It has been over year since the financial crisis started, yet only this week it would seem as if nothing had happened at all. Much like an alcoholic who promises to give up the booze in order to have a life-saving liver transplant, only to recover from the operation, sober up a little and then go on another round of binging until the new liver packs-in – and then he pleads again for an operation, and so on.
This is uncannily reminiscent of the banking and financial sectors. They, not all of them though, were “ill” last year and came to the government for stimulus – some were considered worthy, and some were not. The “too big to fail” behemoths made it; I like to think of them as the George Best of the banking system. Prolific and high profile enough to warrant saving. Now they have been saved what protection is there in place to prevent them from going off the rails again?
Why, regulation silly!
The powers that be have decided that the world needs tighter, coherent regulations to prevent such a crisis again. Such regulations that have been bandied around include: caps on bankers bonuses and tougher capital requirements. The government seems to be staying clearly within the remit of the G20 communiqué and leaving the tough job of regulating capital requirements to the Basel Committee.
Is this a good thing? Probably not, as it closes the door to many debates on a new form of regulation. On 16th October Mervyn King threw his two cents in. He called for a split in the banks, much like the Glass-Steagall Act which was created in America in the 1930s after the Great Depression, which was subsequently repealed by the Clinton administration. King, like the Glass-Steagall Act, called for two banks to be created from one. In other words, the bank will be separated into retail/utility banks and risky ventures. The idea is to get rid of the “too big to fail” mentality therefore the retail side (the high street banks that everyone has their salaries paid into) would not, in theory, be infected from any dodgy goings-on from the venture side (the area responsible for creating ever more boundless wealth from nothing, such as sub-prime mortgages, and risky trading in derivates for example).
Therefore, only the ‘safer’ part of the bank will have access to the lender of last resort – the government – whilst the casino style banks with not be faced the moral hazard and will know that they have no such luxury. Consequently, without state money as a reserve the risky venture banks are less likely to gamble on the outcome of future markets. As a result, no credit crunch part deux – in theory. However, these two banking groups overlap to such an extent that separation may be impossible. Though I do not agree completely with debates on regulations circling in the newspapers, I do believe that King, like Lord Turner, is opening up the floor for debate and this is an encouraging step.
A moral hazard is the closest an economist gets to asking a question about ethics. Economists are essentially the daleks of this world, they may say they understand morality and ethics but n reality and practice, they only ‘understand’ competition, markets and currencies. Simply, if I insure myself – say private health insurance (hypothetically there is no NHS), then I am more likely to take a risk with my health because I have insurance to cover my medical costs – hence a moral hazard.
You do not need me to show you many holes in this “law”. In the financial world, and in this instance, if a bank has a guarantee that they will be bailed-out for any malodorous actions then they are more likely to take the risk as they have “insurance” – that is the backing of the State. However, this assumes a lot, and oversimplifies a very complex problem. It assumes that 1 + 1 = 2 without considering what 1 consists of. It assumes that the problem lies with this moral dilemma and that new incentives need to be offered to encourage increase productive activity and decrease this hazard.
Changing incentives may not necessarily help the economy – it may only act as another mistaken idea that seems good through its simplicity but is clearly out of sync with the real workings of society.
So how can we prevent another crisis? Well simply: you can’t.
No matter what regulations are created – and there will be many – people will find loops and holes to squeeze through. Already as we speak policymakers are making these problems for the future leaders to solve. The Clinton administration thought repealing the Glass-Steagall Act would be a good thing, encouraging free trade, competition and therefore the trickle-down-effect would come into force creating jobs and spreading wealth. This is easy for the economic elite and policymakers to agree on in the gilded ghettos. I am sure the sub-prime mortgage homeowners who become homeless did not think so, particularly when Wall Street employees were given their Christmas bonuses (something around $38bn in 2008).
For the meantime I would favour a utopian tax imposed by the governments, and living wills placed on the banks. It is utopian in the sense that no one will ever want to adopt it. It is not dissimilar from the Tobin tax, which has the backing of Lord Turner, chairman of the Financial Services Authority. Tobin is a tax on all currencies transactions, whereas the utopian tax is a miniscule tax on all financial transactions between companies/banks. This then would create a reserve pool for the governments to use as they see fit, hopefully investing in international development, or public services which are obscenely underfunded. But after the recent Intentional Policy Network Report, Fake Aid, would you really trust the government (DFID) to invest the money wisely, and not just waste on advertising campaigns in the UK by Oxfam, et al.
To discourage the banks from using government as a lender of last resort I would impose “living wills” onto the banks. Why should the state always be burdened with the risk, whilst profit is privatised? A living will ensures that a bank prepare for the eventuality that they may collapse, thus not using the public purse to aid there recovery.
No doubt King has created another headache for Labour and, coupled with the Office of National Statistics report stating that the UK is still in a recession, this does not help an already ailing party; a party that stated Britain was best-placed to ride out the recession, and that the economy would be “now coming out of recession as a result of the actions that we have taken”, yet here we are, apparently, still in it when most other countries have recovered. This is due to the UK’s over-reliance on the financial sector and under-investment into the manufacturing sector.
Finally, King echoed in his speech, drawing from Churchill: “never in the field of financial endeavor has so much money been owed by so few to so many” And, one might add, “with little real reform”.
Is King suggesting that we have not improved since the last crisis 80 years ago? Have we learnt anything of value? It would seem so and when the next crisis comes around people will be asking the same thing again: how did this happen? And then undoubtedly there will be a call for more regulation! Instead of creating a perpetual problem a new narrative is needed. Controlling the symptom of a problem is not going to cure it. The problem will return, much like our unfortunate alcoholic.