Of banks and bankers (1)
Lately, there has been a noticeable increase in the number of times a day I hear the question, “Do you think an Israeli bank will go bust soon?”
Media interviewers pose the question to analysts and other real or supposed experts, and sometimes even to bankers. The question is muttered in boardrooms, munched over lunch and taken with tea. Why are people so focused on the likelihood of a bank bankruptcy here – other than genuine concern for their own money, which is certainly a valid enough reason for concern at all times.
The assumption behind the talk seems to be that because this is now the fashionable thing to do – the biggest banks in London and New York are bellying up as if there was no tomorrow (and for most of them, there isn’t) – it would be right and proper for our local banks to follow suit. After all, don’t the Israeli banks generally adopt the latest fashions among their larger and more famous peers around the world, such as awarding their senior echelon salary packages and share options in the framework of “incentive” programs?
In a very general sense, Israeli banks do tend to do what banks everywhere else do. Banking is very much a herd business, and not to follow the herd is considered very bad form. Of course, bankers do not consider themselves sheep, or even cattle, and tend to take offense at the suggestion that their behavior is akin to that of domesticated animals – and certainly not of lemmings.
Bankers present a facade of seriousness, conservatism and professionalism. They project an aura of specialized knowledge of those things that ordinary people cannot – indeed, should not, and should not even be expected to – understand. They wrap their business in a mystique that generates respect verging on awe, but that also serves to discourage outsiders – especially politicians – from even attempting to penetrate the arcane mumbo jumbo that serves as their language.
Yet the sad but solidly grounded fact about this supposedly solidly grounded sector is that is suffers from severe cyclicity – itself exacerbating the natural cycle that characterizes economic life. Bankers have always tended to do the opposite of what they preach, notably by getting carried away in every economic upswing and lending excessively to borrowers of increasingly dubious financial strength.
This leads – to their never-ending surprise and consternation – to the banks suffering heavy losses when the financial and economic environment turns sour. In times when, as Warren Buffet noted, the tide goes out and you can see who was swimming naked, the banks tend to discover that it is they who have no clothes, having “lent” them to others. They then hasten to the other extreme, cutting lending to even the best borrowers, thereby intensifying the downturn.
That is how the system has tended to work over the course of the normal business cycle: The banks record profits in the upswing and then spew them out again as losses in the downswing. But there are also more extreme cases, abnormal times, in which the banks (are allowed by their regulators to) run amok and do exceptionally stupid things, thereby creating losses so large that they could be put out of business entirely.
This kind of situation is known as a “systemic crisis,” and it forces the banks to use their secret weapon: Unlike normal businesses that, if they collapse, can only cause limited pain and damage, when big banks go bust, they can pull the entire economy down with them. Big banks, therefore, are deemed “too big to fail” and require – and receive – bailouts from governments. Often these bailouts are conducted in ways the public never even realizes, such as rigging the interest-rate structure so that banks pay low rates of interest to their depositors but can invest (or loan) the money at much higher rates and make a handsome profit from the differential.
Another frequently used approach is to change the accounting rules governing how banks calculate their equity and report their losses. In plain language, this is called cooking the books. But again, when the government does it, “in the interests of the general public,” it’s not only kosher, it’s a mitzva.
Unfortunately, the scale of the current crisis suggests that these standard ploys will not work. In this case, it seems that the ultimate weapon – of direct government acquisition – must be used. Israel has been down that road before, in 1983, and survived to tell the tale. That might explain why the widespread expectation that one or more Israeli banks will collapse is only a conversation topic, not a panic-level action item. But is that nonchalance justified? For that matter, does the expectation have any validity?