Saturday, December 3, 2011

Where’s the Public Uproar? Why Banks Can’t Pay Back the Secret Bailouts

By Dr. Suhaib Riaz

Recent revelations on the secret loans by the US Federal Reserve to banks should cause massive public uproar, if reflected upon. That a lawsuit was needed to show the scale and no-strings attached nature of these bailouts, suggests the explosive potential of this information.

On one side these secret loans were saving the banks, on the other side bankers were assuring the world of their health – as detailed in an earlier study of bankers’ rhetoric during the crisis, co-authored by a team that I was part of (presented this year 
at the Academy of Management in San Antonio).

The key question these revelations should re-invigorate is this: How do you “pay back” a secret bailout that saved you – in human equivalent terms, saved your life?

Well, you could return the dollar amounts, once your health has been restored. Which is what the banks keep harping about – we’ve paid it all back, just leave us alone now – no need for any fundamental changes. Many are so confident about this “paid back” argument, that they believe anyone who protests on this count doesn’t understand Business 101. Such comments were common on a recent piece I co-authored (with Hari Bapuji) in the HBR blog network, suggesting the need to at least listen to arguments by protestors, including some by “Occupy Wall Street” protestors, who smell something rotten in today's business environment.

Agreed, the dollars might have been “paid back” in a narrow sense. But let’s look beyond that for a moment.

First, what price were these dollars, coming as they did at a time of severe crisis, when all other sources of loans, and that too on such a massive scale, were non-existent. Shouldn’t the “market” price be way higher than regular price at such a time? It turns out, of course, that these secret loans were below the market price.

Second, what’s the value of keeping the loans secret? How do you repay that – given that keeping loans secret certainly helped banks present themselves in better health, which has all sorts of additional symbolic and substantive benefits. Amongst these are the ability to be back in business faster - raise more loans – as well as resist tighter regulation that might have resulted from public uproar earlier. And one doesn’t have to connect too many dots to see how this secrecy and consequent impression of good health would help continue the outrageous executive compensations at banks that were in reality utter failures.

Third, what’s the value of the scope of these loans – not just the scale, but the fact that these were distributed across so many banks at the same time, effectively helping save them all: in a tide, all boats rise. Saving the system was what saved the individual banks. How can you pay back the value of the “tide”?

Fourth, what’s the value of the “future guarantee” offered by these loans – once the Fed has demonstrated the scale and scope of actions it is willing to take to save banks, this in itself endows banks with a legitimacy and “failure-proof” guarantee for the future. This perception (related to the idea of ‘moral hazard’) works in the background, and is not much talked about – but it certainly helps banks conduct their business. How do you pay that back?

Overall, these arguments call for a broader shift in the way banks look at their own roles in society. Banks do not exist in isolation, but are part of a complex socio-economic system that includes, amongst others, taxpayers and the general public. A complex systems perspective is essential to have any hope of seeing this bigger picture, which seems to be consistently eluding bankers. It was heartening to see much ongoing work on complexity at the annual MIT Systems Thinking conference a few weeks ago – yet much more is needed specifically on the financial system as part of society. 

Perhaps such a broader perspective will help banks understand why you can’t “pay back” someone who has just (secretly!) saved your life.

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