Original URL: http://www.theregister.co.uk/2013/04/05/hbos_collapse/

Gov report: Actually, evil City traders DIDN'T cause the banking crash

Lending money to SMEs and giving people mortgages did

By Tim Worstall

Posted in Financial News, 5th April 2013 13:33 GMT

So we've now got the official report on the glorious cock-up that was Halifax Bank of Scotland.

There will of course be cries that lessons must be learned, such things must never be allowed to happen again and that the guilty must be punished, as is traditional in such post mortems.

But the important thing is that the right lessons be learned.

And the right lesson here is that this was nothing at all to do with casino banking, derivatives, excessive trading, nor even The City. This was simply a bank going bust the old fashioned way by lending too much money to people who couldn't repay it.

The actual report is the Parliamentary Committee on Banking Standards' Fourth Report. You can read it in all its glory here.

No, don't. The full report is only for masochists and journalists - to the extent that those are different groups, anyway. Below is, in full, what you really need to know about what happened:

This was a traditional bank failure pure and simple. It was a case of a bank pursuing traditional banking activities and pursuing them badly.

We all know what the political narrative about the banking failures - the Great Crash of 2007 - is. Excessive speculation, trading in swaps and options and futures using high speed trading algorithms. Greed and financial capitalism run mad in free markets led to the collapse of the economy and we've got to do something about it.

So, the narrative runs, what we're going to do is tax the transactions with the Robin Hood Tax. We're going to separate casino banking from real banking, slice the investment banks off the commercial banks. Cut The City down to size and force them to invest in the real economy rather than gamble everything away in frenzied trading.

There are only two problems with this analysis, and thus, the plan of action.

The first is that it comes from those who would enforce such a plan anyway, whether the system had collapsed or not. The second is that it gets who collapsed, and why they collapsed, entirely wrong.

As Parliament's report has found, HBOS fell over simply because it lent too much money to too many people who couldn't pay it back. Banks have been going bankrupt in this manner ever since the very concept of a bank was invented (13th century Italy to some, about 30 seconds after the building of Ur to others).

HBOS didn't have a huge investment banking arm: it had a tiny investment wing that wasn't responsible for the losses HBOS racked up. Those losses were also nothing at all to do with futures, options, swaps, CDS, CDOs or any of the plethora of acronyms that infest investment banking. There was no high speed algorithmic trading unit of any size. They weren't short selling, naked or not; they weren't even trading stuff very much.

Quite simply, they made loans to people who said they had a great plan. And fewer of those plans turned out to be great than was necessary to keep the bank afloat. One revealing number in the report is that in 2008-2010 they wrote off 10.5 per cent of their total 2008 loan book.

Given that banking regulation, even after being tightened up, insists only that a bank has 9 per cent of capital behind its loans, this would have busted the bank anyway. Well, maybe HBOS would have survived if it had more capital, but it would still be a close-run thing.

This is a problem with the general narrative about reforming finance. That reform is needed isn't in doubt: it's what needs to be reformed - and why - that is. You don't have to look far to the left to find people telling us that it was indeed all to do with that evil casino banking. Those free markets, running wild and unregulated.

So how do we solve the banking problem?

The narrative-writers' solution is to rein in the trading part of the banking industry and force them to concentrate on real loans to real economic activity - to break up the banks, perhaps, or to have regional banking again.

The further left one goes, the more insistence you'll find that politicians, or maybe trade union leaders too, should be part of banks' senior management so that the 'wider interests of society' are considered.

And then there's that financial transactions tax - the Robin Hood Tax - which will curb the excessive trading once and for all. (I'll leave it to another day perhaps to explain why that's so wrong-headed in itself.)

Where this fails is in the original analysis. As above, HBOS didn't go bust as a result of any of that trading or market speculation stuff. They didn't really do any of it to begin with, so that couldn't be the cause. They just lent money to too many people who couldn't pay it back. It was, as the report itself says, a traditional bank collapse - nowt whatsoever to do with the bright new world of speculation.

RBS went bust because it bought ABN Amro for too much money. No other reason at all. Northern Rock didn't gamble or speculate; it just issued mortgages. Northern Rock in particular suffered a bank run, something which banks have been subject to since 13th century Italy (or 30 secs after Ur's foundation, take your pick).

They didn't have the money to pay back all their depositors because, as in It's a Wonderful Life (plot synopsis, relevant part is a quarter of the way down), the money isn't in the bank. They gave it to the man down the street to buy his house with, and he hasn't finished paying them back yet.

Dunfermline Building Society didn't even have the lust for profit from shareholders to blame. It went bust lending too much to commercial property projects.

As to having regional banks with the politicos on board, have a look at the Spanish cajas. They were actually owned by charitable foundations, so greed wasn't part of it. They also didn't do any of those neoliberal market things like trade stocks or bonds or swaps or futures. They just made loans to people who wanted to buy houses or run businesses.

And they had politicos on their boards, indeed there often was a revolving door between high office in politics and high office in banking management. It's interesting to note that every single one of Spain's cajas has gone bust as a result of supposedly taking society's wider interests into account.

That something went wrong in banking is obviously true. But it is important to note what actually did go wrong. Only then can a reasonable and effective solution be found.

The bits of the banking system that went titsup did so for the traditional reasons that banks go titsup. They lent too much money to people who couldn't pay it back. Or in the RBS case, suffered an overdose of the auction winners' curse. It simply wasn't to do with the trading culture or speculation. This is why attempting to change the trading culture and speculation won't provide a solution.

What will provide something of a solution is to insist that banks must hold more capital against their loan books, something that's already been put in place under the Basel III rules. Unfortunately that has a side effect: the banks can therefore lend less money. As everybody can see now, banks don't want to lend money to anyone at present.

That just brings us to the great truth at the heart of the subject of economics. There are no solutions; there are only trade-offs. You can have a robust banking system where it's difficult to get a loan, or you can have easy money and a banking system that periodically goes titsup.

Your choice, but the choice does have to be made. ®