The HSBC Moral Hazard Paradox

by Benjamin Studebaker

Recently HSBC, the British bank, was found by the Department of Homeland Security to have laundered vast amounts of money for drug cartels, terrorist organisations, and rogue states. One would expect a steep penalty for aiding and  abetting such malevolent organisations. Consider Salim Hamdan, a man whose sole crime was to drive Osama bin Laden around for $200 a month, yet nonetheless ended up in prison from 2001 to 2009 and was subjected to “coercive interrogation” and “sexual humiliation”, whatever that means. Given the billions of dollars HSBC laundered for these kinds of groups, what Hamdan got should be a picnic in comparison, right? Well it turns out, not so right, as the Justice Department decided not to prosecute.

Why did the Justice Department decide not to prosecute? Not for lack of evidence, of which there is plenty, but because of the “collateral consequences”–the deleterious effects on the economy of HSBC losing its US banking license. In other words, HSBC is, as The Guardian put it, too big to jail. This is a valid argument of the consequentialist variety; it’s the same argument we used when we bailed out the financial system a few years back. It goes something like this:

  1. The state has an obligation to produce good consequences.
  2. Allowing bank X to fail or destroying bank X through a criminal trial harms the US economy.
  3. The negative effect on the US economy is not countervailed by the satisfaction we get from punishing the offender.
  4. In order to produce the best possible consequences, the state is obliged to bailout/not prosecute bank X.

The consequentialist counterargument is the argument of moral hazard–if the bank is not punished, it sends a message to other banks that they will not be punished for similar behaviour, encouraging risky lending or, in this case, laundering money for terrorists and drug lords.

Meanwhile, in Europe, Portugal, Spain, Italy, and Greece continue to suffer through policies of austerity. Wait a second–what does the Eurocrisis have to do with all of this? Quite a bit. The same argument is being had in Europe about the periphery nations as is being made right now about HSBC. The question for the European Union is whether or not the periphery nations should be bailed out. What is interesting here is that in the EU, instead of embracing the ethos of maximising economic output, the EU chose to follow the moral hazard line of argument–if the periphery does not suffer, then it sets a precedent for other nations to create future Eurocrises, or so the argument goes. As a result, these countries are being forced to decimate their welfare states and send millions of people into poverty. The resultant collapse in demand has created deep economic decline and sky high unemployment.

On the small scale, we accept the moral hazard point. It’s only on the larger scale where the economic consequences are so large that we are meant to consider the “too big to fail” argument. What greatly disturbs me here is that HSBC is being given the “too big to fail” treatment, while an economically huge nation like Spain is being forced into disastrous spending cuts to protect against moral hazard. Spain is, as a result, running an unemployment rate of 25% and still climbing. There is no way the exodus of HSBC from the United States could ever produce such a huge negative impact. So let me see how this works:

  1. If your small business fails, we cannot help you because that produces moral hazard.
  2. If a multinational corporation fails, we have to bail it out or refuse to prosecute it because it’s too big to fail.
  3. If a state’s finances fail, we have to ensure that any aid we provide is conditional upon pain and suffering because otherwise there’s moral hazard.

This is illogical. If the “too big to fail” argument is valid, then it is valid beginning at a certain size and including everything above that size. That means that the only objective of European policy should be to heal the economies of the periphery, regardless of how much bailout money that requires and including radical policies like Eurobonds and high inflation targets in the core economies. Getting those unemployment rates down should be all that matters. Call this “straight too big to fail”.

If “too big to fail” does not apply to the economies of countries, then it is utter madness to apply it to smaller units. If it is invalid on the large scale, then it is invalid on all smaller scales. This would mean that HSBC should be thrown out of America and the various banks should have been allowed to fail. Call this “never too big to fail”.

Either banks are wrongly being treated with kid gloves, or states are wrongly being punished at great cost to their citizens’ welfare. There is also a third potential position, one which argues that states are too big to fail while banks are not, which would involve both punishment of banks and a cessation of punishment of states by setting the level at which the “too big to fail” argument comes in higher than it is presently set. Call this “modified too big to fail”.

As a visual aid:

Method of Bailout Small Business Multinational State
Straight Too Big to Fail Fail Too Big to Fail Way Too Big to Fail
Never Too Big to Fail Fail Fail Fail
Modified Too Big to Fail Fail Fail Too Big to Fail

Theoretically, one could argue that all three types were too big to fail, but as I have not seen anyone argue that and do not think the argument particularly good myself, I leave that out.

Personally, I lean toward “straight too big to fail”. I’m inclined to buy that the banks were too big to fail without producing disastrous consequences, though I do not accept that this means that they could not be punished–I thought governments should have nationalised them and confiscated their wealth in order to punish them without causing their assets (and the demand produced by them) to disappear. That position, of course, entails believing that the current treatment of the periphery nations in the European Union is morally and economically unacceptable. The other two positions are logically consistent and therefore also viable, though I disagree with them because, broadly speaking, I think the consequences produced by them are less positive. “Never too big to fail” would have led to vastly higher unemployment and human misery as a result of the economic crisis across the board due to the disappearence of the assets held by the failed banks; “modified too big to fail” would have had similar consequences.

All the same, at least those two positions are also valid. What cannot be tolerated from any reasoning point of view is this notion that banks are too big to fail but states are not, when the failure of a state’s finances means so much more to so many more people than the failure of any bank ever possibly could. This position, which presently reigns over world affairs, is an illogical paradox. It must be challenged from all three sides.