Global economies have failed to take on board financial crisis lessons

In missing the worst of the global financial crisis, which began to manifest itself a decade ago, Australia was either lucky or well-governed, or both, depending on who you talk to. Either way, have we learned the lessons?

It’s hard to overstate the ­impact of the financial crisis. Quite aside from the millions of jobs lost and trillions of dollars wiped permanently off the growth path of the world’s economies, the crisis stripped the West of its intellectual credibility.

The vast array of support provided to banks, the most powerful sector in pretty much any economy, revealed the fundamental notions of equal treatment by the state, that pay correlated (at least roughly) with the inherent value of an individual’s contribution, were ridiculous.

The trend of electorates in the US, Britain and France ­towards political out­siders should not surprise anyone. The political disquiet in Australia about the four major banks is a local example.

The start of the Bank Executive Accountability Regime this week, one strand of the government’s response to this disquiet, is a reminder of how little we have learned. BEAR will give the banking regulator, the Australian Prudential Regulation Authority, power to disqualify and fine banks up to $200 million and ­require a share of bankers’ pay to be delayed. It’s well intentioned, but the extra powers assume regulators have the information and incentives to act on them — the same premise that led to the ­financial crisis.

Don’t let anyone tell you the ­financial sector wasn’t regulated before 2008 — in fact, it was the most regulated sector in terms of the number of people and the supposed sophistication of that regulation. Tens of thousands of highly paid PhD graduates were poring over the financial statements of the world’s biggest banks before the financial crisis.

This system and philosophy of financial regulation was shown to be hopeless. The litany of official pronouncements — from central banks, banking regulators, the International Monetary Fund, you name it — about how safe and efficient the banking system was, right up until it suddenly wasn’t, is among the most gobsmacking cases of bureaucratic incompetence in history.

Broadly, that was the lesson. So, what’s happened?

We have more of the same: more regulators and more com­plexity, while very little has actually changed on the ground. The global rule book that national bank regulators sign up to, with a few tweaks here and there, grew from 50 pages in 1988 to 350 in 2004, to more than 610 in 2012, excluding the thousands of pages of guidance notes that go with it. “Bankers and regulators have colluded in a self-defeating spiral of complexity,” writes former Bank of England governor Mervyn King in his recent book.

To be sure, complexity of regulation has been a boon for consultants and financial regulators worldwide. The payroll of the Federal Reserve board in Washington, DC, rose 17 per cent to 2825 staff over the four years from 2011, while the US workforce grew 2.5 per cent. The British bank regulator ballooned 30 per cent to 1250 in the four years to 2016; about 80 people supervised British banks in 1979. The Europeans win hands down, though. In the three years since 2012, the European Central Bank’s payroll surged 70 per cent to 2700 staff.

The Reserve Bank and APRA ­deserve credit on this score, having kept their policy headcount below about 1000. Australia’s ­financial services sector, however, spent more than $US1.1 billion on consultants last year, more than any other sector; these costs are ultimately borne by customers and shareholders.

At a conference in London last month, John Vickers, an ­Oxford economist and author of the British government’s 2011 post-crisis review of banking, pointed out how little had actually changed, despite all the fanfare about tough new rules.

“You would struggle to find an area of public policy where what objective analysts believe is in the public’s best interest is so at odds with reality,” he explained.

“You don’t build flood defences for normal weather conditions,” he said, ­lamenting the still absurd levels of leverage allowed in the world’s biggest banks.

British banks’ leverage — the ratio of debt to shareholders’ funds — has fallen from a ludicrous 50 times in 2009 to about 25 today, which is still far above levels of between seven and 10 recommended by people who have thought seriously about what is sensible. The leverage of Australia’s big four banks has barely changed at all since 2007, still hovering at about 25 times, which APRA seems to believe is “unquestionably strong”.

The utterly discredited system of “risk-weights”, where bank regulators guess in advance which assets are risky (business loans) and which aren’t (home loans), also remains at the heart of bank regulation. This has been a monumental gift to the industry, fuelling the growth of derivatives and securitisation that allow banks to slice and dice assets so as to maximise their debt levels and returns.

Vickers says the level of leverage permitted in a nation’s banks is a “fundamental parameter of capitalism”, given its effect on everything from house prices and mortgage rates to the business cycle, and the implicit subsidy ­allowed to flow from government to banks.

It is remarkable how little ­attention the fundamentals of banking — as opposed to anecdotes about particular cases of customer neglect — receive in Australia. A Martian would be shocked to learn that financial services, a sector meant to be an intermediary serving the interests of commerce, is both the largest and highest paid. As OECD chief economist Catherine Mann observed at the same conference that even the cleaners earn 15 per cent more if they work at banks, holding everything else about them constant.

None of this would have surprised the great Chicago econo­mist George Stigler, who said regulators would inevitably be captured by the firms they regulate, tending to regulate in their interest.

The answer is to reduce the complexity and number of rules, regulators and regulations, and gradually reduce the leverage of our biggest banks by limiting dividend payments for several years.

This would force banks to internalise the cost of their own decisions and investments, which would improve the efficiency and stability of Australia’s economy for the long term.