Banks, Risk, and Moral Hazard: So Much for “Lessons” of 2008 Crash
In the 1939 screwball comedy “Idiot’s Delight,” Harry Van (played by Clark Gable) and his troupe of dancers are on tour in Europe and trying to get to Geneva for their next engagement. But they are stopped at the border, which has just closed. Harry demands to know why. Asked if he knows “the present international situation,” Harry says, “Well, I know it’s always regrettable.” Told a war is coming, this veteran of World War I says, exasperatedly:
“What? Another one?”
I thought of this line when the specter of another financial crash was raised by experts upon the recent collapses, in quick succession, of Silvergate Bank, then the bigger Silicon Valley Bank, then Signature Bank, all here in America, followed in Europe by the venerable Credit Suisse, founded in 1856. As another crash loomed, no doubt many other Americans, veterans of crashes past notably 2008, thought: “What? Another one?”
For now, a global crash appears averted, barely, with federal governments stepping in to bail out depositors and bigger banks stepping up to buy the collapsed banks at fire-sale prices. But, once again, risk — namely, the risk taken by offending banks in making ever riskier investments for ever higher profits — is the culprit, the “always regrettable” flaw in the system. Experts are laying the blame on the failed banks’ inept risk-management.
Which is the exact same scenario Wall Street banks played by in 2008, when their wildly risky investments, based on ever-thinner paper with ever fancier names, exploded all over the financial landscape and onto Main Street, causing a worldwide financial meltdown. We recovered, but, as I wrote at the time, without a proper reckoning. Which is why, with this new crisis— tagged the SVB crisis after the biggest offender, Silicon Valley Bank, the second-largest collapse in American history — I thought: “What? Another made-in-America global financial crash?”
Lessons needed to be learned from the ’08 crash, specifically lessons about risk-taking. But those lessons clearly are not taking — and, instead, taking indefensible risk continues. It was not a good sign when key regulatory requirements stipulated in the Dodd-Frank Act — enacted in 2010 precisely to prevent another crash by curbing risk and reining in Wall Street, thus averting more bailouts — were gutted in the Trump administration. Forbes explicitly states Trump’s deregulation regime “sowed the seeds” for the current crisis. (It was also not a good sign when one of the Act’s signatory sponsors, Barney Frank, now retired and serving on Signature Bank’s board, supported the reduced regulatory requirements!) (For an overview since ’08, see Frontline’s superb documentary “Age of Easy Money.”)
Senate hearings to examine the roots of this latest financial crisis were conducted last week by the banking committee, chaired by Ohio Democrat Sherrod Brown. The estimable senator nailed the main driver: “hubris, entitlement, greed.” In turn hubris, entitlement, and greed drive excessive risk-taking. Brown went on to connect daring behavior (risk-taking) with presumed backstop (government rescue). Going a step further, writes Politico, Brown unleashed “sharp criticism of venture capitalists who were SVB’s key clientele and helped drive the run that took down the lender when they encouraged companies to pull out their money. Some of these investors later demanded that the government rescue SVB” [emphasis mine].
“Just as there are no atheists in foxholes,” Brown added, “it appears that when there is a bank crash, there are no libertarians in Silicon Valley.” Libertarians advocate minimal state intervention in the free market and in citizens’ private lives. But, here again, the advocates of minimal state interference — i.e., regulation — suddenly want maximal protection — i.e., government rescue — when their excessive risk-taking comes a cropper.
Risk-taking coupled with expectations of rescue is the quintessence of “moral hazard.”
As defined by Investopedia, moral hazard exists “when a party to a contract takes risks without having to suffer the consequences,” no matter the damage done to the other party. The significance of consequence-free risk-taking? Its dire impact on consumers and the economy. Per MasterClass: “The result is a win-win for business — risk-taking can yield greater profits but is also covered by bailout — but a loss for taxpayers, who foot the bill when these risky investments upend the economy” [emphasis again mine]. Or as a saying from the ’60s put it: “Sow the wild oats and hope for crop failure.”
I am not equipped to engage in a technical discussion of the problem. Economics and I never grafted in college; the argle-bargle doesn’t compute. But, as my readers know, I do respond to the moral element in play, the rightness and wrongness of things, thus my focus here on the moral hazard of consequence-free risk-taking, which strikes me simply as wrong, about which I have written often (here, here, and here).
Yet even more, my distress this time is this: A mature entity would not behave in ways that imperil other entities or its environment. A mature entity — be it bank, business, government, or citizen — would, from the get-go, operate with a keen sense of moral responsibility: How does my/our action impinge on others and on the whole, on my/our community and the ship of state? A mature entity not only embraces responsible behavior, but understands that, if broadly embraced, the whole system hums as it should.
Put more prosaically, a mature America would not keep crashing its economy or itself.
By now, 22 years since 9/11, “the day everything changed,” after enduring and suffering so much — crashes, wars, anti-democratic Trumpism — America should by now be there: a mature nation. But, Lord, we are not. Why, at this very late date, does America still laugh at “responsibility” and “prudence” and “virtue”? When will we stop the flailing, the crashes, the degradation? How many at-bats do we think we get with our grand and historically unique experiment in capitalism and democracy? How long can the American dollar remain the world’s reserve currency, when certain immature Americans keep whacking away at it from within? One of my themes going forward — where Americans always want to go — is: Grow up.
Regulation is key. It’s not enough to say banking is an inherently “risky business”; the risk can be regulated. (In the present crisis, it’s valid to ask: Where were the regulators?) Mature entities accept regulation. Play in any game, there are rules. Conservatives still fight it, though, with some who touted deregulation now blaming the current crisis on Democrats’ “woke” agenda (which effectively derails debate). The Wall Street Journal, leading conservative organ, is of two minds: Addressing the current banking crisis, its editorial board writes, “So much for 13 years of banking regulation,” but at other times it treats regulation — and even moral hazard — as an unacceptable “cost.”
The real “cost” of nonstop financial crashes is people’s growing anger and fury at government bailouts, which have profound political consequences (see: the rise of the Tea Party and the demagogue Trump, which the Frontline doc is very good at delineating). But enroute to anger and fury, there is another very real cost: the citizenry’s growing cynicism and distrust.
To recur to the screwball “Idiot’s Delight,” the line following Harry Van’s outburst at news of another war — “What? Another one?” — is one dripping with cynicism: “When’s that scheduled to begin?” By now, the reader senses this particular screwball comedy is quite dark, more like screwball tragedy. (A bright note is Gable dancing to “Puttin’ on the Ritz,” which, come to think of it, is a hymn to hubris, entitlement, greed.)
Will we — can we — mature, meet the moment, and avert tragedy? Talk about suspense….