Mervyn King chooses his words carefully. So when the Bank of England governor
said in his Mansion House speech last week that banks should not be allowed
to become too big to fail, he knew what he was doing.
His comments on his lack of weapons to force changes in bank behaviour and his
musings on whether Britain’s banking sector had become too big for the
economy were also well rehearsed.
He insists he was not starting a battle with the Treasury or making a crude
grab for more powers. He was interested in generating a debate on the future
of banking and how it is policed, and there was no better place to do this
than at one of the City’s great occasions.
That debate has further to run. Alistair Darling, the chancellor, while
playing down differences with King, will publish the government’s proposals
on regulation over the next 10 days, drawing heavily on Lord Turner’s recent
report for the Financial Services Authority.
However, it was King’s remarks on the size of banks, and whether governments
can provide guarantees against the failure of large banks that “combine
high-street retail banking with risky investment banking or funding
strategies” that caused most controversy.
Anyone who wants to see the full impact of what can happen when banks grow too
big for their economies need only look at Iceland. When the bubble burst,
Icelandic taxpayers were asked to pick up the tab. Now the country is living
on loans from the International Monetary Fund, which is enforcing savage
cuts to public services.
Iceland’s banks were bigger than the economy by a considerable factor, but in
the international context they were small.
Most banking analysts insist the credit crunch has thrown up no evidence to
prove that bigger institutions are more likely to fail. If global regulators
had drawn up a list of systemically important institutions, Northern Rock
would not have been on that list. Yet the queues outside its branches did
more to dent consumer confidence and the international perception of
Britain’s financial strength than the subsequent failures of HBOS and Royal
Bank of Scotland (RBS).
“There has been no correlation between banks failing and their size,” said one
bank analyst. “Dunfermline [building society] was tiny yet it failed – and
was saved. Northern Rock and Bradford & Bingley were in the middle. RBS
was huge but only failed because it bought ABN Amro. Restricting the size of
banks would not stop them failing. Paying more attention to what they do
would be more effective.”
Swiss regulators last week warned they would consider curbing the size of
their two big banks, UBS and Credit Suisse. Switzerland, with a
long-established role in the international financial community, will not
allow itself to become the next Iceland. Nor is it likely to score an own
goal by sitting back and watching while banks in other countries start
making big money again, leaving Switzerland in their wake.
If banks were to be limited in size by the size of the economy in which they
operated, serious international banks would simply move headquarters to
America or, in time, China, India or Brazil.
“King seemed to make a quite direct attack on Barclays last week, when he
spoke about the need to separate investment banking from retail banking,”
said one senior banker.
“What he doesn’t understand is that by the time a new government or regulator
is in a position to introduce any new rules, Barclays is likely to be one of
the biggest investment banks in the world, run primarily from America.
“By this time, John Varley [Barclays’ chief executive] will have his
knighthood for keeping the bank out of state hands. Would King really want
to force it out of the country?”
Banks such as Barclays and Deutsche have managed to avoid state ownership
thanks to profits generated by their investment banks, even as bad debts on
traditional loans have soared.
Bank of America /Merrill Lynch, the universal bank created by the American
authorities on the same weekend last September that Lehman Brothers
collapsed, also disproves the logic. While losses in Merrill’s
investment-banking business forced it into the deal, it is now the Bank of
America business that is in greater difficulty.
That is food for thought for President Barack Obama who has been trying to
reshape America’s system of banking regulation. He inherited the biggest
financial meltdown since the Great Depression and has staked his presidency
on clearing up the mess. Last week he began to outline his grand plans to
sweep aside a “culture of irresponsibility” that had taken root “from Wall
Street to Washington to Main Street”.
Obama’s plans were launched with a 13-minute presidential statement in the
White House, in which he called for “a sweeping overhaul of the financial
regulatory system, a transformation on a scale not seen since the reforms
that followed the Great Depression”.
The plan aims to give the Federal Reserve the authority to police all
financial institutions – not just banks – whose failure could threaten the
financial system. The lightly regulated hedge-fund industry would also be
compelled to register with the Securities and Exchange Commission and a new
agency would be created to safeguard consumers. The proposals mark the end
of an era when self-regulation was the preferred route which, critics claim,
led to the credit crisis and the disasters at AIG, Bear Stearns, Citigroup
and others.
“Every financial crisis of the last generation has sparked some effort at
reform. But past efforts have begun too late, after the will to act has
subsided,” said Tim Geithner, Obama’s Treasury secretary. “We cannot let
that happen this time.”
Obama’s critics, however, are already arguing that the reforms give too much
power to the Fed. “This represents a grossly inflated view of the Fed’s
expertise,” said Republican senator Richard Shelby.
Charles Geisst, author of Wall Street: A History, said that given the public
outcry over the financial crisis he was surprised by how “toothless” the
proposals seemed. He said it was too early to see how the legislation would
pan out. “The thing about American financial legislation is that you really
have to wait until the final vote.”
Others said there was much to admire in the plan. Gus Faucher, director of
macroeconomics at Moody’s Economy.com, the financial data firm, said today’s
financial crisis was very different from the Great Depression. “Things were
much worse then than they are now,” he said, broadly welcoming Obama’s
moves.
“Regulation has been very scatter-shot and not very effective,” he said. “The
nonbank financial institutions have become much more important. We saw that
with AIG. The problem is not that they make mistakes and they fail. The
problem is that they have knock-on effects for the wider economy. I think
there is a recognition that we need to look at systemic risk.”
Some see the proposed changes as window dressing, warning that they would not
have prevented the current crisis. “I’m not someone who says we should do
nothing. I think we need to make some big changes,” said Mark Calabria,
director of financial regulation studies at the free-market Cato Institute
in Washington. “The big question is if this package had been in place seven
or eight years ago, would we be in any better position now? I think the
answer is no.”
He said the proposed changes set a bad example globally and that Britain and
Europe were likely to follow suit and extend their safety nets. “It’s a race
to the bottom in terms of policy,” said Calabria.
It is a race that has a long way to run, in America and Europe. Gordon Brown
spent two days last week in Brussels, fighting proposals to bring financial
regulation under European Union control.
The prime minister won one battle: the EU will not be able to force national
regulators to rescue troubled institutions but there are plenty more to come
before decisions are reached in the autumn.
