Commentaries

Now raising intellectual capital

What banks can learn from hedge funds

Should the banking industry look more like the hedge fund sector? That’s the surprising suggestion made last week by two Bank of England officials.

In a fascinating paper, Piergiorgio Alessandri and Andrew Haldane explore the level of public support given to banks in the crisis and the problem of institutions that are too big too fail. Their main point is that if this issue is not addressed it will lead to new crises and even bigger bailouts in the future – a state of affairs they describe as a “doom loop”.

But the most eye-catching passage is a suggestion that banks have a lot to learn from hedge funds:

It may be coincidence that the structure of the hedge fund sector emerged in the absence of state regulation and state support. It may be coincidence that the majority of hedge funds operate as partnerships with unlimited liability. It may be coincidence that, despite their moniker of “highly-leveraged institutions”, most hedge funds today operate with leverage less than a tenth that of the largest global banks. Or perhaps it might be that the structure of this sector delivered greater systemic robustness than could be achieved through prudential regulation. If so, that is an important lesson for other parts of the financial system.

Banking? Keep it simple stupid

In 1873, Walter Bagehot wrote that “the business of banking ought to be simple; if it is hard it is wrong.” He would have struggled to recognize today’s banking system.

It is not just ever more ornate derivatives that bend the mind. Financial firms themselves have become fabulously complicated. Citigroup lists 2,061 subsidiaries and affiliates while the institutional chart of JPMorgan Chase is 267 pages long.

FSA barks up wrong tree on guarantees

The Financial Services Authority has since the credit crunch had a bee in its bonnet about the incentives and rewards offered by financial firms and whether these encourage risky behaviour. It’s a perfectly reasonable concern. Big bonuses probably did skew behaviour towards excessive risk taking in some cases, although the crazy risks run by employee-shareholders at Bear Stearns and Lehman Brothers suggest it might be a more complex picture.

But the FSA’s latest campaign — against long-term bonus guarantees — simply doesn’t make sense. The regulator has written to more than 40 chief executives in the financial services industry warning them against offering bonus guarantees with a duration of more than one year. This is “inconsistent with effective risk management”, the letter states.
 
The whole idea of guarantees is of course a loaded one in the wake of the crisis. Some feel that bankers have come through it in better shape than their shareholders.

Mervyn King’s uncomfortable sermon for the City

Did Mervyn King miss his true vocation? Last night he compared the Bank of England to a church – with the Governor as the priest – as he took to the Mansion House pulpit to pour a rhetorical bucket of cold water over guests at the Lord Mayor’s banquet.

Headline writers predictably seized on King’s disagreement with Alistair Darling over Britain’s regulatory structure. But the more interesting section of his speech dealt with banks that pose a threat to the stability of the financial system.

from Neil Collins:

Brown’s bombshell for the Bank of England

You may not have heard of Adam Posen, but you hadn't heard of David "Danny" Blanchflower before the banking crisis. Posen is Blanchflower's replacement on the Bank of England's Monetary Policy Committee and, boy, does he have some strong views. Here he is before the US Congress three months ago, with some modest proposals.

The rest of us may struggle to come up with remedies for the current malaise, but Posen has no doubts. He calls his address "a proven framework to end the US banking crisis". His framework looks more like a cross to nail up bankers, owners and regulators, since he suggests firing the lot of them, wiping out the shareholders, and wholesale nationalisation. He is wonderfully free of self-doubt:

  •