What this shows is that from 1900 to 1985, the financial sector produced an average annual return of around 2% a year, relative to other stocks and shares. So for 85 years investing in bank shares was "close to a break-even strategy", nothing special (and very much like a utility).
But in the subsequent 20 years, from 1986 to 2006, returns went through the roof: the average annual return soared to more than 16%, which was the best performance by financial-sector shares in UK financial history. And it's no coincidence that the pay of top bankers also zoomed up to the stratosphere. Which at the time upset only a few, because the bankers seemed to be enriching the owners of the banks, their shareholders (millions of us through our pension funds) ... but did they earn it?
Additional observations made by Handlane and/or Robert Peston include:
1. The collapse of banks' share prices in the past two years has wiped out most of those gains. What this means is that in the full period from 1900 to the end of 2008, the annual average return on financial shares was less than 3%, almost identical to the market as a whole. Which is what common sense would predict should have happened, since banks are to a large extent a utility, serving the needs of the wider economy, and its difficult to see how banks in general can therefore grow significantly faster than the wider economy.
2. Were top bankers much more brilliant than their predecessors between 1986 to 2006 such that they deserved disproportionate rewards? Haldane answers this question by breaking down banks' return on equity - the return generated on ordinary shareholders' capital - into its two component parts, which are the return on gross assets and the leverage employed by the bank.
3. If you want to know whether bankers are particularly skilful, you have to look at the return on gross assets. If one bank earns consistently bigger margins on the loans and investments it makes, that tells you it is probably doing something cleverer than its rivals.
4. By contrast, leverage - or the ratio between a bank's gross assets and its stock of shareholders' equity - is the Las Vegas part of the return on equity, the contribution made by a punt or a gamble.
5. The important point: for any rate of return earned per unit of a bank's gross assets, the return on shareholders' equity rises as the assets-to-equity ratio rises - or, to use the jargon, as leverage rises. Increasing leverage is a simple and automatic way of increasing returns to shareholders and there's nothing terribly clever about it.
6. Maximising leverage is the equivalent of buying a house with the maximum amount of debt: it looks like an awfully smart thing to do when everything's going up up up, but is the fastest way to lose money when the economy turns.
7. Haldane found that (since 2000) the rising leverage fully accounts for movements in UK banks' ROE [return on equity] - both the rise to around 24% in 2007 and the subsequent fall into negative territory in 2008. In other words, in the seven years before the crash, British banks' bumper profits were in aggregate generated wholly by a massive increase in leverage by the industry: and in Haldane's view, these would be returns generated by gamblers' luck (the jackpot from the roulette ball landing on black) and we all playing the price (because the Government couldn't allow then to fail because of millions of people's savings), in the form of the worst global recession since the 1930s, now the bankers' luck ran out (when the wheel spun to red) ... ie it was nothing to do with skill or ability.
8. The overall level of bankers' pay was inflated over the past few years by the rewards they scooped from the leverage gamble, not due to their skill, hence the title of his post!
Robert Peston went on to discuss ways of preventing bankers from repeating these reckless gambles again ... eg i) cutting to a level commensurate with an industry that's closer to a boring utility than to a wealth-creating, entrepreneurial venture [NB This has not happened yet. In fact, if anything, bankers are pumping up their pay packages again], ii) Regulators imposing a legally binding maximum - and at a relatively modest level - for the ratio of a bank's gross assets to its equity, the leverage multiple, to restrict bankers' freedom to gamble. iii) Owners of banks should be very cautious indeed about rewarding bankers for the returns they generate on equity, and should focus rather more on the returns earned on gross assets. iv) Introducing 'moral hazard' into banking to persuade bank chief executives and employees that they'll really suffer personally if they place reckless bets that go wrong.
All are good ideas, but there's more to it than this, as Brown and Darling have a great deal to answer too. It was they who created the non-robust tripartite approach to regulation, to 'profit' from it and increase public spending ... for instance take a look at my comments (and others on his blog too) ...
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Post 156 (Leanomist) wrote:
A provocative article, some good insight and some great comments - my joined up highlights (and a few of my own comments) include:
1. Wee-Scamp wrote:
"This is a good article but I also think we need to look at banks, their leaders and their shareholders in the context of what they achieved for the country ... In the UK's case their activity did huge amounts of damage to manufacturing, slashed the business birth rate, pushed house prices through the roof, created record household debt levels, created a record trade deficit and so on and so forth ... "
2. BankSlickerminustheR wrote:
"This is just fraud on a massive scale...but who will grow some cajones to go after these banksters and start prosecuting these vermin ... The discussions on regulation reform are shaping up to be a complete whitewash ... We have been soft soaped and shafted by The City ... and they are being given carte blanche to do it all over again! GIVE US A NEW GLASS-STEAGALL (EQUIVALENT) LAW - NOW!"
5. John_from_Hendon wrote:
"The other critical element in the explosion of the 'fake' returns of banks was to permit asset price inflation to be seen as a good thing (which of course it is not, and has never been, and if we are to get a recovery this must be fully understood). This was achieved through successful lobbying of the banks and their economic friends educated in institutions which themselves became dependent of the finance sector (See Harvard) to have mortgage costs and house prices removed from all inflation indices (these indices being used to measure the effectiveness of monetary control) This was insane and inevitably led to the collapse in the price of money, which itself let to the 'necessity' to loan this worthless money to less and less creditworthy customers on poorer and poorer security which let the CDSs and CDOs etc. etc. which led to the global collapse ..."
72. At 12:42pm on 03 Jul 2009, stanilic wrote:
"...In the light of what you describe one can only ask what were the regulators doing whilst all this was going on? It was not as if there weren't enough of them under the new Tripartite system introduced in 1997 by you-know-who. Was there a sub-text at that time nobody noticed as looking at current circumstances I doubt very much if you-know-who had the ability to think it through on his own?
So we have bankers cutting and shutting debt instrument thanks to deregulation, massive development in computing power, mathematical modelling and a perception of a new paradigm. Talk about The Bubble as it was once known.
More significantly we also have governments using this explosion in presumed wealth to expand the base of the state into all parts of the economy and society on an assumption that the government cares. Inevitably government will not regulate the bankers too hard as they too became dependent upon the money. So we now had a Double-Bubble.
Both of these events at the time pushed the remainder of society into a cul-de-sac where we were left to live of the remains of the feast. It became very difficult to create commercial value in real terms because the rate of return on investment was vastly inferior to what could be got from The Bubble. So we lost a million manufacturing jobs.
Now that the Bubble has burst we remain still at only the start of the new times. The state is a bloated shell that needs to shrink in size. The banks want life to continue as before: well they would wouldn't they? And the political will to move on is just not there.
The real economy once discarded as too cheap and too poor is now underpinning the lot. The balance of power in the economy has changed; but nobody has noticed yet.
At least the bankers got their new paradigm: it is not the one they expected but then they never are. Time to change and change big because (old cliche coming round the bend) those who refuse to learn the lessons of history are doomed to relive it.
The public are in a hanging mood because they understand times have changed but those who say they are our betters have not and probably cannot. Time to encourage the others, methinks..."
125. ExcellenceFirst wrote:
There was me thinking that just a little bit of reality was seeping into the public consciousness, and that maybe, just maybe, we were getting towards the stage where we could start to put our intellects together and devise an appropriate way out of this mess which is of our own making - all of us ... And then I read the comments to this post, and with the notable exception of stanilic (above), everyone's come to the conclusion that the independent decisions of banks and bankers are wholly to blame for the situation we are in. It will never cease to amaze me the power of the establishment to mould the thinking of people into whatever shape it wants. Absolutely unbelievable ... So the reality is that we still can't make any progress in sorting ourselves out, because, other than a handful of people, everyone is heading off on a mental wild-goose-chase. At the end of which we will end up with reams and reams of "action" none of which is remotely close to addressing the issues that need to be addressed ... O brave new world that has such people in it..."
144. ExcellenceFirst wrote:
"I think we should start by reacquainting ourselves with reality. And top of the list would be the criminalisation of using deception for advantage. So goodbye most advertising, promotions, public relations, marketing and spin. Communication becomes genuine and honest. Making progress as individuals requires us to do things better - and not to waste time and effort to work out more and more convoluted ways of describing what we actually do as being better than that which it replaced.
The point is that we will have to do this sometime, and sometime soon. There will come a time when so many people refuse to believe a word they're told about anything, that government of the country becomes impossible. We're moving ever closer..."
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And my observations:
It is amazing to see the Government (Gordon Brown and his Darling) focus on blaming the banks, when it is they that introduced the flawed/ineffective tripartite system of regulation, which allowed lax regulation to prosper so they could build up the economy (and hence public services) based on the 'short term economic bubble of profit" that resulted - and all at the expense of the real economy! Shame on them - and all who allowed them. Given Gordon is supposed to be a religious man - perhaps he should re-read the ten commandments and scriptures related to money lenders.
David Clift, a Future 500 Leader
PS Contrary to popular belief, Brown and Darling are not dealing with the crisis - They want to maintain the tripartite system and Darling is now having to 'plead with the bankers' not to start the bonus culture all over again e.g. take a look at http://news.bbc.co.uk/1/hi/business/8131898.stm (and http://poweromics.blogspot.com for a wider perspective too ). They created the problem, refuse to acknowledge this, and are failing to fix it too (and people allow them to).
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