Carving the Turkeys
The LIBOR scandal will run and run, and it is far too soon to say where it will all end. Nonetheless, there are two conclusions that we can already draw from it.
The first is that LIBOR (and its foreign relatives, EURIBOR, NYIBOR and all the other bores) are as dead as Monty Python’s Norwegian Blue. They no longer carry any credibility as an index of bank borrowing costs and in fact they no longer represent any economically meaningful quantity at all. The world of finance is now suspended in a ridiculous state of limbo, where contracts amounting to trillions of dollars are being priced off a number which, with or without the connivance of the agencies supposed to be regulating its integrity, has been systematically manipulated for years by financial institutions which are themselves major parties to the contracts. Inevitably, the distortion intended to conceal the fragility of the banking system has ended up exposing it more brutally than ever.
The obvious thing is to replace these self-generated synthetic interest rates by something firmly grounded in reality, an index based not on the price banks say, or believe, or say they believe they would have to pay to borrow, but on the deals they actually do. Against the objection that those rates would look like the ones quoted for Greek Government debt right now, one can only say: so be it. If borrowing costs had been honestly reported all along, we might never have got in the current mess. Bank shares would have fallen far sooner, their empire-building schemes would have been stopped in their tracks and history might have been different.
The problem, apart from the fact that the damage has been done, is that in any case replacing LIBOR will take time – years, rather than months. In the meantime, we know it seriously overestimates the extent to which banks trust each other, and even more seriously overestimates how far the rest of us trust the banks.
The other lesson we should learn from this fiasco relates to the Vickers Report. When the interim conclusions of this Report were published, I wrote that the notion of Chinese Walls between the investment banking and deposit-taking divisions of banks was a nonstarter, because they would easily find ways of circumventing the restrictions so as to make the deposits available to the casino. Can anyone now seriously dispute that prediction?
I made it clear I was thinking in terms of clever legal devices cooked up by smart corporate lawyers. The LIBOR affair has shown that I was, not for the first time, insufficiently cynical. Who needs expensive lawyers to get round regulatory requirements when an email and a bottle of Bollinger will do the trick?
It vindicates those, including the early post-Lehman pre-nobbled Mervyn King, who argued that we need to return to the Glass-Steagall separation of deposit and investment banking, precisely because the alternative is regulation of the latter so tight it will strangle the industry altogether.
Indeed, public trust in banking as a whole has already sunk so low that we may need to go even further and consider a tripartite segregation, splitting what is often called the utility – commercial banking to the household and SME sector – into two parts. The most basic would be a pure current account operation, a sector in which banks competed to provide the cheapest, most efficient and most convenient service of minding people’s money, providing them with cash on demand and money transfers – the same service we get from our cheque accounts today, but from institutions which did nothing else but take deposits from the public and lend them to the central bank, which could then provide a copper-bottomed guarantee for every last penny of the bank’s liabilities. These one-hundred-percent-reserve current account banks would be able to pay their depositors very little interest, and might even have to charge for their services – so no change there then!
The other vital functions of high street banking – taking longer-term interest-bearing deposits, providing loans to SME’s and mortgages to housebuyers – could be operated as banks are, in principle at least, today, with limited deposit-insurance in exchange for tight regulation of their leverage, capital adequacy and equity ratios.
The rest of banking should be left as untamed rainforest, with its predatory wildlife allowed the freedom to follow its Darwinian destiny in a cycle of continual unregulated expansions and extinctions. Those who venture into the jungle would do so only because they believed the rewards justified the risks (rather like an investor in somewhere like Russia today). This is important, because it is all too often forgotten that taxpayer generosity to investment banking dates not from the crisis, but from the day, long before 2008, when it became clear that the cowboys included a number of institutions judged too big to fail. From that point onward, everything they did – borrowing, lending, hedging or speculating – always included a taxpayer subsidy in the form of a more favourable deal to reflect their TBTF status. The end of this state of affairs can only be unambiguously signalled by hiving off the parts of the bank which matter most to voters (and therefore to politicians), making it crystal clear that from now on the investment banks are to be regarded as risky and that capital the market supplies to them could be lost, so investors had better demand both a high enough return to reward them for the risk they are taking and also a voice in governance to safeguard their stake.
I write these words from Greece, where any refugee from the misery of a British summer is forced to reflect on the fact that the sun shines brightest on the bankrupt. There may be a message there somewhere, but I’m not sure what it is.