Even after separation, investment banks will continue to use funds from retail banks, pension funds and insurance companies for their speculative activities. The speculators will continue to shelter behind limited liability and dump losses on to innocent bystanders. Unless the benefit of limited liability is removed from investment banks, their losses and reckless risks will inevitably be transferred to other sectors.
Hmm. Not convinced. Goldman was a partnership until recently and no one\’s said that Goldman has only become a problem recently. But let\’s see what his case is:
For any possibility of containing the crisis, speculative banking needs to have unlimited liability. Thus, if the bets go bad, bankers will personally need to bear the negative consequences.
Ah, no, he doesn\’t understand it, does he.
Limited liability protects the owners of the business, not the people in the business.
You could, in theory at least, have a firm where the shareholders had unlimited liability. Although we more normally think of this arrangement as a partnership: the way accounting and law forms are organised.
But it\’s still the owners of such organisations that have the unlimited liability. Not the people working in them (to the extent the two do not overlap).
And, like other bets, derivatives don\’t always pay off – as the cases of Nick Leeson at Barings and more recently Jérôme Kerviel at Société Générale exemplify.
Wouldn\’t have made the slightest difference to either of those two.
The above reforms will help to reduce speculative activity and quarantine the negative effects of reckless gambling. They will also remind neoliberals that the freedom to speculate needs to be accompanied by responsibilities.
And he\’s very slightly missed the point of all these derivatives: which is to transfer risk from operators to speculators. The whole point of the system is to allow speculators to gambol: that\’s what it\’s fucking for!
All of those who go on about how investment banking was ruined by the transition from the partnership model to the corporate model seem to focus on the limited liability aspect. That is wrong. The issue with the corporate model was not limited liability but the separation of management and ownership.
Under the partnership model each partner had unlimited liability (true) but they were also the owners and managers of the business. Thier personal and business incentives were aligned. Business did well, they did well, business did poorly they suffered personally.
But changing into limited liability companies, the managers of the business were no longer the owners. The managers had an incentive to maximise returns for themselves via salary and bonuses etc which meant taking on more risk, any downside would be borne by the shareholders and not them personally.
So this has nothing to do with limited liability and everything to do with misaligned incentives.
As everyone who reads this blog regularly would no doubt agree. Incentives matter.
Hmmm….Not entirely sure here, I accept the banks lending out money which I have put in there for safety (let’s assume for the moment they actually lend MY money rather than just making it up). I expect them to lend only to sound ventures, since it is MY money, what I do not expect is that they can lose MY money and then just shrug and show empty pockets while going back to their million pound houses in their flash cars. What am I missing here?
(my emphasis) I must admit, that is a new perspective on banking.
Tim adds: I thought that was quite a good pun myself. Certainly it was deliberate…..
The LTCM partners at one point had nearly $2bn in the business. That didn’t stop them blowing up and losing the lot.
The CEO of Lehman, was too slow to make a deal that might have saved the business. The reason was that as a major shareholder he was in line to lose a fortune, as the company had to be sold on the cheap.
Ownership does not immunise companies from stupidity either.
Robert the Biker
What you are missing is that the banks have to repay your money unless they go bust, at which point your money will be paid to you under the deposit insurance system.
The only people hurt by Kweku Adoboli, for example are the shareholders and his former colleagues now being laid off. I feel sorry for them, losing their jobs due to no fault of their own.
I doubt Prem Sikka would ever have sympathy for an investment banker, or a bank shareholder for that matter. He and his ilk are just trying (quite successfully unfortunately) to make everyone believe that the casino side of the banking business is responsible for our current problems, rather than the boring side of banking which is the true culprit.
Separation will ensure that investment banks get access to capital at a rate that fits their risk profile, rather than allowing cross subsidy from the retail business. If retail banks, pension funds and insurance companies are stupid enough to supply funds to investment banks without proper due diligence then I suggest that these sectors are employing complete idiots.
I note how terrible limited liability is that all those honest lawyers and wonderful accountants are rushing to embrace it. Even the Sage of Wandsworth himself worships at the altar of the LLP. Despite it being a hideous evil tax avoiding (or did I mean efficient?) way for stinking capitalist barbarians etc, etc …
Let’s have full responsibility for politicians too. When they proudly splurge billions on ‘progressive’ crap which goes tits up, we can seize their assets and jail them for 20 years.
“The whole point of the system is to allow speculators to gambol: that’s what it’s fucking for!”. Thanks Tim, now we know what is system is for and wht your brand of free markets are about. Well, I don’t wnat them to gamble with my savings and pension money without my permission.
You laud Goldman but fail to note that it received federal bailout monies and also lobbied heavily for the AIG bailout which sent $13bn to Goldman.
Also another fallacy. Most partnerships that you refer to don’t exist. They are limited liability partnerships and their partners. That was the reason why lawyers, accountants and others were so keen on the concept.
Tim, you find it so easy to throw stones at others but fail to come up with any solutions other than letting markets trample all over us.
Prem’s idea that unlimited liability solves the speculative banking problem is total nonsense. First, partners’ total worth is probably nowhere near enough to cover all the losses that casino banks can make.
Second, if a SMALL casino bank goes bust, who cares? Barings went bust in 1995 and no one turned a hair. As to large systemically important casino banks, their excess risk taking will just have to be curtailed, else we get another Lehman event.
As for high street or retail operations, it would be perfectly feasible to have ALL POTENTIAL LOSSES covered by making ordinary depositors loss absorbers, and for reasons spelled out here:
So don’t let them have access to them. Simples. You might not get as good a rate as you hoped but you’ll be safer.
According to Vickers, the point of opting for a ring fence rather than full separation was to enable investment bank divisions to provide liquidity and/or capital to failing retail bank divisions, thus reducing the likelihood of taxpayer involvement. Unfortunately the popular meme has this the wrong way round.
“The LTCM partners at one point had nearly $2bn in the business. That didn’t stop them blowing up and losing the lot.”
Agreed, but that’s not unlimited liability. That does seem to worry people – as noted above, every large law and accountancy firm incorporated the moment they could.
But today is not a day for disagreement and strife. The sky is blue, the sun is shining (really is, exiles). As I look out my window, speculators are frolicking and gambolling through ‘Change and Cheapside, looking adorable in their cute striped suits. But a note of sadness comes over me, as I think of the inevitable trip to the abattoir that awaits them…
We your loyal followers believe you when you say “gambol” was deliberate, despite past mishaps with spell check. But if so, don’t you think you’re taking this “capitalism red in tooth and claw” a bit far? Even Prem is just calling for bankruptcy.
expect them to lend only to sound ventures, since it is MY money, what I do not expect is that they can lose MY money and then just shrug and show empty pockets while going back to their million pound houses in their flash cars. What am I missing here?
Caveat emptor, possibly.
Missed this …
If it’s not your money then you don’t need to worry about them losing it, do you? NB – if banks could just ‘make money up’ then no bank would ever go bust.
Without the benefit of hindsight, how do you determine “sound ventures”? Hell, mortgages used to be thought sound (even the 100%+ ltv ones).
Why not? They’re employees. What do you do after a bad day at work? The agent / principle problem is a major issue for any organisation where ownership, authority and risk are not well correlated. And you’re not even the owner, merely a customer.
Dick Fuld of Lehman gambled with the firm because he had enough cash to live on ($400m) and the stock was the icing on the cake which made him a billionaire. If he had has no cash then he would have been less reckless.
Reportedly there was a deal on offer late on from the Koreans, which would have saved Lehmans but wiped out the shareholders. Perhaps if Fuld had been a bondholder rather than a shareholder he would have accepted the deal.
“Perhaps if Fuld had been a bondholder rather than a shareholder he would have accepted the deal.”
I reckon if he was facing unlimited personal liability for Lehmans’ losses, down to his last cufflinks, he’d have bitten their hands off.
FWIW I’m not saying that unlimited personal liability is the way forward. You can be too cautious. Alternatively it might mean that the only people who went into banking would be the very kind of chancers we’d prefer to keep out.
And I’m not clear who/what is he advocating unlimited liability for? Shareholders? Senior management? Going back to partnerships for banks?
Actually partnerships died out because gambling became more profitable (and technology in general made banking more capital intensive) and reduced the value of individual reputational capital being sold to the next generation of investment bankers –
Look at the example of the old fashioned private banks, owned by the partners who are lending their own money. It sure focuses the mind whether to lend or not, and what percentage of loan to value.
That’s ultra-conservative, so banks with more of a risk appetite are required, especially to lend to businesses. Where it all went horribly wrong was a combination of fractional reserve banking, 100% mortgages, and the fact that they were always playing with other people’s money with no risk to themselves. Its really not rocket science to see what’s been wrong with the banking system.