Quote of the Week: Leverage

"The banks were incredibly profitable not because they were doing anything better but simply because they were making bigger, riskier bets -- plunking down more money on the roulette wheel. That isn't just a metaphor, it's the actual conclusion of an academic study made by Andrew Haldane, the Bank of England's executive in charge of financial stability. Between 1986 and 2006, the average annual return on banking shares rocketed from its historic norm of 2 percent to 16 percent. Why? Because the banks were making bigger bets. There was no skill, efficiency, intelligence, or judgment involved, just riskier bets. In Haldane's exact words, 'Since 2000, rising leverage fully accounts for movements in UK banks' ROE [return on equity] -- both the rise to around 24% in 2007 and the subsequent fall into negative territory in 2008.' This is astounding stuff. Haldane is in effect saying that most of those bankers paying themselves monster bonuses were doing so simply as a result of making bigger bets -- and, as it turned out, it was we the taxpayers who, unwittingly and unwillingly, were bankrolling their ever-riskier wagers. This wasn't just looking for trouble, it was sending trouble a 'save the date' card, followed by a formal invitation, followed by nagging e-mails and phone calls just to make absolutely sure."
- John Lanchester, I.O.U.: Why Everyone Owes Everyone and No One Can Pay, pp.36-37