Why banks don't lend to businesses

Amongst all the smoke about the current budget, the problem of bank lending to small and medium sized businesses does not get much detailed debate. The trenches between the government and the Labour opposition are drawn roughly along the lines of trying to incentivise the banks to lend, or order the state owned banks to lend. The latter position is taken of course by many Labour politicians and union leaders who like to bash bankers for the damage done to the economy during the balance sheet crisis of 2008/9.

The Business Secretary Vince Cable has stubbornly tried to get away from these caricatures of the problem and recently outlined once again why banks are not lending. Apart from the de-leveraging that banks are currently doing to prevent any future bailout (and are required by European and British law), the main reason for their failure to lend is actually their weak presence in the local economy. British banks may have become major global players and draw much of the profits from foreign investments, but, despite their protestations and adverts to the contrary they have failed to foster strong community relationships with small and medium sized businesses in the local economy. It is here that local knowledge is generated which would allow banks to accurately assess risks of investments, and make informed choices about the financial support they grant to local businesses.

Not quite so local

This lack of local knowledge is not something that happened over night. In fact, Britain has long cultivated a different banking culture to that of Germany where banks are highly diversified and engaged in the local economy through investments. British banks have mainly drawn their income from investments in the commodity and financial markets whereas the investment functions often fell to entrepreneurial and venture capital. To turn this around and to create a more diversified banking sector is a major undertaking, and it would start with promoting more competition in the banking sector in Britain.

Four more years but the shine has come off

So there it is. The people have spoken and they have handed another victory to Barack Obama. Whilst there was less enthusiasm for his re-election amongst many Americans, he eventually mustered enough energy to mobilise many of his original supporters to give him a second chance. And a second chance it is since neither has he achieved much of that which he spoke so eloquently of in 2008, nor has he fulfilled the hopes of so many of his countrymen.

The main narrative of this campaign was that it was a choice between two widely different visions of America. I beg to differ. Whilst the Obama campaign ran a vicious personal campaign against Romney, the Romney camp was careful to avoid shrill sounds and personal attacks. In fact, observers on the left of the political spectrum corroborated that when they spoke of a 'Chicago' campaign run by the Obama camp (Chicago politics is famous for the nasty vilification of your opponent and the spreading of 'halftruths' or outright lies).

So as the shine has come off the Obama campaign, the Romney camp seems to have mainly articulated a moderate vision of America that widely commanded respect amongst independents. Romney's address to his supporters reflected this gracious and fair attitude in the political struggle, while Obama's speech to his supporters seems to have been mainly a repeat of the hollow phrases and high flying rhetoric from 2008.

Yet the media distortion about Romney and his supporters goes even further than that. The media suggested repeatedly that there were major differences between the opponents. This is largely wishful thinking. Take the reform of the banking sector and the effect of Wall Street on the US economy. Obama had strong words of criticism for Wall Street and the investment banks in 2008 yet failed to deliver a single effective reform package that would prevent a similar breakdown of the banking system.

Or look at the bailout of the car industry. Whilst this clearly won Obama plaudits from the car makers and their unions, the money mostly went to pay enormous pension liabilities that had built up over decades. This only achieved one thing: the American car industry is back to square one. It remains largely uncompetitive vis-a-vis foreign car makers and technological innovation is low. Obama may have saved it temporarily from going to the wall, but it is still heading for a crash, bailout or no bailout.

The most important weakness of all may however be Obama's personality. In an insightful documentary Andrew Marr spoke to close advisors of the President and they indicated that, despite the rhetoric about collaboration, Obama is not somebody who knows how to work together with others. He (perhaps too much) relies on his intellectual strength and believes that by simply thinking hard about a problem, he will come up with the right answer. This showed throughout his presidency. As some of his supporters argued, Obama may be the most lonely president ever, unable to reach out to colleagues and work with them to achieve robust solutions to difficult problems. This contrasts markedly with Romney who as governor favoured a managerial style, often delegating problems to capable staff and colleagues.

And so, I suspect, we will see more of the same. A president increasingly frustrated by an allegedly intransigent 'Washington' political system and hemmed in by an inability to reach out to others. What Obama does not seem to understand is that rational thought may sometimes be a poor guide for political decision making. Politics is about people, not abstract ideas.

Britain's oligarchic elites

Inequality has made some headlines in the UK since the recession and the (former head of Downing Street's policy unit) Ferdinand Mount has helpfully distilled some of the public discussions in his new book The New Few (Simon & Schuster). Not content with simply rehearsing the debate, Mount argues that there is something foul in the state of Britain when managers receive large bonuses at times of decreasing share prices and poor people struggle to get by. 

His conceptual frame is the idea of oligarchy but this is where the argument sadly wears thin. Although Mount drops the names of Pareto and Michel who defined the debate on elites in the first half of the 20th century, his take on oligarchy and elitism is more discursive and argumentative rather than analytical. Aristotle gets a mention too with his juxtaposition of democracy, oligarchy and monarchy (where notably, Aristotle thought democracy a perverted form of rule). 

Yet, it is Mount’s concept of oligarchy that fails to convince. One reason why is well illustrated by the argument Michael Walzer employs in Spheres of Justice (1983). Walzer distinguishes between the economic, political and social spheres and identifies the main challenge for modern politics in moments where power in one domain spills over into influential positions in another domain. It is this cross-sectoral ability to call the shots that hints at the essence of oligarchy in Aristotle’s meaning. 

In other words, only where political influence directly translates into economic power, or vice versa, is democracy seriously jeopardised. Now, Mount may cite several instances where managers appoint each other to directorships on boards, and he might be right that there is an unhealthy cross-fertilisation amongst some people with influence in quangos and companies. Yet, Britain is nowhere near a true oligarchy in Walzer’s sense. In fact, we know an oligarchy when we see one, and we can observe one at our (European) doorstep: Russia. 

The insidious aspect of Russian political and economic life is not that there are some extremely powerful people and some who are filthy rich but that both elites are deeply intertwined in personnel. Political power directly translates into economic power, often, as under Yeltsin, with immediate effect through shareholding. 

Britain is a far cry from this paradigmatic type of oligarchy. You may deplore that Tony Blair is cashing in his fame (and perhaps his influence with some foreign potentates) but he has little say on who sits on the Labour front bench or on the board of BP. 

But it is not only Mount’s conceptual take that has a wonky quality, it is also the overarching narrative that does not quite stack up. As he starts with an exploration of the banks and financial services, he follows a story that is shaped like a valley curve, with greed and usury at its highest during the beginning of the 20th century, followed by strict legislation curbing the power of the banking sector, leading to a resurgence of reckless financial activities after the Big Bang (in Britain) and the repeal of the Glass-Steagall Act in the US. 

The problem is that this development is not neatly aligned with the increase or decrease in political and social participation, or oligarchic behaviour in either of these spheres (to use Walzer’s terminology). The story is a more complex one, with British industry suffering from one of its worst moments of corporatism (union and otherwise) during the times when banking demons were largely tamed. At the same time (during the 1060s and 1970s), Britain also saw a deepening of social mobility that, Mount hints at it, may have had little to do with the economy itself. 

The sad fact is that much of the transformation that took place in the 1960s was due (amongst other things) to the delayed convulsions of war and the changes that came with them. The galvanising and transformative effect of war can be seen even more clearly in Germany and Eastern European states, where (sadly) the largest push in terms of social mobility was achieved not through democratic means but through the extermination of a whole section of society. 

The Holocaust and the loss of 6 million people in Germany alone removed a whole cultural and political elite from society. Similar transformations happened in Eastern Europe where the Holocaust and the subsequent extermination of entire sections of society by the Communist regimes achieved temporarily an extraordinary upwards pull of lower working classes into the ruling elites. 

In essence then Mount’s desire to forge a single trajectory of concentration of economic and political power fails to convince. Britain, just like West Germany and many other developed capitalist countries, experienced a plethora of significant economic, political and  social changes, that had various origins and pulled their societies in different directions, hardly any of them exclusively oligarchic in character. 

Nothing wrong with payday loans!

The credit crunch has brought into sharp relief some questionable activities of the banks in the UK. But it is not only the high street banks that are in the spotlight. As people struggle to get credit from the main UK banks, people with poor credit history increasingly turn to loan sharks or payday loans. While loan sharks often operate in the murky zone of informal non-contractual credit agreements, payday loans are technically regulated contracts. Their agreements with customers are based on clear terms and conditions. Wonga is probably one of the best known in the UK.

Yet, pay day loan companies serve a difficult segment of the market. Their customers are mainly people who have been turned away by the highstreet banks and payday loans are temporary credit agreements which can only serve as a stopgap, not as a source of long term credit. Given their exorbitant interest rates (sometimes up to 4,000% p.a.) payday loan companies have come under fire from various campaigners. Most recently, the Labour MP Stella Creasy has argued that payday loan companies should be brought under the financial regulation as any highstreet bank (not that the regulation by the FSA made any difference to banking behaviour before the banking crash in 2008) and their interest rates should be capped by a fixed cash amount. 

At first glance, this seems one of those worthy campaigns that is driven by righteous indignation at poor people being exploited by ruthless companies. However, the first impression does not last once the reasons why many people use payday loans become clear. 

First, people who use payday loans do so because they fail to get credit from the main UK banks, often because of their poor credit history or previous default on credit agreements. Stella Creasy mentions the case of a young woman who has lost her home because of the demands of payday loans. This is difficult to understand for two reasons. 

First, payday loans provide cash to people who would otherwise get no credit at all. So, in a way they serve a community that is being failed by the main banks. 

Second, payday loans are unsecured loans which is one reason why the interest rates are so high. This means that if somebody cannot pay back the loan at the end of the month, the only consequence is that the company wont lend her money in future. Payday loan companies can employ agencies to recover their loan but they have no power over any assets people have, including property. So, in effect, if you default on a payday loan you cannot lose the home you own, no matter what happens. 

Remains the prickly issue of the high interest rates. In the wake of the financial crisis and the bailout some banks received from the tax payer, bashing a banker has been a popular sport in the UK. Yet payday loan companies are not banks, nor have they been bailed out. The reason they levy high interests rates is exactly because of the nature of their clientele, people who disproportionately fail to meet the repayment requirements. 

Payday loan companies calculate the interest rates by spreading the risks of their customers across their customer base. In a sense, they operate along the lines of insurance companies, socialising risk, rather than individualising it. So they use a risk spreading mechanism that should be close to the heart of any social democrat. The better off amongst their customers (who tend to pay back their loan) finance the loans of those who fail to repay. 

Seen this way, Stella Creasy’s campaign to cap the cash amount in interest to be paid on pay day loans reveals itself as a cynical ploy to hit the poorest hardest. If legislation was brought in to cap interest payments, loan companies would have to screen out those who are least likely to repay their loans. Which in effect means to close off the last chance to receive cash in difficult times for many of the poorest people. 

So is there no worthy cause Stella Creasy could turn to? Of course there is. Payday loan companies are here for a reason: the high street banks who refuse to lend at acceptable interest rates to ordinary people. It is the tightening of credit from the main banks that drives the demand for payday loans. 

Not that the likes of Barclays and HSBC differ much from payday loan companies. Using NatWest's unauthorised  overdraft facility can cost anyone up to 2,190% APR. Not a rate to be scoffed at. But presumably Stella Creasy doesn’t want to take the fight to the high street banks. That would involve a lot of protracted work with her parliamentary colleagues. Rather make some cheap shots at the bottom rung of financial services, it pays off with the Guardian readers. 

Why bashing bankers is shortsighted

Michael Fallon revealed the real motivation behind the decision to strip Fred Goodwin of his honour. On the Today Programme he said that there was a 'persistent demand from the public that he should lose his knighthood'. Is this the way the government is making policy these days: decisions by public acclamation? Who shouts loudest and displays the greatest amount of moral indignation wins? 

Fred Goodwin clearly has a case to answer. But his decisions should be subject to questions of competence, not moral standing. He can be accused of taking the wrong decisions, perhaps out of a lack of expertise. Yet his moral integrity has never been questioned, nor should it be. After all, let us not forget that, apart from very few far sighted observers, Goodwin's decision to buy NatWest was praised by everyone at the time. Not least was it loudly applauded by the Treasury and the FSA back in the day. 

Now, Ed Milliband was 'outraged' and appalled that Fred Goodwin retained an honour awarded by Milliband's own government back in the day. This smacks of populism and his indignation looks synthetic. While the real problems with the banking sector are allowed to continue to fester, have you heard Ed Milliband talking about banking charges recently that puts ordinary people up and down the country out of pocket every day? Not a word! 

Stripping Fed Goodwin of his knighthood is bad politics by a political class with a distorted sense of what it means to lead. As John Humphreys said on the Today programme this morning, Fred Goodwin is being stripped of his knighthood for making a wrong decision, not for committing a crime. Milliband's moral outrage is a sign that increasingly the Labour leader makes political decisions with the benefit of hindsight. It wont take him far, nor anyone else who tries it, because the fundamental fact of modern society is that everyone who comes after us will know more than we ever do. 

Our own personal greed

The debate about what caused the financial crisis seems to have been settled. Greedy bankers have gambled recklessly with our money and when the bad bets came off, the people had to bail out the financial institutions. This narrative operates with the notion that bankers are motivated solely by greed, essentially placing their actions outside the realm of normal behaviour. 

I have previously argued here that this strikes me as a highly simplistic narrative. It rests on the questionable assumption that bankers are somehow different to the normal population, engaging in high-risk conduct which no ordinary person would condone. My reservation about this account flows from the simple idea that human behaviour across populations at large and across cultures is fundamentally stable, which means that those who argue that bankers are profoundly different to ordinary human beings need to demonstrate how they came to be so different from everyone else. 

A more plausible explanation of the banking crisis may be that reckless behaviour is taking place wherever restrictions and sanctions on what is harmful to society are either vague or absent. In other words, bankers did what they did because they could. And, arguably, few of us would probably have acted differently.

There is however another dimension to the financial disaster that is rarely discussed. It is a deeply unpopular trope because it points the blame at least partially to all of us. Kieran O’Hara hints at this point in his recent book: 

‘The house price bubble, the rise and fall of credit were all engineered by bankers and financiers of course - but were only possible because very large numbers of people wished to spend money they had not earned.’ (p.255) (O’Hara: Conservatism, 2011)

This is a deeply uncomfortable truth. The desire to find better interest rates for investment, to seek out the highest return for savings or the satisfaction that many of us felt when house prices reached stellar heights, is testimony of our own personal greed. Ditto our pension funds, and how much we wanted a decent return for our monthly pension payments when we retire. 

This is of course not a narrative that you are likely to hear from politicians who are only too eager to blame bankers. Yet, the fact remains that our society has lived on borrowed means and many of us were only too happy to turn a blind eye to the reckless way in which wealth was created out of thin air. 

Better regulation of the banking sector may produce more stability for our financial system in due course, but unless we also come to value hard work again, and stop believing in ever increasing returns through financial wizardry, our society will be a mirror image of the greed in all of us. And for that there can be no regulation; only our moral code and common sense can protect us from seeking immoderate personal gains. 

What's wrong with greed?

According to the Christian doctrine it is one of the mortal sins. You may think that with the decline of christianity as a lived doctrine, talk about sin becomes less fashionable as well. Yet, greed is back and since the financial crisis in 2008 it dominates headlines and public debate whenever people talk about bankers and their behaviour. 

The main accusation is that those who were dealing with our money (pension funds and the like) were guided only by instant monetary gratification. Enormous bonus payments were the motivation for their actions, rather than any concern for sustainable banking practices. What makes ordinary people so angry is that, while the bonuses were still being paid, governments all over the world had to foot the bill for dubious banking deals that carried little actual value. It seems, so people believe, there was a dissociation between what bankers did (allegedly in the interest of their clients) and the result of their actions. 

If you ask ordinary people, they may say that greed appears to be the primary motivation of what bankers did every day. And their indignation may be spurned by a vision of a lost society where work contributed to the wealth of the nation as a whole, not just a few. But did we really just have ‘the wrong bankers’?  

There are two strange assumptions that lie at the heart of this idea that all is the fault of the greedy bankers. The first is that the outcome would have been different if we had had bankers with a stronger moral compass. Second, that our economy would be better if there was no greed. Both assumptions I think are questionable.

For Christian theology greed is one of the mortal sins and so those acts that are motivated by greed are condemnable. However, as theologians tell us, greed is not something we can simply shed off in the morning as we get out of bed. In fact, the doctrine of original sin articulates the opposite notion, that we are all prone to commit sins in our life. Christians are adamant that there can be no person who stands outside this circle of potential misconduct. While not all may share the Christian doctrine of original sin, this narrative tells us an important insight into humanity: to think that some people are innately morally better than others, is bound to disappoint. 

Scientists who study large organisations use a different language to theologians but their claim is very similar: individual actions may have intended consequences for the whole system. Pinning blame on individuals who operate within the rules is hardly helpful. Specialisation and rationalisation of processes in large companies lead to a fragmentation of tasks. Marx’s ‘process of alienation’ for the worker still echoes faintly in this idea. 

If they are right, then it must be foolish to think that we only need to get ‘moral’ bankers to have a better banking system. Blaming the banking crisis on ‘sinful’ bankers fails to recognise that everyone may have done the same in their position: to get the best results within the parameters set by current regulations. There is nothing greedy about this. We do what we are told to do, and some of us do it very well indeed. That does not exonerate people from the consequence of their actions. It does, however, shed some light at the way in which presumably innocuous behaviour can have unintended consequences for the whole system. 

The second questionable assumption is that economic relationships should be marked by morality, not greed. Ed Milliband’s recent comments on ‘bad’ and ‘good’ entrepreneurs at the annual Labour conference publicly rehearsed this idea. 

I believe he is wrong on two counts. First, it suggests that to be moral makes a better entrepreneur. But how can we judge this? What is the benchmark for morality in economic transactions? Are we supposed to examine the immediate actions of entrepreneurs or their ultimate consequences? If a company relocated their production line to overseas to cut costs and jobs are lost in the UK, yet in the process becomes more efficient and manages to expand its research and development section, hence creates other jobs here, should we condemn this? On Milliband’s simplistic terms, such a company acts ‘immorally’. Yet, judged by the outcome of their actions, the company is very moral indeed. In other words, we get into deep philosophical troubles if we try to interpret utilitarian economic exchanges with the benchmark of inter-personal morality. 

Second, injecting morality into the economic arena may lead us to misunderstand the need for regulation in the first place. Big companies do engage in social responsibilities schemes but their motivation is arguably not to be ‘morally good’ but to create a positive brand identity. It’s just part of the daily competitive struggle in the market place. If we thought all we need are company directors that are cut from our own moral cloth, we overlook that the purpose of envisaging economic relationships outside the moral domain is to highlight the need for a stable and compelling regulative framework. 

It is our responsibility as a society to define what we want the economy to achieve within the framework of free and fair market exchanges, yet it is the task of entrepreneurs to be successful and contribute to the wealth of the nation. While we should set the regulative framework for economic transactions, it is up to them to freely engage in the market place to pursue their economic interests. To conflate morality with the economy is to absolve us of the most difficult task: to define what wealth creation is for. The answer to this cannot be found in the economy, no matter how moral we want our entrepreneurs to be, sinners or no sinners.