The cocktail of ineptitude and recklessness that caused the global financial crisis should leave a bitter aftertaste. It has proven easier to mask when bankers use the terms of their trade - collateralised debt obligations, credit default swaps, and leverage among them - to explain (or to obscure) what happened. But how bankers used leverage - borrowed money - to earn record profits and pay themselves record bonuses provides a clear and galling lesson. At the first hearing of the Financial Crisis Inquiry Commission in Washington last week, it was revealed that Citigroup had leveraged its common equity up to 68 times at one time before the crisis. To understand that kind of risk in the world inhabited by the rest of us, imagine that you lent your child Dh100,000 for a down-payment on a home in 2003 and that he used that as collateral to borrow Dh6.8 million more. He would have made a killing in the next four years if he invested that sum in the purchase of stock and property around the world. Until late 2007, you might have mistaken your child's "financial innovation" for genius as markets hummed and property prices rose at record rates. Likewise, few dared tell anyone at Citi or any of the other mammoth banks engaged in over-leveraging that this kind of behaviour depended on markets reaching ever upward.
The CEO of JPMorgan Chase, Jamie Dimon, explained his bank's behaviour by telling regulators that they never expected the property bubble to burst. That is understandable. When you are making many millions each year through the use of leverage, helping to inflate that bubble, why not commit this oversight? The surprise Mr Dimon described did not match his certainty later in the hearing. "A financial crisis happens every five to seven years," he explained. So when do they plan to have the next one?
The bankers at JP Morgan are probably not keen to point out their chief's contradiction; on Friday it was revealed that they shared $9bn in bonuses in 2009, approaching pre-crisis levels. Such incentives for blindness help to explain why bonuses must be reined in and why banks cannot be trusted to regulate themselves. The CEO of Goldman Sachs, Lloyd Blankfein, compared the recent financial crisis to an act of God at last week's hearing. "How would you look at the risk of a hurricane?" he asked. The commission's chairman, Phil Angelides, provided a stern reply: "Having sat on the board of the California Earthquake Authority, acts of God were exempt. But these were acts of men and women. These were controllable." This rebuke should be only the first dose of stiff medicine that bankers must take to prevent them from poisoning the global economy yet again.
