January 24, 2010
Do you remember the concept of the ‘free house’? When I was a teenager, one of the greatest gifts a parent could give a child was a ‘free-er’. Parents who went out on a Saturday night and left their 16-year-old son or daughter in charge had no one to blame but themselves for the state of the place when they came home.
In Dun Laoghaire in the 1980s,the news of a free house could travel miles, with all sorts turning up at the doorstep to be let into someone’s house to drink Stag or flagons of whatever was going.
The free house was a mystical place. It was much better than hanging around with nowhere to go, and infinitely better than going to Wesley, where you would have to run the gauntlet of the bouncers – and then figure out how to get home.
Most of the time, there were enough sensible people – mainly teenage girls and a keen bloke waiting for favours based on good behaviour – who cleaned up the freer after everyone was gone. They made the place look as if only the daughter herself was there all night doing her French homework.
Anyway, for many of us, the free house was a rite of passage, a wonderfully chaotic place where all sorts of carry-on passed for normal teenage behaviour. The golden rule was that, if you were snared or if things got out of hand, the free house wouldn’t happen again. Parents who rumbled a melee made sure that was the last. A kind way to look at our delinquent Irish banks and the mess they have left us with, is to regard them as the equivalent of out-of-control teenagers who were mistakenly treated as adults and acted like little children. Over the past ten years, the government gave them the equivalent of a financial ‘free house’, and they made a hames of it.
Worse still, they gave us the bill. Like dumb teenagers who couldn’t see that if they just kept the lid on things, they could have free houses every week, they blew it – and their chance of ever being left on their own again.
Last Friday, US President Barack Obama closed down the ‘Wall Street free house’. What will our toothless government do to penalise and rein in our economic adolescents?
‘‘Never again will the American taxpayer be held hostage by a bank that is too big to fail.” With these words, Obama did what almost everyone outside Wall Street had been hoping he would do for at least a year. Obama has pulled American – and by extension global – investment banking back to the 1930s.Like errant children, they were given the run of the house when the parents were away, and they messed up.
He has told banks that they must get back to the knitting and stop running their own private trading desks, investing or owning hedge funds or private equity firms.
At the stroke of a pen, he has taken a huge amount of the risk off the balance sheets of the banks so that, in the future, if there is a market meltdown like last year, it will not threaten the banking system. It is not that there won’t be the same trading and risk-taking; it is just that the traders will not be risking ordinary depositors’ cash, and therefore there will not be a risk for the taxpayer. By taking this risky stuff off the balance sheet, the US government hopes that the risky speculation of the few will not be paid for by the many – which is now the case in Ireland with Nama.
Before we get back to our own case, let’s examine what Obama is trying to do by explaining these shadowy-sounding entities like proprietary trading desks, private equity outfits and hedge funds – and how the banks ended up owning them.
Many years ago, I worked on one of these proprietary trading desks at French bank BNP. We traded the government debt of emerging market countries, such as Russia, Brazil and the Asian tigers. We also traded debts that had defaulted, such as those of Argentina, Venezuela and Brazil.
The idea was that we would bet on these risky but very high return markets, using the bank’s (depositors’) money. By doing this, we would drive the profits of the bank through the roof and everyone would be happy.
Over the next ten years, international banks extended these types of operations to include hedge funds. These were again trading operations taking risky bets on listed stocks and bonds to make more money than the average stock. In later years, private equity operations emerged which took large positions in existing private companies and then sold them either to competitors or to the market by way of a flotation. In many cases, the banks themselves financed the acquisition of their own companies by lending to the potential buyer. All the while, profits increased.
Then, of course, the hedge funds started buying all sorts of property-related derivative products, as did the proprietary trading desks, taking bigger and bigger and riskier and riskier bets to make the more elusive ‘home run’.
When the market collapsed, so did these bets, and the depositors of the banks had to make up the shortfall. But they couldn’t, as the banks had been borrowing many times the deposits on the books due to deregulation. The free house was out of control.
So Obama had to come in and buy all this stuff that was on the banks’ balance sheets to make sure the banking system didn’t collapse, even before the traditional runs on the banks occurred. These schemes, where the Treasury paid good taxpayers’ money for rotten derivative products, were nicknamed ‘cash for trash’.
In Ireland, we have our own ‘cash for trash’ deal. It is called Nama. Here our government will buy trash from developers to keep the banks afloat and try to tell us this crud is worth something.
Imagine the government went one step further and, like Obama, vowed ‘‘never again’’. What could it do? Well, it could prevent banks from ever again getting involved in property and move back to a building society model. Remember: our ‘derivatives’ equivalent was commercial property,100 per cent mortgages and speculative development land deals. If we were to follow the US, the next move after Nama would be to ban the banks from getting involved in property again.
We could also change the rules associated with how much collateral we extend against property. In order to make sure that a property boom never happens again, we could restrict the collateral given against property to the ‘average’ price of the property for the last 30 years. We would never have a property boom again.
But such moves would imply learning from our mistakes. Is this something we do in Ireland? Or, putting it another way, are we, the parents, prepared to make the out of control teenagers pay for their mess? Nah, never, that would be too sensible.
The lesson from the Irish financial free house is: don’t worry, you can do whatever you want. These parents are a walkover.