John Lanchester provides another entertainingly depressing account of the financial crisis (LRB, 28 May). One caveat: his discussion of the US bank bail-out plan is incomplete. Sadly, fleshing out the picture creates more gloom, not less. While it’s possible in bookkeeping terms to have negative equity, limited liability means that the market value of equity never falls below zero; investors’ losses can’t exceed the size of their original stake. That effect (limited downside, limitless upside) is magnified the more debt a corporation has, and is likely to have unfortunate consequences for the US bail-out proposals.
In the Geithner plan there’s a huge slug of government-provided debt available to purchasers of banks’ toxic assets. Paul Krugman has shown how that subsidy, plus the effects of limited liability, boosts purchasers’ returns to such an extent that they would rationally be willing to pay more than the assets are worth. The result will be a substantial transfer of wealth from the taxpayer to toxic assets’ sellers and buyers.
But it’s also possible that banks won’t sell their toxic assets, even when a buyer offers a higher price than the value the bank has assigned to them. These assets are highly volatile, and could end up worth more than the banks value them at today. They could also be worth squat, but however much the value of the toxic assets falls, the (market) value of the banks’ equity can never fall below zero. When toxic assets are swapped for nice safe cash, that potential for a steep rise in value (but limited losses) disappears. So bankers may prefer not to sell, even at artificially inflated prices, and toxic assets will carry on gumming up the financial system.
For the US some form of bank nationalisation may ultimately be the only solution. But, as Lanchester argues, there is still an implausibly wide gulf between what is economically most desirable and what is politically feasible. Expect more pain.
John Lanchester’s forensic analysis fails to mention one major player in the financial disaster: the auditors. Of the RBS annual report, he says that, despite being ‘models of clarity and translucency … you still can’t tell from them what the hell was going on,’ thus completely obscuring the company’s real financial position. Telling us ‘what the hell is going on’ is precisely the auditors’ duty, for which they collect their magnificent fees, confirming that the year’s key financial documents presented to them for scrutiny accurately portray the true state of the company’s condition. (Presumably even Northern Rock had auditors.) It cannot be fanciful to suggest that the relationship between the big banking institutions and the auditing conglomerates is far too cosy for anyone’s financial safety. A glance at the complex incestuous interlocking of non-executive directorships between auditors and audited will provide ample grounds for this fear.
John Lanchester’s balance sheet for an individual – call him JL – shows him owning a house worth £200,000. But instead of showing JL’s house as £200,000 in credit and £130,000 in debt (his mortgage), net £70,000, as it should, the balance sheet shows the house as worth £70,000 on the credit side and £130,000 on the debit side, net minus £50,000, as it obviously isn’t.
The error is compounded in the following paragraph where JL takes half of £200,000 (the value of the house) to be £50,000.
The notional investor in 10 per cent of JL, instead of putting in £1000 which becomes £14,000 a year later, would have to put in £14,000, worth £26,000 after the year.
As JL’s thesis is that all the big numbers on toxic debts are dodgy, is he perhaps looking for a career in banking?
John Lanchester writes: It may be relevant that my forthcoming book about the credit crunch is called Whoops.
The Money that Prays
Jeremy Harding’s discussion of sharia-compliant finance in the West becomes even more fascinating if one reads it with an awareness that our word ‘risk’ derives from the Arabic (LRB, 30 April). During the Middle Ages rizk meant (I quote Edward Lane’s definition): ‘A thing (or provision) that comes to one without toil in the seeking thereof: or, as some say, a thing (or provision) that is found without one’s looking or watching for it, and without one’s reckoning upon it, and without one’s earning it, or labouring to earn it.’ Italian merchants picked it up from the Arabs, and it shows up in 14th-century Italian mercantile documents, where it refers first to the unanticipated good that can come of chance or mishap alongside the bad, then to the uncertainties of trade in general.
Ann Arbor, Michigan
Jeremy Harding underlines the challenges facing Islamic banking in modern times. During the 1980s and 1990s, the issue was hotly debated in Pakistan as part of the Islamicisation drive launched by General Zia-ul-Haq, and Islamic banking was introduced alongside conventional banking. It has undergone some organisational changes in the last ten years, but its share has remained at about 3 per cent of the total banking sector. Approximately 90 per cent of lending by these banks involves ‘risk averse’ modes of financing such as ijara, murabaha and sukuk.
With the growth of sharia finance, a meaningful comparison in the workings of the two systems has become possible. It seems that Islamic banking elevates form over substance, doing much the same thing as conventional banking, but with the help of subterfuges (hiyal). It will continue to do so, since form matters to some for moral reasons. Over time, Islamic banking will converge with conventional banking, or become irrelevant, unless the Islamic banking system decides to revisit the concept of riba (interest), and focuses on offering differentiated services to customers.
Andrew O’Hagan thinks of Susan Boyle’s transformation from ‘heffalump to heroine’ as ‘a piece of schmaltz’ (LRB, 14 May). To me, it looks more like an indictment of Britain’s education system. Haydn’s parents were poor but recognised their son’s musical talent and gave him into the instruction of a choirmaster. Nureyev’s parents were so poor they had to send their son to school without shoes and in his sister’s overcoat, but he was spotted by a ballet teacher and given the chance to study in Leningrad. Susan Boyle has been singing since she was 12, yet nobody seems to have noticed until now. Britain’s Got Talent, yes, but does it have an education system in which talent is recognised and nurtured?
Brighton, South Australia
Getting off at Mill Hill
Susan Pedersen, examining working-class attitudes to birth-control techniques in the early and mid part of the 20th century, makes a delightful, if potentially disastrous howler (LRB, 28 May). The euphemism for coitus interruptus isn’t ‘getting off at Mill Hill’, as she supposes, Mill Hill being the terminus of one branch of the Northern Line. The correct expression, Liverpudlian in origin, is ‘getting off at Edge Hill’, Edge Hill being the penultimate station on the Manchester to Liverpool line before the terminus at Lime Street.
Old Windsor, Berkshire
Banks and Poets
In the advertisement from T.S. Eliot’s old employer Faber on page 11 of the 28 May issue of the LRB, I see that the Faber Academy is offering a course on ‘Becoming a Poet’. Interestingly, Eliot once said that he understood the desire to write poetry but not what it meant to be ‘a poet’. He might have been amused to see that the Faber Academy is sponsored by Coutts: in Eliot’s day the only way to be sponsored by a bank was to work in one.
I was surprised by Daniel Soar’s inability to see why the Russians call the @ ‘a dog’ (LRB, 28 May). It’s a sleeping dog with its tail curled around itself, isn’t it?
Daniel Soar notes that in modern Spanish email usage the symbol @ is called an arroba. Arroba beyond any reasonable doubt comes from the Arabic rub, but this does not mean a quart, as Soar writes, but a quarter (of a hundredweight, qintar).