Mansion House Hangover
Last nightâ€™s two big Mansion House speeches were impressive when they dealt with the macroeconomy, but depressing (if unsurprising) on the subject of reforming the banks, representing final confirmation of the gloomy conclusion of a blog I posted here in September 2009: Itâ€™s All Over â€“ the Banks Have Won.
Of course the banks will squeal â€“ why wouldnâ€™t they? After all, they darenâ€™t be seen cracking open the bubbly.
The Vickers Report apparently never took seriously the only possible remedy for Too Big To Fail, which would be, as I have argued previously and as the Governor of the Bank of England came out publicly as favouring in his Mansion House speech of 2009, to break up the banks, separating investment banking (the â€ścasinoâ€ť) from the utility (retail deposit-taking etc).
This reform would not be a perfect solution. Even if it resulted in far smaller institutions, it would not necessarily prevent a possible wave of bank failures forcing a taxpayer bailout, if for example the insolvency of a medium-size bank threatened to bring down a string of other lenders in its wake. But
with smaller institutions shorn of their high-risk investment banking subsidiaries, there would be far lower systemic risk and the cost of a bailout if the worst should happen would be very much reduced.
From the outset, this proposal was the thing the banks feared most, far more, I suspect, than easily-bypassed limits on bank bonuses â€“ and in Britain, the banks clearly have the power of veto over any measures they oppose.
Instead, the Government has accepted the Vickers proposal to ring-fence investment banking and other high-risk activities so as to create an artificial separation between the utility and the casino. This would be fine, if there were any way of maintaining the separation, but I remain to be convinced. Indeed, the very fact that the banks have so successfully smothered the break-up proposal at birth suggests to me they will have no difficulty doing the same thing in the not-too-distant future, when the regulatory authorities have to consider more drastic measures to deal with the wheeze the banks have found to get round the firewalls between their deposit-taking and investment banking arms.
For decades, banks have made large amounts of money by circumventing regulatory restrictions introduced to stem the growth of credit for macroeconomic or for prudential reasons. We would not expect them to do anything other than exploit their room for manoeuvre to the full â€“ that is their job. But equally it is the job of the authorities to restrict that space to the degree consistent with prudence and stability, since the banks have shown themselves unable or unwilling to exercise self-restraint.
In the light of experience, is it really plausible that so-called Chinese Walls will stop the investment bank using the publicâ€™s deposits as chips in the casino?
After all, consider â€“ yet again â€“ the mechanism which brought the banks to their knees in 2007/2008. The shadow banking system, as it was called, was a network of specially-created vehicles through which the banks could channel their riskiest activities involving asset-backed securities and other structured products whose pricing neither they nor anyone else really understood. In theory, these shadow(y) institutions were independent of the banks which created them, but in reality, thanks to what was euphemistically called credit-enhancement (i.e. loan guarantees), they were independent only in good times. As soon as the loans turned sour and the asset-backed securities turned out to be backed by next to nothing, the commercial banks were called on to make good their guarantees.
Now I am sure the new regulatory framework will stop the banks pulling exactly the same stunt again, but I am equally sure their lawyers will put their heads together immediately to work out ways of emasculating the rules, while of course observing the letter of the law.
And even if the firewall works in formal terms, ask yourself the question: in a crisis, how will depositors react faced with the spectacle of a clearing-bankâ€™s other-half in trouble? Will they keep their nerve, trusting that, though the investment bank may be 100%-owned and bear the same name as its parent, their deposits are nonetheless safe? As far as the public at large are concerned, the guarantee by HM Government may be reassuring enough to avert a panic. But what about foreign currency depositors? They may be less reassured, since even if they are covered in principle, the guarantee can only be as good as Britainâ€™s relatively meagre foreign exchange reserves. Moreover, the Icelandic imbroglio showed how nebulous is the situation within Europe, let alone outside it.
Towards the end of his speech last night, the Chancellor (I think) wheeled out the usual argument in favour of going easy on Britainâ€™s banks, reminding us that there are plenty of other countries queuing up to welcome the Cityâ€™s financial institutions if they decide to quit London. No doubt this is still true, even today.
But people should bear in mind that, until 2008, Ireland would have been jostling at the front of the queue. Iâ€™ll bet they arenâ€™t so welcoming today. Sure enough â€“ they had a boom in high-paid jobs in Dublin, and the Irish Treasury must have bulged with the tax paid by the Irish-based banks, but now the people of Ireland are paying the price â€“ and it is many times greater than all the benefits they ever enjoyed.
And the Irish did far better out of the deal than did the Icelanders.
What about Britain? It would be a multiyear research project to compute the net value to this country of the expansion in the financial sector since, say, 1990, and in any case the bill for the crisis is by no means in yet. We are still paying, with no end in sight â€“ and we can have no idea of how much the Treasury will ultimately be able to recoup from the sale of the bank shares it currently owns. (Note: get ready for vast overestimates of the returns on taxpayersâ€™ investments in HBOS, RBS and Northern Rock).
But my guess is that the net value to the UK will prove to have been negative â€“ and that, of course, is assuming there is no further banking collapse, something which is by no means certain either. (As I have pointed out many times before, the so-called sovereign debt crisis is actually a banking crisis, since â€“ in spite of their vast and highly-rewarded expertise in lending â€“ it was the banks who provided the bulk of the finance to Greece, Portugal and the other indebted nations, and it is they who are therefore the primary beneficiaries of the current round of bailouts).
There was one bright spot in the Chancellorâ€™s speech. He now feels it is safe to claim that Britain has seen off the vindictive and stupid campaign being waged by Brussels against hedge funds and private equity. If only we could persuade them to buy Greek bonds, we could solve a lot of problems. Unfortunately, theyâ€™re a lot smarter than bankers…