National politics

Moral hazard, or why we only have one sound bank left

Over the last week the banking chickens have been coming home to roost in a big way. On 19th February the Office for National Statistics announced that it would re-classify credit crunch victims RBoS and Lloyds as being part of the public sector thus adding between £1 trillion and £1.5 trillion to Public Sector Net Debt. To underline this the Bank of England governor told the Treasury Select Committee yesterday that these banks had effectively been nationalised:

The Government owns more than 50pc of the equity [in RBS and Lloyds] and can take its decisions accordingly.

I don’t see a significant difference between that and outright nationalisation – except in the sense that this system we have now has the merit of trying to make it clear to everybody that nobody thinks the Government should be running these banks indefinitely.

Fred the Shred’s £693K a year pension is a side show if a totally unacceptable one. This man is in large part responsible for us going from having four large, capable world class banks to having one. HSBC still stands tall, we will find out how tall on March 2nd when it announces its figures. Barclays is walking wounded and will probably try to offload some of its worst assets onto the government. It still managed to post £6.1 billion of profits this month so there is reason to be hopeful about Barclays.

Lloyds is effectively nationalised, an otherwise sound bank laid low by a combination of the hubris of its management, thinking they had a once in a lifetime opportunity to grow by swallowing HBOS, with Gordon Brown’s inept meddling. A vain attempt to save another once great Scottish institution – Bank of Scotland. Yesterday Lloyds announced an 80% profit fall in its original business on top losses of £10.8 billion at HBOS.

Goodwin’s pension has totally overshadowed yesterday’s formal announcement of the largest corporate loss in UK history – £24.1 billion on the part of Royal Bank of Scotland. RBoS took over NatWest nine years ago in a £21 billion deal that made Goodwin’s name and saw this upstart Scottish bank take NatWest’s place at the top table of British banking – the big four.

There are two phrases we hear a lot recently. One of those is that our banks are too big to fail. The technical phrase used by central bankers is moral hazard. Moral hazard is the prospect that a party insulated from risk may behave differently from the way it would behave if it were fully exposed to the risk. Moral hazard arises because an individual or institution does not bear the full consequences of its actions, and therefore has a tendency to act less carefully than it otherwise would, leaving another party to bear some responsibility for the consequences of those actions.

Another phrase we hear a lot is hindsight or rather that it all very well to carp about the credit crunch now but you can only do so with the benefit of hindsight. Really?

For the average man in the street the first chapter of the credit crunch was the failure of Northern Rock. We first knew there was a problem on 13th September 2007 when Northern Rock applied to the Bank of England for emergency support. Those in the banking world knew there were problems in banking over that summer. RBoS’s takeover of ABN Amro was only completed in early October in the face of a lot of negative comment about the sense of the deal. Apparently the whole RBoS board were in favour of the deal. They didn’t hear that the music had stopped. Could it be that they figured that the Government would cover the downside? You didn’t need hindsight to avoid buying ABN Amro just some feeling that it was risky and that it might destroy you. Clearly Goodwin and his board thought that they were immortal. Moral hazard at work.

I can’t help feeling that if Northern Rock and even HBOS had been put to the sword rather faster and more emphatically than they have been our bankers would have woken up and smelt the coffee rather sooner. I also can’t help feeling that Newcastle based Northern rock and Edinburgh based Bank of Scotland were not only too big to fail but too dangerous to Labour’s re-election to fail. Goodwin and Brown are surely the joint authors of this mess.

4 replies on “Moral hazard, or why we only have one sound bank left”

Don’t forget that we have got a few sound building societies left (compared with the banks). The Chelsea is one example. There is also the Post Office.


What do I think to the Royal bank of scotland? RBS boss Fred goodwin should be stripped of his pension. If they pay him a profit related percentage he will get minus figures. Taking away his pension is the best option.


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