The Banking Bailout Business

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The financial crisis of 2007-2008 was the worst since the Great Depression. It was triggered in the United States due to the collapse of the subprime mortgage market, and its effects spilled across the global banking system, resulting in many governments bailing out the private banks that had caused the crisis, in an attempt to prevent the collapse of the global financial system. This bailout means private debt is now public debt, and the consequences of this will be carried for decades to come, if not the entirety of the Millennial generation’s lifetime and beyond.

The financial crisis was the nail in the coffin in terms of Millennials’ trust in government and banking. Trillions of dollars of additional debt are now the responsibility of the taxpayer, at a time when Western economies are not as robust as they could be or have been, Baby Boomers are leaving the workforce and no longer contributing to the tax base, and the easiest response by most governments will be to increase taxes. People are progressively burdened by their personal debt, government debt that now includes these extra trillions, and publicly-funded pensions for older generations – a luxury many Millennials will never have. Eventually, the well runs dry, and Millennials have barely had the opportunity to fill the well to begin with.

 

Was it necessary to bailout the banks that created the mess in the first place?

In early 2017, Sol Trumbo Vila and Matthijs Peters published a report, The Bailout Business, exposing the private companies that made huge profits from the bailout packages implemented in the European Union at the expense of taxpayers, citing more than €1.5 trillion of taxpayer money that has been spent to bail European banks. Between 2008 and 2015, EU member states, with the approval and encouragement of EU institutions, have spent €747 billion on different forms of rescue packages or bailouts, plus another €1,188 billion made available in guarantees on liabilities. Despite these sizeable and growing numbers, bailout packages have a further hidden cost: the massive fees charged by financial experts for giving advice to governments and EU institutions about how to rescue the banks.

Vila’s and Peters’ research shows the bailout business is made up of, firstly, the audit firms that audited the banks before the crisis and who have continued to service them after the crisis, dominated by the so-called Big Four: Ernest & Young, KMPG, Deloitte, and Price Waterhouse Cooper. In addition to providing auditing services, many of these firms also provided financial advice to the same banks. Secondly, it includes financial consultancy firms that assessed the banking sector’s financial state and risks for both debtor governments and the European Commission and have also advised on how to structure and carry out the bailout programmes (such as Lazard, Rothschild, Oliver Wyman, BlackRock, and Marsh and McLennan).

 

What does the report show?

  • Bail outs in the EU have a hidden cost for taxpayers. Contracts worth hundreds of millions of euro have been given to financial consultants to advise member states and EU institutions on how to rescue failed banks;

  • The Big Four audit firms, which operate as a de facto oligopoly, together with a small coterie of financial advisory firms, have designed the most important rescue packages. Combined with their roles as consultants and auditors, the concentration of this work in just a few firms often leads to conflicts of interest. In cases where the bailout consultants gave poor or inaccurate advice on the allocation of state aid there have been few consequences, even when state losses actually increased as a result. Bailout consultants have often been rewarded with new contracts despite their repeated failures;

  • The firms responsible for assuring investors and regulators that EU banks were stable, the Big Four audit firms, maintain their market dominance despite grave failures in their assessment of the EU banking sector’s lending risks. Failed banks were systematically audited by one of the Big Four before being rescued. In every case, another Big Four firm took over the audit of the saved bank. Up to June 2016, the Big Four also provided non-auditing services to their clients, leading to repeated conflicts of interest, which have so far had little or no legal consequence. The Big Four are still receiving massive contracts from EU member states and institutions for advisory and auditing work;

  • Current EU legislation does not tackle the influence of the Bail Out Business. New audit regulations tackle the worst practices and conflicts of interest of the Big Four: the provision of advisory and auditing services to the same clients. However, such regulations do not tackle the dependency of governments and EU institutions on the Big Four. The effectiveness of the Banking Union in reducing the burden of future bailouts on taxpayers remains to be seen. However, it institutionalises the use of taxpayers’ money to save failed banks upon the decision of the European Central Bank (ECB). This centralisation is likely to deepen further the influence of the Bail Out Business as a result of the ECB’s practice of outsourcing its mandated supervisory activities.

 

What if the banks had not been bailed out?

Iceland did not bailout its three largest banks, despite having the largest banking system collapse in the economic history of any country. As a result, Iceland experienced a severe economic depression from 2007 to 2010, but by 2011 saw what has become increasingly positive GDP growth and rapidly declining unemployment. Its economy is now one of the strongest among developed countries. Over a dozen bank executives faced criminal charges and were imprisoned, unlike those in the United States who faced no such consequences. This Black Swan event may have pushed Iceland to its knees in a surprisingly very short-term period, but the country has emerged as much more robust and antifragile than economists and politicians believed was possible.