BoE's Andrew Haldane: Losses caused by banks as bad as a 'world war'

The Bank of England's Andrew Haldane put a price tag on the size of the loss from the financial crisis caused by the banks:  a 'world war'.

As reported by the Telegraph,

The financial crisis has been as economically devastating as a world war and may still be a burden on “our grandchildren”... 

Andy Haldane, the Bank’s executive director for financial stability, added that public anger at the banks was fully justified and that pay in the industry remained too high. 

“In terms of the loss of incomes and outputs, this is as bad as a world war,” he said. “It would be astonishing if people weren’t asking big questions about where finance has gone wrong. 

“If we are fortunate, the cost of the crisis will be paid for by our children. More likely it will still be being paid for by our grandchildren. There is every reason why the general public ought to be deeply upset by what has happened – and angry.” 

Four years since the crisis struck, the economy is still 3pc smaller than at its peak. The scale of the problems will be exposed again on Wednesday when the Chancellor updates the country on the economic outlook and his austerity plans. 

To boost “growth, job creation, exports, investment, and business confidence”, George Osborne needs to be “bold” in his mini-Budget, the British Chambers of Commerce said as it downgraded its growth forecasts for next year and 2014....

Regular readers know Mr. Osborne needs to end the pursuit of the Japanese Model for handling a bank solvency led financial crisis and adopt the Swedish Model.

Under the Japanese Model, bank book capital levels and banker bonuses have been protected at all costs.  As a result, the burden of the excess debt in the financial system has been shifted to the real economy.

As Mr. Haldane notes, 'our grandchildren' will still be paying on this burden.  If and only if we keep pursuing the Japanese Model.

Under the Swedish Model, banks recognize upfront the losses on the excess debt in the financial system.  This protects the real economy and allows it to continue growing.

As for the banks book capital levels and banker bonuses, they take a hit as they are responsible for 'paying' for the financial crisis.  The way the banks pay is through retention of 100% of pre-banker bonus earnings until such time as they have rebuilt their book capital levels.

Mr Haldane told BBC Radio 4’s The World at One that banks remained one of the major impediments to the recovery because they need to own up to their bad debts to restore confidence and get credit flowing again. Failure to come clean would mean “the fog will persist”, he said.

Please re-read the highlighted text as Mr. Haldane has nicely summarized what the banks need to do under the Swedish Model and how continuing with the Japanese Model will result in a prolonged Japan-style economic slump.

“Investors will be much less willing to put their money into the banking system. They will lack confidence in the banking system and will either charge very high rates for lending that money to banks or will just withdraw their money entirely,” he said.

The only way to restore confidence in the banking system is for the banks to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

With this information, investors can independently confirm that banks recognized all of their losses.

“More could and should be done to get lending moving as a springboard to getting the economy moving.”

This cannot happen until banks step up and recognize their losses.  Until they do this, the bankers know that their use of 'extend and pretend' to turn bad loans into zombie loans distorts the value of the underlying collateral.

If a banker doesn't have confidence in the value of the underlying collateral, they cannot make a loan.  Hence, banks need to recognize their losses so that there is certainty surrounding collateral values.

He added that bankers pay had been “ratcheting down” but that there was “still some way to travel”. “Back in 1980, your average investment banker was paid the same as your average lawyer or doctor. By the time we got to 2006, they were being paid four times as much,” he said. 

“Have we got further to travel south? I suspect probably yes.”

Adopting the Swedish Model will help to get bankers pay back in line.  After all, they are unlikely to receive much in the way of cash bonuses while the bank is rebuilding its book capital levels.

He also admitted that “with 20-20 hindsight” the Bank should have done more to deflate the bubble ahead of recession.

This is an incredibly important admission by Mr. Haldane.  In essence, he is saying that the BoE knew it should take away the punch bowl, but didn't.

Regular readers know that with adoption of the Swedish Model, the Bank of England can also stop pursuing the zero interest rate and quantitative easing policies that are part of the policy menu under the Japanese Model.  Ending these policies should further boost growth in the real economy.