Even in a week when there are plenty of other stories (poorly executed terrorism, Brexit negotiations, scandalously flammable buildings, hung parliaments) the news that four Barclays executives are being charged with fraud has made the front pages today.
I am not going to discuss the case itself. It is a prosecution brought by the Serious Fraud Office over the recapitalisation of Barclays using Qatari money in 2008; the SFO reckon there was misrepresentation and some other malfeasance. I’m not going to discuss it for two reasons: first, it’s obviously sub judice so I could get myself in some hot water; second, because it will be a case of such bewildering complexity (acres of accounting reports, emails and memos, internal legal opinions etc.) anything I said would just be ill-informed speculation.
But I am prepared to say this: I am sure that a lot of the complexity that will undoubtedly surface in this affair was magnified hugely by the stress and panic under which the deals were done. The banking system was falling to pieces. Banking executives, politicians, regulators and central bankers in a number of countries had to think quickly. They made some pretty bad errors – worst of these being the decision by the US authorities to allow Lehman to fail – but that is to be expected from humans acting under stress.
Could the crisis have been handled better? More importantly could future crises be handled better? (You’d have to be unforgivably optimistic or deluded to think that another will not occur.)
Regulators are trying to make sure that they are. Their efforts go along three main paths. One, to make sure banks have more capital and that crises are therefore less likely; two, to make trading (especially of derivatives) less bilateral and more exchange-based; three, to make banks easier to ‘resolve’ in the case of crisis so that they can fail without systemic consequences.
All of these steps probably won’t hurt but I doubt that in a real panic they would be sufficient. For one thing, how much capital is enough? Ratios have improved but I am not convinced that – in a meltdown – the extra percentages will be that helpful. There were banks runs and panics in the 19th and early 20th Centuries when capital ratios were multiples of where they are now.
Exchange trading is a decent step in the right direction but it might result in the largest exchanges becoming the ‘too big to fail’ transmission mechanism of a future crisis. I am also profoundly unconvinced by the efficacy of ‘living wills’. If my town is being attacked by flesh-crazed zombies, my fear is not diminished by the comforting thought that their funeral arrangements are all in order.
So what to do?
One suggestion that I have made in print (but which has not, as far as I know, been embraced by any government) is to make explicit the implicit put option that governments are already short to systemically important banks.
The implicit option is the market’s expectation that a government will step in to recapitalise a big failing bank if it looks like its failure might bring down the system. Despite all the effort by regulators in the last nine years, this option is emphatically still in existence. Is it really feasible that the German government would let, say, Deutsche Bank go under? Or the British government let Barclays go?
One problem with the implicit option is that the market is never completely sure that it will be triggered – witness Lehman Brothers. Net effect? Uncertainty in conditions of panic. Another is that the government (the taxpayer: that is, you and I) don’t get paid for it.
My proposal (which I dubbed the Option Based Recapitalisation Charge or OBRC) is that the implicit is made explicit. Each year a bank’s home government would sell a systematically important bank a very low strike put option on its equity in sufficient size to bring its capital ratios back up to regulatory minimum if the stock price collapsed. The terms of the deal would be public knowledge.
The advantages would be numerous. In quiet years, the option premium would be paid to the government and it could set aside the money to help offset negative effects from a future crisis. If a crisis occurred, in the panic it would be totally transparent where the government support would kick in for any bank. Uncertainty would be replaced by certainty.
Another advantage would be that, because the option premium would be driven by the volatility of the bank’s equity, and because that volatility is damped by the market’s perception that the bank is conservatively leveraged and capitalised, the fee (the option premium) would be linked to bank riskiness. The safer the bank, the lower the fee.
Now I’ve heard some criticism of the idea. From people who dislike government interference, the prospect of explicit state support is an anathema – to them I point out that the transaction (the option) would be done at market prices and that in extremis state support is implicit anyway.
Another critique from the other end of the political spectrum is that it would put a huge contingent liability on the state’s balance sheet. That might make borrowing harder. To those folk, two points. First, the liability’s there already. Second, if the market looks at the state’s commitments and decides that it doesn’t like the effect on the state’s creditworthiness, maybe that’s a signal for it to sort its banking system out? (Certainly, there is one historic instance where this might have helped. Clue: the country has lots of volcanoes and its citizens chow down on puffins.)
But this argument brings us back to where we started. There’s nothing to say that it has to be the bank’s home state that sells the option. Another state, or group of states might step in. Or maybe the huge pools of money sloshing around in sovereign wealth funds could be used? The only condition would be that the money is definitely there if required and that the home government is fine with the identity of the option seller. Norway would probably be fine for most western governments. Others, less so.
So imagine that, back in 2008, this scheme had been in place and that the seller of the OBRC options to Barclays had been Qatar (signed off and approved by the British government). The deal would have been agreed in calmer times. The recapitalisation via an option exercise would have had the same net effect as the deal that was actually done, but, crucially, it would have been agreed transparently in advance.
More certainty; more transparency; same recapitalisation.
And, I’m guessing, 100% fewer court appearances.