Mitchell Feierstein: Systemic banking fraud means next crisis will be worse

Henry Paulson. Hank. Remember him? Of the crisis in 2008, he said: “Where I come from, if someone takes a risk and they’re going to make the profit from that risk, they shouldn’t have the taxpayer pay for the losses.”

Quite the wisdom one expects from the 74th US Secretary of the Treasury.

Yet, as Paulson (pictured) played pass the parcel with the rest of us, it was he who unwrapped the final layer when the music stopped, and discovered that the prize within was a grenade.

Understandable, therefore, that he offered a second opinion somewhat in contrast to his first: “It’s better to have the taxpayer pay for the losses than have the United States of America become an economic wasteland. If the financial system collapses, it’s really, really hard to put it back together again.”

Well, it did, and it was. Two years after the fall of Lehman Brothers, former Federal Reserve chairman Alan Greenspan was still reflecting on the solution. “There are two fundamental reforms we need — to get adequate capital and… far higher levels of enforcements of… fraud statutes.”

So what progress has been made in the efforts to reduce the risks of another crisis?

Not enough. In a letter this year to Bank of England’s Governor, Mark Carney, (in his capacity as chairman of the Financial Stability Board), the Senior Supervisors Group reported that “firms’ progress toward consistent, timely, and accurate reporting of top counterparty exposures fails to meet supervisory expectations”.

It said there is still too little reform, and too little essential knowledge of counterparty risk.

But what of Greenspan’s assertions of criminal behaviour in financial markets?

Again, no change. Market manipulation is not a conspiracy theory. The Bank of Japan has manoeuvred its bond market to a point where bond futures no longer trade. Its interventions have distorted free-market pricing mechanisms to the point that risk is virtually impossible to quantify.

But the most pressing concern is the behaviour of central banks, which had previously appeared a solid safe haven.

Recently, the Official Monetary and Financial Institutions Forum think-tank revealed that global central banks have speculated with $29 trillion (£23 trillion) in global markets, including stock markets.

I may have been absent that day but since when were central banks given discretion to trade and speculate to such an extreme? How effective can they be at managing the risk of others?

The European Central Bank’s Asset Quality Review is underway and seeks to review the provisions set aside by banks. But AQR is an unhelpful distraction. The exercise has understandably placed further pressure on all banks to bolster their capital positions.

But in preparation for the stress tests, most European banks have been furiously strengthening their balance sheets, increasing the likelihood that they will avoid the spotlight of attention, but masking more fundamental weaknesses.