion? The sort of markets that  
serve a public purpose should be reasonably efficient and transparent,  
which implies low margins for intermediaries.

But note the clever positioning by Diamond, per the Financial Times

Mr Diamond acknowledged the public anger towards bankers and the  
emotion surrounding pay, and admitted he wished he could “make the  
issue of bonuses go away”.

But he argued it was not possible to stop paying bonuses without  
severe consequences for the business and the broader banking sector  
and said it was now time for the bonus debate to move on.

Yves here. This is priceless. Diamond wants the “issue”, meaning the  
controversy, over bonuses to go away. I’d love to see the “severe  
consequences to the business” of forcing lower pay on incumbents. Yes,  
a very few might find be able to raise money from investors. But as  
John Whitehead, a former co-chairman of Goldman said in 2006 when  
hectoring Lloyd Blankfein over the firm’s “shocking” pay levels, the  
firms could afford to lose them. But Whitehead missed the dynamic of  
the post-partnership era. The partners had every reason to keep pay in  
line; it was their capital at risk, after all, and overcompensating  
staff reduced their take. Now the top brass is aligned with the  
interest of the producers in taking as much from any source they can.

Back to the Financial Times:

“We can’t just isolate bonuses and assume it won’t have consequences,”  
he said.

“The biggest issue is putting the blame game behind us. The time for  
remorse is over.”

While Mr Diamond said he would “show any restraint possible” on  
bonuses, he would not commit to waiving his own personal award, as he  
and rival bank chief executives did last year.

Yves here. If you believe that, I have a bridge I’d like to sell you.  
And of course, the excuse is that CEOs like Diamond have no choice,  
they are forced to do so by competition. That logic sounds remarkably  
familiar:



For banks, the threat is that if anyone puts their finger on the pay  
dial, the business will be hurt and by implication shrink. But if you  
are talking about an operation that is destructive, that’s a good  
thing. The banking industry is bloated and cancerous, sucking talent  
and resources out of the rest of the economy and allocating capital  
poorly (examples include the series of bubbles and busts, the way it  
has become acceptable for bankers to suck so many fees out of deals  
that they cannot possibly make sense for investors, as in the case  
with Goldman in the Facebook funding, the destructive impact of  
turning commodities into an investment).

And don’t even try the defense that the industry is “innovative” As we  
wrote in ECONNED:

The dirty secret of the credit crisis is that the relentless pursuit  
of “innovation” meant there was virtually no equity, no cushion for  
losses anywhere behind the massive creation of risky debt. Arcane,  
illiquid securities were rated superduper AAA and, with their true  
risks misunderstood and masked, required only minuscule reserves.  
Their illiquidity and complexity also meant their accounting value  
could be finessed. The same instruments, their intricacies overlooked,  
would soon become raw material for more leverage as they became  
accepted as collateral for further borrowing, whether via commercial  
paper or repos.

But even then, the bankers still needed real assets, real borrowers.  
Investment bankers screamed at mortgage lenders to find them more  
product, and still, it was not enough.

But credit default swaps solved this problem. Once a CDS on low-grade  
subprime was sufficiently liquid, synthetic borrowers could stand in  
the place of subprime borrowers, paying when the borrowers paid and  
winning a reward when real borrowers could pay no longer. The buyers  
of CDS were synthetic borrowers that made synthetic CDOs possible.  
With CDS, supply was no longer bound by earthly constraints on the  
number of subprime borrowers, but could ascend skyward, as long as  
there were short sellers willing to be synthetic borrowers and  
insurers who, tempted by fees, would volunteer to be synthetic  
lenders, standing atop their own edifice of risks, oblivious to its  
precariousness.

Institution after institution was bled dry. Yet economists and central  
bankers applauded the wondrous innovations, seeing increased liquidity  
and more efficient loan intermedation, ignoring the unhealthy  
condition of the industry.

The firms that had been silently drained of capital and tied together  
in shadowy counterparty links teetered, fell, and looked certain to  
perish. There was one last capital reserve to tap, U.S. taxpayers, to  
revive the financial system and make the innovators whole. Widespread  
anger turned into sullen resignation as the public realized its  
opposition to the looting was futile.

The authorities now claim they will find ways to solve the problems of  
opacity, leverage, and moral hazard.

But opacity, leverage, and moral hazard are not accidental byproducts  
of otherwise salutary innovations; they are the direct intent of the  
innovations. No one was at the major capital markets firms was  
celebrated for creating markets to connect borrowers and savers  
transparently and with low risk. After all, efficient markets produce  
minimal profits. They were instead rewarded for making sure no one,  
the regulators, the press, the community at large, could see and  
understand what they were doing.

Diamond’s candy-coated defiance shows that three years after the  
crisis, nothing has changed.

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