The Economist exonerate the bankers

(The author of this blog has to declare his personal interest in this article as a person who was brought up on The Economist and is still a very keen reader. Therefore this article might be too benevolent to The Economist than it possibly should have been.)

On 8 October 2009 The Economist wrote in a Leader "It wasn’t me" that banks bosses "were mostly useless, not venal." This may actually be correct, to some degree, but it does not justify the key premise as somehow this crisis was a giant global cock up caused by "useless" bankers.

Cautious conclusions, based on other fraud investigations, indicate that a bunch of quite (not that) clever financiers changed the banking system practice from "fractional reserve banking" (i.e. lending with loan to deposit ratio below 100%) to, what the author of this blog called, "depleting reserves banking" (i.e. lending with loan to deposit ratio above 100%, which technically and legally is a pyramid scheme).

"Depleting reserves banking" rather than accumulating cash reserves at every deposit – loan cycle, depletes them. To cover this up a lot of instruments and methodology were invented (so-called "financial innovations") giving an illusion that whilst banks' reserves were rid of cash they somehow still had the reserves to cover for cash liabilities. This has nothing to do with whether cash is a paper or electronic record, but who is the guarantor of liability. Cash is guaranteed by a state. This is the key to understand this crisis: whilst capital reserves appeared to have been sufficient at the start of this crisis they collapsed in value as there was no sufficient cash on the market and only a state intervention prevented the financial system from a melt down.

"Depleting reserves banking" practice needed an army of incompetent "professionals" to run it. Incompetent to such a degree that they did not understand that this was a crude pyramid scheme that was bound to collapse. Hence a huge bunch of history, anthropology, other social sciences and, importantly, lawyers were employed as banks executives to execute heist designed that way. Typically these people's career in banking was very often based on hang-ups. A huge majority of them were very poor in math in school and banking environment gave them a sense of massive self-importance and belief. They became "masters of the universe" whilst many of their friends who were so much better at it in school were left behind in pretty poorly paid and mundane engineering jobs. This was very important to the heist organisers. It created a mindless and incompetent army of financiers, like child soldiers in Africa. It also built a massive lobbying army protecting heist organisers from criminal consequences. It is rather impossible to lock up thousands of influential thieves, most of whom did not even understand they were stealing. A lot of them still believe they were "creating value". Psychologically it is like prosecuting child soldiers in Africa. However this time we deal with the adults who should have known not to do jobs they were not suited for. Like a butcher should know that he cannot operate on humans: even taking appendix out which is a surgically trivial operation.

The Economist should not rush to any conclusion. Exonerating the bankers does not look like a balanced and objective judgement. Their leader writer does not have to agree with the analysis above. However in old Economist tradition it should advocate a thorough forensic examination of the causes and mechanics of this crisis which is too big for half a page broad brush editorial judgment.