Putting bankers in jail won’t necessarily stop them making mistakes

Sam Bowman
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THE final report of Parliament’s commission into banking standards recommends many (often contradictory) things, but running through it is the theme that the industry suffered from a cultural failure. According to this narrative, individual responsibility was forgotten before the crisis, little was resolved afterwards, and action must now be taken to make bankers act less irresponsibly. Bankers should, it says, be made criminally liable for reckless professional conduct.

Leaving aside the question of how to judge “reckless conduct in the management of a bank” (and who can do it), or whether targeting bankers (and not other executives) could be a breach of human rights laws, the assumption is that bankers acted recklessly because they were insulated from the negative consequences of their actions. Perhaps that is true. But a way of testing the proposition is to see what happened to their personal wealth during the crisis.

And it seems that many executives at failing financial institutions made much the same mistakes their firms did. According to the Washington Post, the former chief executive of AIG Maurice Greenberg – who led the insurance group from 1968 until 2005 – kept much of his net worth in AIG stock. He lost most of it. Richard Fuld of Lehman Brothers lost about $1bn. Executives at Bear Stearns lost billions.

There are other examples. According to Andrew Tyrie’s report, HBOS’s Andy Hornby invested his entire cash bonus for his final eight years at the bank in HBOS shares. If bankers knew they were acting recklessly in business, rationally they would not have done the same thing with their personal holdings. That so many of their losses were so great suggests that they did not realise what they were doing. Their bad business moves were errors, not calculatedly reckless decisions.

Indeed, Jeffrey Friedman has shown that the real error was on the part of regulators. Financial regulations like the Basel capital accords, designed to make banks act more prudentially, did the opposite – incentivising banks to load up on government-backed mortgage debt and, particularly in Europe, government bonds. Unlike mistakes made by individual firms, these were compounded across the entire global financial system.

Making the punishment for failure harsher will only improve behaviour if the people affected already know that they’re doing wrong. If they’re simply mistaken – as I would imagine you would have to be to lose billions of dollars of your own wealth – tough new punishments like this will not have the effect we want them to.

But what about the ones who did know what they’re doing? We used to have a mechanism for punishing reckless business practices – it was called bankruptcy. In banking, at least, this was abandoned in favour of unlimited bailouts, even for systemically unimportant banks. If we had let bad banks go bankrupt, as Iceland did, we might not be in such a bad situation today.

Throwing a few scapegoats in jail to satisfy an anti-banker mob ignores that the crisis was largely about regulators’ and bankers’ errors. It is no replacement for letting bad firms go bust and punishing them the old-fashioned way.

Sam Bowman is research director at the Adam Smith Institute.