Saturday, 7 February 2009

Here are your conclusions, now go and investigate

Well well, what a surprise. The government is going to launch an "independent" investigation into how banks are managed, so the BBC tells us. There seem to be no plans to look into how haulage companies are managed, or estate agents, or clothing manufacturers, or fish and chip shops or saunas & hanky-panky parlours. Just banks. Why? And why now?

Investigating how certain businesses are run is a perfectly legitimate role of government. There have been many such investigations over the years and for many different reasons. Perhaps there is a suspicion that a cartel is operating and keeping prices artificially high to the detriment of the consumer, or that company law regulations are being breached or taxes being evaded; all sorts of potential wrongdoing can justify an investigation. The common theme always is a concept known as "the public interest".

That term is used in various different contexts to mean different things. In relation to business it covers three things: law-breaking, unfair trading and business practices which cause structural problems to the economy.

Although it is not widely known, the Companies Court has the power to order the winding-up of a business for acting against the public interest. It is a power used to protect the public from cheats and spivs who appear to be running legitimate businesses but are in fact misleading or manipulating people in a dishonest or otherwise unfair way. I recall it being used a few years ago to wind up a company that appeared to be offering a roadside recovery service but had no trucks or contracts to use trucks and, on close examination, the contract gave the company an absolute discretion whether to send out a recovery vehicle at all. It wasn't a fraud because the contract was clear (at least to a lawyer), but it was misleading and the whole operation appeared more geared to refusing assistance than giving it, so the court wound it up to protect the public.

Applications to the court in such cases are made by the Department of Trade (or Business, Enterprise and Regulatory Reform as it is now so absurdly named) in its capacity as a regulator of good business practices. To my mind that is an important function which, perhaps, could be carried out by a non-governmental body, but I have no objection to it being done by a government department provided they keep politics out of it. The reason they must keep politics out of it is that investigatory powers and powers to take action against those who appear to be misbehaving are powers of law enforcement not law-making. Enforcing the law, in a fair society, should be impartial and aplotical. For decades they have had no difficulty keeping politics out of it because governments of both parties have accepted this basic point.

One aspect of aplotical impartiality is that investigations launched by government departments into particular businesses have been concerned primarily with seeing whether existing laws have been complied with. Government has no legitimate function in assessing the efficiency of individual private businesses, that is for the directors and shareholders to consider. So what is this new investigation going to look at?

The report suggests one area is "the extent to which financial incentives encourage bankers to take risks". Call me simple if you will, but I fail to see how any useful conclusion can be reached about the effect of financial incentives (ie bonuses) generally by looking only at one type of business. Nor can you discover anything by looking at specific transactions that you cannot already infer by applying a bit of common sense. You don't need to investigate anything to be able to infer that bonuses payable on the current paper value of business you write will cause people to try to maximise the amount of business they do unless there are countermeasures operating against that incentive.

Any individual banker faced with a decision whether to lend or not lend will be influenced by the desires of his employer. These are contained in formal documents outlining lending criteria: "thou shalt not lend more than 75% of the value of the property offered as security, thou shalt not accept a valuation except from a surveyor holding the qualification of Membership or Fellowship of the Royal Institution of Chartered Surveyors, though shalt not accept proof of the income of a self-employed applicant other than ..." and so on. If these criteria are sound then the total value of business written doesn't matter and no incentive by way of bonus can do anything other than result in increased good business. On the other hand, if the criteria are too lax and leave the bank open to risk, bad business will be done and incentives to increase the amount will also result in an increased amount of bad business.

There. That's the investigation done for them. My invoice is in the post.

Bonuses do not and cannot define the quality of business done although they can influence the quantity. If a bank does not have sound lending criteria it will make bad loans. The relevant question is not what effect bonus structures have, it is what role the regulator should play in circumscribing lending criteria. There is a public interest here, namely the benefit to the whole economy from having a stable financial system. It is, therefore, legitimate for government to investigate causes of instability. What is not legitimate is to hone-in on one of the two forces governing the amount of lending undertaken while leaving the other out of account. In other words, an investigation into the management of banks is so far wide of the mark it will be a waste of time and vast sums of taxpayers' finest.

It has already been made clear what conclusion the government expects the "independent" investigators to reach. It is set out in terms by Mr Darling in his remarks quoted in the BBC article. He is reported as having said "people feel angry about excesses of bank bonuses". There we have it, the conclusion has already been reached, banks have been paying excessive bonuses. Game set and match, thank you and good evening. That is not to say I do not believe bonuses to have been excessive. My belief is that they have been obscene because they have resulted from doing bad business rather than good business and, as far as I am aware, they are not liable to be recouped when risky loans turn sour. That is absurd and, I suspect, is in part the result of bankers believing the government's constant assurances for the best part of a decade that the economy was on a path of irreversible real growth and nothing would turn sour again. More fool them.

If there is to be a formal investigation into what went wrong it must cover all relevant factors. The way banks were managed is only a small part of the picture but it is the one from which the government thinks it can gain the most political capital. Why has it not been announced that there is to be an investigation into false claims that boom and bust have been abolished, or into the failure of regulation of lending criteria, or into Credit Default Swaps and the other ways in which risk was passed back-and-forth and multiplied? It's obvious, because there is no possible chance of gaining votes from the result of the investigation.

What has been announced has nothing to do with the public interest. It is pure party politics and, as such, is an abuse of power.

No comments: