Financial practitioners will no doubt feel that “sabotage” is an unduly harsh word to describe their livelihood. For the rest of us it might seem wholly appropriate, given how close high (and low) finance came to wrecking the global economy in the great financial crisis of 2007-08.
That said, the title of Anastasia Nesvetailova and Ronen Palan’s book Sabotage deploys the word in a rather specialist sense. In an attempt to understand what they call “the remarkable persistence and prevalence of rogue behaviour” in finance, these two political scientists from London’s City University turn to the economist Thorstein Veblen (1857-1929).
Veblen, author of The Theory of the Leisure Class, observed that businessmen were adept at making profits by interfering in markets. He wrote that in looking at business behaviour, he always found “something in the nature of sabotage — something in the way of retardation, restriction, withdrawal, unemployment of plant and workmen — whereby production is kept short of productive capacity”.
The nub of the authors’ thesis is that markets are extraordinarily competitive and efficient in the sense of reflecting all available information. Even the smartest financial folk cannot consistently beat the market and make good profits. They argue that banks’ ability to earn super-profits before and after the crisis was not because they had a competitive edge in capacity, expertise, hard work or superior knowledge. The profits arose through sabotaging the price mechanism via either internal misrepresentation of information or facts, or predatory practices that damaged clients, competitors or government.
The focus of much of this predatory behaviour before the crisis was the practice of securitisation, whereby banks converted illiquid assets such as subprime mortgages into tradeable securities that could be sold to investors. The extreme case of this financial engineering was that of “ninja” loans — those made to people with no income, no jobs and no assets. Since the banks had sold the loans, they were unbothered about the risk of default. They just took their fees and ran.
Such sabotage, the authors say, is not malicious or a reflection of greed but an attempt by bankers to insulate themselves from the intense competition in the markets in which they operate. The harm inflicted on clients, competitors and the state is a byproduct of the pursuit of this imperative. Nor is there anything new about this. The book covers at some length the famous forensic US Senate committee investigation by Ferdinand Pecora into the Wall Street Crash of 1929, which revealed similar examples of sabotage and provided the basis for a powerful regulatory response.
Nesvetailova and Palan go on to argue that regulators, in contrast to the 1930s, have unwisely given priority to financial stability instead of recognising that for finance to work for society the central aim should be to curb the urge to control markets by imposing tougher regulation on abuses such as rigging interest rates or fleecing customers. They feel that the rolling-back of the regulatory structures put in place in the 1930s has gone too far and that penalties for the various forms of bad behaviour in banking are unduly slim.
It is hard to disagree with their contention that what has gone wrong is not just a case of a few rotten apples. The rigging of foreign exchange markets and interest rates such as Libor, abusive business lending practices, mis-selling and the role of the City of London in money laundering and tax avoidance — such behaviour is so pervasive that the culture of finance has clearly been drained of ethical content.
But the notion that these conduct issues should take priority over financial stability is bizarre. Clearly egregious conduct calls for a robust response and it can reasonably be argued that policymakers have not been robust enough. Yet banks pose a greater threat to society when they are fragile than when they are dishonest — the loss of output arising from financial crises is far more damaging to living standards than the increase in the cost of financial services arising from the kind of market-rigging explored in this book.
Moreover, the notion that these examples of sabotage are the main source of profitability in the financial sector is a nonsense. Bank of England data show that in the period before the crisis, UK banks’ return on assets — which reflects the skill with which they managed their underlying pool of assets — was stagnant or falling. So they were lousy saboteurs. And the reason why their return on equity rose was down not to manipulating markets but almost entirely to increased borrowing. That is, their response to intense competition and capital market pressure was to do more business on a shrinking buffer of capital.
Much of their trading profits were anyway illusory because they were mispricing risk in new and complex financial instruments, thereby ensuring that markets were inefficient. Efficiency only dawned when big global banks wrote down $210bn on such products in 2008. As for the suggestion that banking is still generating super-profits, this may be true of one or two megaliths such as JPMorgan, but most big banks are struggling to earn a surplus over their cost of capital.
The book’s overall thesis, then, is hollow. And it is marred by occasional factual sloppiness such as the reference to Ferdinand Pecora as a senator — he was chief counsel to the Senate committee — and to the now-defunct investment bank Drexel Burnham Lambert as Drexel Benham Lambert. This is very much the proverbial curate’s egg.
Sabotage: The Business of Finance, by Anastasia Nesvetailova and Ronen Palan, Allen Lane, RRP£20, 240 pages
John Plender is an FT columnist
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