Banks all over the world must be prudent lenders to avoid crisis

Just as every society has a creation myth, banking is now busily writing a destruction myth that seeks to explain and soothe in a world torn to its foundations. The myth, as expounded by regulators, bankers and their various service providers, is that they were hit by a perfect storm, a 1,000 year flood so unpredictable that they can not possibly be held accountable for it. An act of God rather than the folly of man.

The implication of course is that now banks know these sorts of things can happen, banks will behave sensibly because it is their best interests to do so. It is just that the data we put into the models only covered the boom years. Now that we are getting good data on a downturn problem is solved. No need or overly heavy handed regulation that will only stifle growth and recovery. No need for intrusive compensation controls; this will simply drive risk takers out of banking and into less regulated areas, or prompt a brain drain with the best minds going into God forbid industry.

There is a pronounced unwillingness to take responsibility and to recognize that many of the factors that went into creating and sustaining the bubble were not so much unknowable but more likely for those in a position to do something about it at the time, either unprofitable, unpleasant or politically inconvenient to know.

Nobody was prepared for this. He has been paid $115 million excluding stock options, since 1999 and was advising Citigroup when it decided to mimic its peers and take on more risk. What came together was not only a cyclical undervaluing of risk (but also) a housing bubble and triple. Ratings were misguided.

There was virtually nobody who saw that low-probability event as a possibility. There is no doubt that many were raising red flags about risk use of ratings issues around securitization and most certainly about an emerging real estate bubble. But it proved impossible of those risks to get a proper hearing within a system that was throwing off so much life changing money.

But while everyone is free to take money that is on offer that is different from saying that you have earned it, or that in a system in which pensioners and taxpayers are the ultimate bag holders, it is appropriate and should not be subject to regulation. There is a similar argument on pay making the rounds: that since so many senior managers lost so much of their fortunes in the failure of companies such as Lehman Brothers and Bear Stearns this demonstrates that there was not a misalignment of risks between employees, shareholders and the governments that ultimately must pick up pieces when things go wrong. It is very sad that so many people lost so much, but this is not even close to being an argument or continued light touch regulation.

The issue is not so much that people in banking and finance have skin in the game, but that they are far from alone in having it, and that their ultimate cost of capitals is in part a function of the fact that it is and has been understood that the state will step in if things come to grief.

That argues, for stricter regulation of bank capital and of bank compensation so as to decrease the risks. That means trying compensation more closely to risks, including the risk that things look good today and bad in three years time. The UBS scheme, under which bankers can lose money they er6an based on various performance factors to subsequent years, is not a bad start.

Those who argue against more stringent regulation have one thing right: It is gong to cost, and requiring banks to hold more capital will impose a ceiling on the speed at which the economy can easily grow. Of course, we are always regulating the last war out of existence.