How Should Banks be Tested?
What do tests really test? This may seem a silly philosophical question, but educators and government agencies are keen to figure this out.
My concern here isn’t with education, but with banking. Usually the banks do the testing: Are you credit-worthy? What’s your score?
Any one of us who ever took out a car loan, house mortgage, or business loan knows what obstacles we had to overcome to be found “worthy” of a loan, passing a test.
We should recall that if banks borrow money from federal sources at around 0.25% and just charge twice as much, 0.5%, then their gross profit is 100%! Charging 2.5% (and paying only 0.25%) provides 1,000% gross profit margin. Wouldn’t you want to own a bank?
But banks must pass tests, too: according to a government “stress test,” 31 of the largest US banks somehow passed: in case of a financial crisis, they seem to have enough cash reserves to manage their leveraged portfolios.
Given that Forbes claims that just five banks control more than half of the $15 trillion of the financial industry, the test of 31 banks ranges close to 80% of financial assets. More tests will be coming, so there may be some unexpected surprises in the next few weeks.
We have heard since the Great Recession by Republicans and Democrats alike that without a healthy banking system our economy would collapse, so this should be good news to all Americans, no?
What would you say if I told you that all my students always pass my courses? Wouldn’t you suspect grade-inflation, low standards, or simply academic incompetence?
Passing is passing, and if all students or banks deserve to pass the test, why quibble? Isn’t the Millennia Generation big on giving trophies in athletic contests even to losers for just showing up?
Well, if everyone on Wall Street seems delighted with banks, it’s because self-congratulation is part of game, making sure that the banking welfare system (with government subsidies and bailouts) shields bankers from Main Street and pesky regulators.
But, the cozy and perhaps too intimate bond financial institutions enjoy with their regulators—and the politicians who enjoy their campaign largesse—isn’t shared by everyone.
Most surprisingly, the naysayers don’t only include the Occupy Wall Street members of yesteryear or the Tea Party when its members objected to the banking bailout; instead, it’s the Oracle of Omaha, Warren Buffett, who has had some nasty comments about the financial industry, despite (or because of) his intimate knowledge of its leaders and their practices.
Reuters reports that in his latest letter to his shareholders, he said: “Periodically, financial markets will become divorced from reality—you can count on that . . . never forget that 2+2 will always equal 4. And when someone tells you how old-fashioned that math is—zip up your wallet, take a vacation and come back in a few years to buy stocks at cheap prices." Instead of reflecting reality, Wall Street is mired in fantasy.
As The New York Times reported only days ago, Buffett mockingly calls the “the Street’s denizens” “money-shufflers” who “don’t come cheap” and who have “expensive tastes.” Does he really mean it?
When your personal fortune is $72 billion and your tastes remain relatively upper-middle-class, you can say whatever you want. Are these just cheap shots? Or is there an argument here? And if there is one, is it an economic or moral one?
When Buffett laces his Letter with a description of Wall Street bankers as those who “are always ready to suspend disbelief when dubious maneuvers are used to manufacture rising per-share earnings, particularly if these acrobatics produce mergers that generate huge fees for investment bankers,” then it’s clear that economics is at the heart of his critique.
At one point, Buffett argues that “Investment bankers, being paid as they are for action, constantly urge acquirers to pay 20 percent to 50 percent premiums over market price for publicly held businesses. The bankers tell the buyer that the premium is justified for ‘control value’ and for the wonderful things that are going to happen once the acquirer’s C.E.O. takes charge.” But, this isn’t true; they mislead.
So, if you are confused about why new mortgages aren’t spurring the housing market even though mortgage rates are at historical low levels, or if you are puzzled why business loans aren’t as easily obtained as expected, just remember: if a bank borrows at 0.25% and invests in US Treasury bonds that yield (February 28, 2015) 4.79%--why bother with risky lending to the public it’s supposed to serve?
Have the banks passed your financial, not to mention moral test?
Raphael Sassower is professor of philosophy at UCCS. He can be reached at firstname.lastname@example.org See previous articles at sassower.blogspot.com