Dominic Lawson: Blame politicians as much as banks


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The Independent Online

If it were possible for bankers to become even more the social pariahs of the age, it might have been achieved by the decision to spend €100bn of the Eurozone bail-out fund to prop up a selection of submerged Spanish banks. Once again, two popular sentiments are given full expression. First: why should we pay to rescue these well-remunerated idiots from the consequences of their own foolishness? Second: isn't it time for the banks, especially if we have part-nationalised them, to lend more to socially useful schemes rather than continue to feather their own corporate nests?

The first sentiment is entirely appropriate. It has been bizarre the way most European countries have put vast sums into keeping zombie banks going, rather than winding them down in an orderly fashion. At the heart of a properly-functioning market economy is the principle that very badly run firms go to the wall. In the case of banks, that should be allowed to happen too, with only the depositors being protected.

Yet the argument that banks must now be made to operate as instruments of society's wishes is to make the mistake of supposing that they weren't doing so all along. This was certainly true in Spain. At the heart of the crisis were the financial institutions known as cajas, regional banks whose boards were stuffed with political appointees and which were expected to fund construction projects to bring lustre, kudos (and jobs) to the communities they served.

As Alavaro Anchuelo, an MP for the small Popular and Democratic Union party remarked: "The use of cajas as the banks of regional governments is part of the origin of the problem. They used them to finance airports with no flights and theme parks that failed." Naturally the big political parties, both on the left and the right, involved in using the money of unwitting bank depositors to buy votes, are desperate to stop the full story from emerging. Attempts to set up a formal investigation into Bankia have been blocked in the national parliament.

Quite cleverly, these politicised banks would put "ordinary members of the public" on their boards, to reinforce the impression of democratic accountability. One member of the Caja de Ahorros del Mediterraneo, which collapsed last year, claimed that among his board colleagues representing the local community were a supermarket checkout worker, a dance teacher and an artist. None of them, we can safely assume, would even have known how to read a balance sheet, let alone work out the true risks of the loans offered by the head honchos to local vested interests.

It would be easy to dismiss this kind of pork-barrel banking as a phenomenon peculiar to Spain. Yet the whole sub-prime fiasco, from which the credit crunch and recession derived, was to an extraordinary extent the consequence of American banks and financial institutions lending according to the dictates of politicians, who themselves justified this by the claim that they were making the banks act in the general good.

Back in the 1970s President Jimmy Carter introduced the Community Reinvestment Act, which compelled banks to lend more to low-income neighbourhoods, if they wanted to retain their banking licence. This was based on a noble ideal – to root out racism in the mortgage market. Next, procedures were introduced which instructed banks that an applicant's "lack of credit history should not be seen as a negative factor in obtaining a mortgage". The resultant vast increase in home loans was underwritten by Fannie Mae and Freddie Mac, two so-called Government Sponsored Enterprises, which by the time of the credit crunch were guaranteeing $12 trillion of mortgages. When these social utilities were left holding the bulk of the subprime mess, they were, of course, nationalised.

The Democrat Chairman of the House Financial Services Committee, Congressman Barney Frank, had fought successfully against the Bush administration's attempts to rein in improvident lending, precisely on the grounds that to do so would make the financial markets less responsive to the general public good. Frank told Congress back in 2003: "I do not want the same kind of focus on safety and soundness [in the regulation of Fannie Mae and Freddie Mac] that we have in the Office of Thrift Supervision. I want to roll the dice a little bit more in this situation towards subsidised housing." And so the dice were rolled once more, all for the public's good (until, of course, the whole house fell in).

This is not to excuse the bankers for their sins: the bonus culture encouraged ever thinner slivers of core capital supporting ever more loans, which meant there was completely inadequate cover when the housing market collapsed. The point, however, is that the banks' riskiest lending was precisely to the project – wider home ownership – the politicians wanted them to fund. Ostensibly this was only for the social good, but not coincidentally it was thought by the politicians that the more the property market boomed, the happier the voters would be, at least if they had a good slice of the action.

By the way, they never learn. In March our Government launched a scheme under which taxpayers will guarantee deposits for new-build houses up to £500,000: this enables buyers to secure such properties with a personal deposit of no more than 5 per cent, when lenders are otherwise refusing to fund such transactions unless the deposit amounts to 20 per cent of the value of the property.

The reason for this caution on the part of lenders is clear enough: such houses tend to command a premium for being completely new and therefore will lose value in a flat market.

In other words, the taxpayer is now underwriting home loans which may well be greater than the resale value of the properties concerned. Once again, this will buy votes both from the buyers and the property developers: but to distort the housing market in this way is simply to encourage the over-pricing of property – which is of no social utility at all.