Wednesday, April 06, 2011

Too big to fail means too big

The CEO of Barclays, Bob Diamond, taking the presentational spin given to him by Peter Mandelson, has famously declared that the time for Bankers to show remorse is now over. Banks- taking advantage of the free ride given to them by emergency ultra low interest rates and large injections into the system through quantitative easing- may not yet have returned to profit, but they have certainly felt confident enough to return to the days of large bonuses for their staff. Economic growth is slowly returning, even in the UK, which remains hobbled by a huge deficit and rapidly rising inflation. It seems that the pressure on the global financial system is easing, even if it is only happening in fits and starts.

Indeed, the British banks are letting it be known that they are now popular: they are being actively wooed by other governments. HSBC has denied that it is seeking to move to Hong Kong or even Paris, while Barclays has move quickly to scotch rumours that it may move its headquarters to New York. Of course the publication of such "rumours" has allowed the banks to put a certain amount of pressure on the British authorities, who have been publicly toying with the idea of firmer regulation of the financial sector, including that Banks pay in a lot more money to cover bail-out insurance. The message from the Banks is clear: hold off on this or we will move, taking our tax contribution to the UK exchequer with us.

Bank regulation no longer carries the urgency it did two years ago, but in my view unless serious action is taken now, the next financial crisis will not be far away, and could be even worse than the panic of 2008. The banks, by seeking to maintain their short term profits (and larger bonus pools), are actively avoiding necessary changes that would increase competition and improve bank safety.

In 1932, the US passed the draconian "Glass-Steagall" act, which prevented banks which took deposits from owning businesses that could use this deposit base in order to finance risk capital investment. It was a strong reaction to the causes of the 1929 Wall St crash, which as in 2008 saw a total implosion of the an overheated credit market and the bankruptcy of several major players. In 2008, the reaction of the US Authorities was the exact opposite. They forced investment businesses, like Goldman Sachs, Merill Lynch or Morgan Stanley to transform themselves into Bank holding companies, or be taken over by them.

In the UK, which never had the Glass Steagall separation in the first place, the Financial Authorities were forced to inject capital into the system directly by nationalizing Northern Rock, RBS and Lloyds Banking Group and indirectly through emergency interest rate cuts and large scale quantitative easing. The forced mergers that this process involved has created a banking system that is even more concentrated than it was before the crisis.

This is extremely dangerous: the UK banks are continuing to combine deposit taking and risk capital businesses, and are now even larger. Yet history tells us that the chance of another banking crisis is a probability of one: it is certain. The costs of rescuing the banking system during this crisis has increased the UK national debt by 100%, that is horrific enough: yet in Ireland it has been even worse, the state has been bankrupted and now faces the unenviable choice of defaulting on its liabilities or enduring crushing debt payments for a generation to come.

That will be the fate of the UK in the future, unless we act to break up the banking system now. So, if I were Vince Cable, I would say to HSBC and Barclays that they were welcome to leave, since that removes the ultimate responsibility for their failure from the UK. I would, however, insist that in order to keep operating in the UK, that they would bear a higher rate of deposit insurance- since there is now a risk that France or China or the US might not provide support in a crisis and simply to allow the UK business to default. Arguably the businesses should incur a surtax as well. I would then break up the nationalized banks into new, smaller institutions that would be encouraged to compete. Nor would these smaller institutions be permitted to merge except in certain circumstances permitted by the regulator.

The Banks have become the ultimate corrupt combination- and the only way to restore stability is to reinforce anti trust legislation and ensure much greater competition. It is slightly unnerving to see British Conservatives supporting the current Banking system, which has become more or less the enemy of the free market.

Too big to fail means too big, and it is time to act decisively- not just because the Bankers have shown insufficient remorse, although that is frankly true- but because a supposed private business that relies on public support in bad times, but keeps its profits private in the good times is socially corrosive and economically catastrophic. Banks, like any other business which is based on risk capital, will always carry a risk of failure. When a failure happens it should not be permitted to create a systemic crisis in the wider economy. It is time to let the bracing discipline of free market competition into this hitherto closed and rigged market.

1 comment:

Anonymous said...

It's about time someone is talking sense! With the controls in place after the Wall Street crash in 1929 the current crisis would not have occurred to the level it did in the US and certainly would not have had a global effect.