[DEBATE] : Banks Are Prevailing in a Tug of War

[Riaz K Tayob]

Banks Are Prevailing in a Tug of War

May 3, 2009

Informed debate is a crucial part of public policy development. But the 
behind-the-scenes tug of war between banks and the government over the 
results of their recent stress tests strains the already tenuous 
credibility of the exercise. It also shows that banks have become too 
powerful.
Skip to next paragraph

How so? First, banks and their regulators run stress tests all the time, 
on individual products, divisions and the institutions as a whole. 
Without them, it would be very difficult to manage risk or allocate 
capital among business lines. The current crisis proved these tests were 
inadequate — or in some cases, ignored by bank managers. But that’s 
largely because of management incentives to take excessive risks, and 
the failure of the tests to use sufficiently grim projections.

So it’s curious that regulators have put so much stock in the tests they 
announced in February. The release of their results has been delayed 
while banks ask for clemency. Since the results will determine which 
institutions will be forced to raise private capital or take further 
government infusions, the stakes are high.

But like the banks’ earlier and insufficiently stressful stress tests, 
the government’s worst-case outlooks aren’t all that far-fetched. They 
also use banks’ own estimates, meaning unscrupulous managers could tweak 
them to get a better grade. And bankers say they’ll produce very little 
information that regulators don’t already have.

Because of this, bank risk managers (not the most credible group these 
days) tend to view these tests as a public relations stunt that 
regulators will use to force their institutions to toe Uncle Sam’s line. 
That, in itself, is worrying. Regulators shouldn’t have to invent 
justifications for regulating properly. The right response by a bank 
when its overseer says jump is, “How high?”

That regulators are wrangling with banks over the results of these tests 
shows that they are not confident in their ability to understand the 
institutions. That gives banks too much power because regulators are 
forced to rely on many of their assertions about, say, complex products’ 
values. It would be better for watchdogs to demand that they reduce 
their complexity to comprehensible levels. Otherwise the banks will 
retain the upper hand and no amount of testing will be sufficient to 
diagnose their problems.

May Day’s Softer Side

“What the bourgeoisie therefore produces, above all, are its own 
grave-diggers.” Stirring words, but they won’t be on the lips of the 
union protesters clogging the streets of big European cities on Monday, 
the May Day bank holiday. If the marchers want a rallying cry relevant 
to the current crisis of capitalism, they won’t find it in the grim 
conclusion to Marx’s Communist Manifesto.

The worst recession in decades might have been expected to spawn more 
widespread violence than it has. European unemployment is up sharply, to 
8.9 percent in the euro zone and 17.4 percent in Spain. There are now 14 
million nonworkers in the euro zone.

But these seemingly alarming rates of unemployment aren’t exceptional by 
the standards of the last two decades. And while unemployment can be 
hard on those it affects, Europe’s jobless don’t seem to be suffering 
enough to do much more than moan. Unemployment benefits are generous, 
health care is widely available, homelessness is minimal.

Unemployment has lost it stigma as well as its sting. The jobless 
include many with a socially acceptable reason for being out of work — 
early retirement, extended education, widening definitions of 
disability, or just taking a break. That may explain why governments 
have to prod hard to get people back to work.

But the complacency of nonworkers cuts both ways. It is frustrating, in 
that their return to the labor force would help restore economic balance 
by lowering wages and reducing the burden on government. But the 
relative lack of violence is also a sign of economic success.

In precapitalist days, a downturn meant famine. Industrial workers were 
often destitute in Marx’s time. If this crisis is the worst that modern 
capitalism can manage, then bosses, workers and nonworkers should really 
unite on May Day to celebrate.

DWIGHT CASS and EDWARD HADAS

For more independent financial commentary and analysis, visit 
www.breakingviews.com.