Diamond’s parting gift: James Saft

July 3, 2012

By James Saft

(Reuters) – Bob Diamond’s gift to the UK, perhaps a parting one, is that he has managed his bank badly enough to provoke real reform but, perhaps out of luck, not so badly as to blow up the whole economy.

That Diamond should go is obvious; that he hasn’t is further evidence of why he should.

Not that Diamond, the CEO of Barclays Plc, has made the case for root and branch reform all on his own. While Barclays has been heavily fined in the UK and U.S. for submitting fictitious borrowing rates to the key LIBOR and EURIBOR panels, it is very likely that it was not alone, either in masking its weakness during the height of the crisis or in manipulating figures for gain in good times. Nor was the bank alone in the further scandal of mis-selling complex and destructive interest-rate swaps to small businesses, a plea it copped along with HSBC, Lloyds Banking Group PLC and Royal Bank of Scotland Group Plc.

This represents a golden opportunity for the UK, a chance to harness public outrage in the service of reform before its banking system, as it very well may someday, causes a crisis too big for the state to handle. Think on this: Barclays’ balance sheet is about the size of annual UK GDP, and the balance sheet of the system of the whole is several times that. At the same time, as recently as the end of last year, median UK bank leverage was still well above 20 times capital, meaning that a typical bank might be rendered insolvent by a decline of less than 5 percent in the value of its assets.

And don’t be fooled by Britain’s AAA rating, already on review for downgrade by several ratings agencies. It, like Iceland, Ireland, Greece and Spain before it, could find itself with a banking crisis it cannot bankroll.

That, in combination with the ample evidence of bad behavior, bad management and misaligned incentives, makes UK banks a real threat to the UK’s future. It is an injustice that the UK subsidizes too-big-to-fail banks, stifling competition and allowing a good proportion of that subsidy to walk out the door in bonus payments. It is even worse that these banks are not just too big to fail but too big for Britain.

Of course this is not simply a nasty side-effect of the financial crisis, it is really the result of a strategy the UK pursued for decades leading up to the crisis, making an enormous leveraged bet on globalization by allowing its industry to wither and concentrating on global financial intermediation.

While this has worked out well for financial services workers, it has helped to create the conditions leading to rather crushing levels of household debt.

It also makes it that much harder for reform to get political backing, though the Bank of England is at least making more radical noises than their peers across the Atlantic.

CURSE OF SELF-REGULATION

The plague of Britain is gentlemanly self-regulation, which has repeatedly proved a failure. The very fact that a key rate of interest, used to compute trillions in mortgages and to fix the value in still more in derivatives, was in the hands of a trade association, and one which offered as its only sanction for fraudulent submissions the risk of expulsion from the panel, is simply amazing.

LIBOR should not be allowed to remain under the auspices of the British Bankers Association, and the fact that major changes to its calculation could theoretically invalidate billions in contracts only underscores how untenable the current set-up is.

Even the cries of outrage from British regulators have a kind of pleading tone to them:

“Perhaps the reaction to the penalty imposed last week on Barclays will be a watershed moment, the point when the industry realizes that it also has to rise to the challenge and to recognize that things have to change,” Tracey McDermott, acting head of enforcement at the Financial Services Authority, said, maintaining that the solution was not solely the job of regulators.

It goes against all the evidence to hope that banking will realize that it must change. The watershed instead will come when people in politics, in regulation and in everyday life realize that it is up to them to impose change on the industry.

This will impose real costs on the UK, but they are likely to be lower and easier to plan for and bear than those of a catastrophic banking crisis in 10, two or one years.

For that realization, which may just have come in Britain, and for helping us to come to it without actually destroying too much of the economy, we owe Mr Diamond an ironic kind of thanks.

(Editing by James Dalgleish)

(At the time of publication, Reuters columnist James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. For previous columns by James Saft, click on)

(James Saft is a Reuters columnist. The opinions expressed are his own)

One comment

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I only wish I had your confidence in the UK to deliver real change.

Posted by Dafydd | Report as abusive