Sunday, February 26, 2012

The Riches Were Privatized and the Rags Were Socialized

I quote from an article by Andrew Haldane in the London Review of Books:
In 1989, the CEOs of the seven largest banks in the US earned an average of $2.8 million, almost a hundred times the annual income of the average US household. In the same year, the CEOs of the largest four UK banks earned £453,000, fifty times average UK household income. These are striking inequalities. Yet by 2007, at the height of the financial sector boom, CEO pay at the largest US banks had risen nearly tenfold to $26 million, more than five hundred times US household income, while among the UK’s largest banks it had risen by an almost identical factor to reach £4.3 million, 230 times UK household income in that year...... 
At the peak of the boom, the wealth of the average US bank CEO increased by $24 for every $1000 created for shareholders. They earned $1 million for every 1 per cent rise in the value of their bank. 
I recommend Haldane's article. It provides an interesting short history of banking in the United Kingdom as well as an explanation of the causes of the recent banking crisis and prescription for the future.

Source of image
It is interesting to recall that a couple of centuries ago, the people who started banks had unlimited liability. If they made loans on the basis of overvalued collateral and the loans were not paid, they bank owners still had to pay the depositors. But there was not insurance for the depositors, and if the bank lost more money than the bank owners had, driving the owners into bankruptcy, then the depositors lost out too. Not surprisingly, the owners were pretty conservative in the loans that they would make and depositors moved their deposits from banks that they thought were risky to those in which they had confidence. Limited liability stock companies and government depositor insurance took away a great deal of the risk in banking. Banks becoming too big to fail, leading to government bailouts also took away risk.

Bank managers, who typically had relatively little capital invested in their banks, got paid according to the profits of the bank. Not surprisingly, since high profits are linked to high risks (but the risks were not shared by depositors nor stockholders in the banks, much less bank managers) they made increasingly high risk investments. The government, which should have acted for the citizens who were now bearing the risks, did not regulate the banks to ameliorate those risks.

Of course, it helps an economy to have healthy banks which lubricate the economy, but the balance of the risks versus the gains got way out of line.

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