September 21, 2018 / 10:50 AM / 3 months ago

Breakingviews - Banks were first to fall in decade of lost trust

LONDON (Reuters Breakingviews) - Banks were the first institutions to fall in a decade of lost trust. The crisis that reached its climax with the failure of Lehman Brothers a decade ago swept away the notion that financial leaders could be relied upon to safely run their firms. Since then central bankers, politicians and the media have also faced growing public scepticism. The malaise shows no sign of lifting.

Customers queue to enter a branch of Northern Rock in Kingston, Surrey, southern England, September 17, 2007. Thousands of customers queued to withdraw savings from embattled bank Northern Rock on Monday and its shares plunged again, heightening pressure for a sale of the business or its assets. REUTERS/Alessia Pierdomenico

Rereading news reports from 2008, the biggest surprise is the credibility they granted to the chiefs of large banks. Even as their financial institutions threatened to collapse, investors, regulators and the media still attached enormous credence to what top bankers had to say.

This aura of plausibility reflected a deep belief that the people running large banks had a better idea than anyone else of the risks that their institutions faced. It was not just credulous fund managers and reporters who subscribed to this view: it was embedded in financial regulation. The Basel II framework that was being rolled out as the crisis struck explicitly encouraged banks to develop their own risk models, and dangled the promise of lower capital requirements to those that did.

With hindsight, of course, this view was mistaken. Banks not only took foolish risks, but were often also in the dark about the dangers they faced. In one telling example from early 2007, Switzerland’s Federal Banking Commission asked UBS about its exposure to subprime U.S. mortgages in the investment banking division. UBS replied that the unit had a net short position. The bank eventually wrote off tens of billions of dollars on subprime-related securities. The Zurich-based group simply did not understand what it owned.

The credibility of bank executives was comprehensively shredded by the vast bailouts that followed Lehman’s collapse. Subsequent scandals reinforced a public image of bankers as greedy and selfish, pocketing hefty bonuses as taxpayers picked up the tab for their recklessness. These days, most bank executives keep lower profiles and rarely speak in public. Those that do occasionally stick their heads above the parapet, like JPMorgan Chief Executive Jamie Dimon, are often met with intense criticism.

But bankers are not the only institutions suffering from a trust deficit. Western governments gambled their fiscal credibility to prop up banks. The policy helped to avoid a deeper slump, but at the expense of lasting public anger that helped fuel the election of U.S. President Donald Trump, the Brexit referendum, and the rise of anti-establishment political parties in Italy and across the European Union. Most of these movements thrive on distrust of established institutions and the technocrats in charge. Central banks like the Federal Reserve, which did more than anybody else to fight the global recession, have faced intense scrutiny of their crisis policies, the effects of very low interest rates, and the extent of their independence.

The news media is a more recent casualty. Technology has eroded traditional business models, while the rise of social networks has fundamentally changed the way consumers access information. The media is the least trusted major institution, according to the annual barometer compiled by Edelman, and is distrusted in 22 of the 28 countries tracked by the public relations firm.

These developments reflect deeper shifts in public attitudes to institutions that predate the financial crisis. Richard Lambert, the former editor of the Financial Times, recalls that during a banking crisis in the early 1970s, NatWest – then one of Britain’s top lenders – responded to rumours that it was in trouble by issuing a statement dismissing the idea that it might need official support. To Lambert’s surprise, the statement was believed, and the crisis passed.

By 2008, such emphatic assurances tended to be met with greater scepticism. Today, any bank that feels the need to publicly confirm its stability risks comparisons with securities firms like Bear Stearns and Lehman, whose bosses insisted they were sound days before they failed.

For banks whose business model depends on preserving the confidence of creditors and depositors, the trust deficit is a source of deep concern. Lenders have more capital than in 2008 and are more tightly regulated. But their dependence on computer systems and susceptibility to cyberattacks add new vulnerabilities. The only consolation is that when it comes to lacking trust, they are not alone.

Breakingviews

Reuters Breakingviews is the world's leading source of agenda-setting financial insight. As the Reuters brand for financial commentary, we dissect the big business and economic stories as they break around the world every day. A global team of about 30 correspondents in New York, London, Hong Kong and other major cities provides expert analysis in real time.


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