International accounting standard-setters have at last recognised the error of their ways and relented on the question of prudence, which they plan to re-instate as a fundamental accounting principle. Bank auditors will have to form an independent view on loan recoverability, rather than rely on the potentially biased judgements of management.

A regime that allows banks to flatter revenues by failing to recognise loan losses until actual default instils a cavalier culture, in which dodgy high-risk activity is treated as the norm. Since 2009, 117 banks with operations in the US (including several based in the UK) have paid $200 billion in fines and negotiated settlements for proven acts of money laundering, financing terrorist activities, rigging currency markets and defrauding clients. Loretta Lynch, the new US Attorney General, has found that “the banks’ actions were criminality on a massive scale”.

The unprecedented level of penalties against miscreants and their institutions may give comfort to those baying for redress, but criminal convictions in the US have become largely symbolic due to the practice of granting waivers. Banks now regard sanctions as part of the cost of doing business, and the rate of reoffending is clear evidence that waivers run counter to deterrence. If criminal sanctions do not deter, why bother to impose them, other than to enrich regulators? By contrast, the State Treasurer of California, to his credit, has banned HSBC from accepting deposits of state funds because of concerns about money laundering, sanctions violations and tax evasion.

Remember Arthur Andersen? What finally brought it down was desertion by clients, following withdrawal of its state practising licence when found guilty of obstructing justice by shredding Enron documents. Sanctions, to be effective, must include the removal of licences to operate.

Playing the government’s own game

Financial delinquency comes as no surprise. Institutions are merely playing the game of “follow-my-leader”. Fiat money counterfeiting by central banks and suppression of interest rates to the point of extinction have produced speculative asset bubbles and state expenditure wasted on construction projects that few would have voted for. The 2008 financial crisis contained all the lessons that, if learnt, would have avoided its recurrence. Instead we have witnessed recourse to monetary policy that, although intended to stimulate economic productivity, has had the opposite effect.

Illusory liquidity may flatter the finances of those that get their hands on it first, but it does nothing to irrigate essential functions in the economy because savings, from real production, have generated none of it. Record corporate profits and dividends, share buy-backs and cash hoards in major enterprises may do wonders for share prices and pension funds, but if they represent nothing more than the effect of unrealistically cheap credit and fake money flooding the system, the bonanza that follows is not only unsustainable; it is a veritable financial time bomb that will make 2008 look like child’s play.

Banks, having at last woken up to the hazard of lending against overvalued collateral, now preside over a lack of real liquidity in the market place: banks’ balance sheets, bloated with fiat bond deposits, dissemble solvency but even they don’t trust the adequacy of their reserves. As a result, lending to even the most solid companies is virtually frozen.

Lessons in unintended consequences

We have observed the law of unintended consequences in action many times. Remember the US government’s 1990s policy intended to encourage home ownership in poorer communities, often with ethnic minorities?

Blatant electoral bribery, masquerading as noble aspiration, created a massive speculative housing bubble and the issue of 27 million sub-prime loans, proving only that the road to hell is paved with good intentions – an alternate expression of the same law.

This phenomenon is known as “cognitive dissonance”, or holding on to two irreconcilable ideas at the same time – as did the Weimar Chancellors and the Zimbabwe Central Bank. Both believed that the only way to feed the poor and save them from the ravages of rampant price inflation was to print more money.