Risk – it’s a tricky concept. And becomes even trickier when bankers start to play with it and not only put numbers on it, but then try to buy and sell it. Modern banking is all about risk and its management. Yet despite paying themselves a fortune and extolling their own skills as risk managers, they have, as a group, demonstrably and undeniably failed to control or even properly understand the risks they exposed themselves and everyone else to.
Back before the ‘crisis’ there was ‘risk’. Risk that a loan extended might not be paid back. Bankers measured such risk, put numbers on it and priced loans and debts according to their risk. Risk became an important part of the value of something. You might have thought the riskier something was, the less it would be worth. If you did think that then you’ll never make it as a banker. Risk is valuable. A loan that isn’t risky has a low interest rate. Whereas a loan that is risky charges higher interest and therefore brings in more money. If it is paid. Of course the risk is that it won’t get paid, it will default and you get nothing or very little. Certainly far less than you would have got with the less risky loan. So the mathematics become a little more complicated. Potentially more money to be made but with a risk of default. What you want is risky, high interest rate loans without the risk.
Bankers wanted high returns without accumulating too much risk. Securitization solved that one. Banks could make risky loans but not accumulate the risk on their own books simply by selling the loan on after they had made their commission for ‘originating’ the loan. From the bank’s point of view once the loan was sold the risk had ‘gone’. Poof ! Just like that. Where had it gone? Into ‘the market’. Like pollution down a pipe it was washed away into the great unknown. Instead of a few banks accumulating risk on their books, the risk was diluted into the larger flow of ‘the market’.
Of course in ‘the market’ someone had bought it. But the market was so big relative to anyone’s particular risk that it was considered gone. And no one was paid to think about loans other than their own. So the cumulative effect was largely overlooked. The market ‘would always provide’ was the wisdom of the boardroom. And then to make the magic even better, if those who had purchased the ‘risky’ loans were ‘clever bankers’ they would have also bought insurance to protect them from whatever risk was left. Enter loan insurance. Call it insurance, call it CDS, call it Emmanuel. I don’t care. What mattered was that the risk was now perceived to have been even further diluted. Now insurers were housing some of the risk as well.
Once insurers began to ‘help’ with risk other people saw that products that were once too risky for them were now not risky at all. So people who could not afford to take many risks, like pensions funds, felt free to buy the higher return products that were once too risky but now weren’t. And so it went on. More and more risky loans serviced by more and more insurance all disappearing into the market. The market was, it was felt or assumed, virtually limitless. There would always be someone there to buy up risk and pay up in the unlikely event that any of the potential risk materialized. The risks were so small, (weren’t they? The ratings agencies certainly said they were) and the markets were so big.
But then one day the equations of risk management and in fact the entire world of banking turned itself inside out. Suddenly it was found that so much risk had been flushed into the market that a toxic bloom of debt had turned the trading boards red. Risk was everywhere all at once, saturation point seemed to have been passed without anyone noticing and the market itself was now at risk.
Systemic risk was the new phrase. That which had been the sink hole for risk was spewing it back and might die of the shock.
The market at risk
What to do? The market had to be saved. The market was, after all, what dealt with risk. Without a functioning market goodness knows what risks we would be exposed to. That stupidity is what we were told. So the answer was to take the risk back out of the market. To cleanse the market of what had poisoned it. Not by getting rid of the risk entirely, by making those who had bought risky debt suffer a loss. No, no that would impoverish the very people who were in charge. Naturally they had a better idea. They would simply quarantine the risk, by storing it somewhere until it all ‘recovered’. So the toxins were removed from the markets, but not destroyed. They were hidden away, safely outside the markets and new clean blood was pumped in. The body financial felt better. Or at least no longer at death’s door. Of course the transfusions were costly. But someone else was paying so what the hell.
Every bank did it. Every nation did it. And everyone who tried the cure felt better. Huge national debt mountains were created in the process as the debts were purchased and stored away. But then another ‘unexpected’ thing happened. All the risk began to go critical. Like stored uranium and plutonium too much was stored in places both too small and not designed for the job.
The National banks where it was all stored found they were running out of space and money. They decided they themselves now needed to go the markets and borrow money to pay for all the purchases and the cost of storage. But now that they were the repositories of so much risk it was difficult for them to get a loan. So they ‘instructed’ the banks whose debt they had bought to buy the nation’s bonds in return. To sweeten the pill they said the banks could pay by pledging as collateral even more of the risky debts they might still have on their books. Turned out the banks had a lot more that they hadn’t mentioned when earlier questioned. But mum’s the word and nothing was said that might frighten the public.
So the banks now bought AAA rated sovereign bonds/debt and pledged more of their risky rotten loans as collateral. This seemed to do the trick again. The private banks got yet more risky rubbish off-loaded, and received in return much lower risk sovereign debt in return. While the nations could trumpet how rumours of them not being able to sell their debt were exaggerated – they were selling it as fast as they could print it!
Unfortunately this fooled the public but not the banks since they were in on the scam. The national banks had been supposed to be big enough to store the great toxic flood of bad debt until the sunshine of better days shone down and evaporated the toxic sludge. Only, those days never came and the flood kept coming. So there came a day when the private banks in their guise of the Bond Market, began, with crocodile tears in their eyes, to say to the national banks, “We’re very sorry, but your sovereign bonds have become a bit risky. Given that you have so much risky paper sitting on your books now. So regretfully we will have to charge you more for buying your bonds/debt. The nations felt a little put out but the logic was sound. They paid. The higher the rate the private banks and bond buyers demanded the more money those banks were making on the deal. The more of it they wanted. So for a while bonds sold. MF Global accumulated over 6 billion euros worth of bonds from Europe’s riskiest countries. They could have bought German bonds but chose, of their own free will, to buy Italian, Spanish and Irish instead.
In, out, shaken all about
The banks were happy to buy the debt because it paid such a good rate of interest. All that was required was that it not default and all that required was for everyone to stick to the plan. The bail out “No one gets left behind to default” plan. And they could still pose as the good guys because they were supporting their sovereign by buying up its debt. Lots of banks did it. Especially, rather sadly, those in the countries whose banks and now whose national banks were in the most trouble. That’s why Greek banks have so much Greek sovereign debt.
It worked for a while. Pressure on the central banks was eased somewhat but at a cost. The cost was that the risk which had been removed from the market and stored in the central banks was now being wheel-barrowed back out and put back into the banks and the markets. The private bonds were still in the central banks but the risk itself had now moved into the sovereign bonds which were flooding the markets and the holdings of the Private banks. A kind of toxic backwash. Madness you might say. Yes, but profitable.
But as it went on the risk began to slosh back and forth in a rather turbulent and unpredictable surge from the market to the sovereigns and back again. In, out everyone was getting thoroughly shaken about. The central banks had been supposed to remove risk from the markets but had instead become the markets and had overwhelmed everything and everyone else. Risk was not only back it was now piled up in fewer and far larger and more ‘catastrophically-dangerous-if-they-fell-over’ piles.
What to do – again?
The answer, because they couldn’t think of anything else, was to do the same again only bigger. Find an even bigger place to store it all and wait for that mythic sunny day that would make everything good again.
So risk that had been in the market, then taken out only to find its way back was now to be taken out again.
Now the debt would be siphoned from both the markets and the national banks in to the über banks of last resort and über bond buying funds. Step up the Fed, the ECB and the EFSF. Of course the Fed had been at this for a while. But the virgin ECB was bashful about filling its pants with other people shit. But hey! Extraordinary times require extraordinary measures. But it was a hell of a measure and M. Trichet walked a little oddly afterwards; but no one liked to say so.
Did this solve it. Of course not. Moral hazard was simply taken to another higher dimension. But by this time the phrase “moral hazard”, which the bankers had never approved of and had quietly boycotted till no one dared use it any more for fear of being accused of being a banker basher, had been all but forgotten. So no one in the media mentioned it.
Instead what happened is that the sovereign debt of the riskier, ‘lucrative’ nations just got a better insurance behind it than the nations themselves could give it. Here was another chance to run the original logic a third time only bigger and faster. And with better ‘insurance’ this time from the ECB (which meant France and Germany). There was no time to lose. First with his face in the trough would get the most. Now you could buy risky sovereign debt with an ECB guarantee standing behind it.
And so the sale of sovereign bonds could continue a bit longer. The nations who sold them could bail out their banks a bit longer. And as an added bonus of perpetuating the debt bubble a bit longer, a long standing neo-liberal political desire could finally be forced through, namely of dismantling the welfare state, of forcing privatizations on people who were not in favour of them and of rolling back half a century of laws designed to protect the rights of working people. The cry was – it was too risky not to. What a stroke of genius.
And now we are almost up to date. The risk has never gone away. It has been concentrated and now no one thinks even the über banks and bail out funds can contain the risk. At least not without printing up vast amounts of new money or getting Germany to take the entire risk onto its tax payers. And still no one will allow any discussion of how we could force the debts and the accumulated risk from the system.
The final question is where does the risk and debt that no one will get rid of, end up? Where is big enough to store it? And the answer is in the future. The future is BIG. Really, really big. It is virtually limitless and the amount of wealth in there, to pay off those debts is also potentially limitless. The only problem is keeping the debt in there and extracting the wealth. To do so requires that none of us, whose future is now a dumping ground for bankers’ toxic waste, and whose wealth must be extracted to pay off the debts, be allowed to object. Which means no pesky democratic voting. Voting has the power to over-turn the bankers plans and present arrangements. Democracy has the power to decide to default on the debt. So what the bankers need to do above all else is to elevate financial contracts above democracy.
If bankers can get us to believe that a contract signed by a politician to pay the bankers debts is above the will of a people to decide their own future then the bankers will have definitely won. Democracy will have ended and so will your children’s hope of a better future.
As long as the bankers can keep their debts in our future to be paid off by us, the tax payers, for as long as it takes - then today, here, the bankers can make money and live it up. Jam today for them, misery for the rest of us stretching away in to the future. Our future,not theirs.
Theirs, they are trying to make brightly lit and debt free. While yours, if they get their way, will be blighted before you ever see it. This is the risk we now run.
Risk – its tricky stuff especially when bankers get hold of it.