By Richard Smith
The publication of a pamphlet from Demos, a British fauxgressive think-tank (unconnected with the American think-tank of the same name), is the latest visible move in a not-always-public epic battle between banks and regulators about bank reform. While Americans may assume that the time for regulatory intervention has passed, the preliminary findings of the Independent Banking Commission, a UK body whose output will put an important stake in the ground in the UK, is to be released on April 11th. Whatever mix of legislation, regulation and inaction is deemed appropriate by the politicians will follow the publication of the final IBC report in September.
Given the importance of this report, it should come as no surprise that the banks, or rather the bank that has most at stake, Barclays, is using every available channel to convey dire warnings about how terrible reining in the banks would be, particularly since the banks are really hardly at fault at all.
A curious centerpiece of this effort is this 100 page abortion of a pamphlet, penned by a fallen Labour MP (the usual expense account improprieties), Kitty Ussher. The pamphlet bears the elite Demos wrapper. If you didn’t know the recent history of Demos, founded by a modernizing Marxist in the early 90s, it would be astonishing that an outfit, which was long a key promoter of soft Left and New Labour thinking, would allow itself to be used as the distribution channel for such a badly written, poorly reasoned, and transparent bit of banker PR. But then you notice the ’08 funding crisis at Demos, the ensuing staff turnover, and the surprising arrival of senior Conservatives as board members in ’09: one of them is George Osborne, now Chancellor of the Exchequer. Suddenly the orientation of the pamphlet makes sense!
Since I need to explain this monstrosity to US readers new to the topic, this post is a bit lengthy. British readers might skip past the “Background” section.
In contrast to the US, the striking feature of the UK’s debate so far has been the near-unanimity of UK regulators in pushing for radical changes in bank regulation and industry structure. It would come as quite a repudiation to the US if the UK, whose banks represent an even bigger proportion of GDP, implemented bloody-minded measures. It should probably be no surprise that this high stakes UK fight is virtually taboo, as far as US coverage is concerned.
Admittedly there’s a Simon Johnson post about Mervyn King, but it skips the conflict between the UK bank lobby and regulators, surprisingly framing the discussion instead as one between two views of banking policy. That’s not how it looks in the UK. From an NC post a couple of weeks back:
in the red corner, we have the entire IBC, Bank of England Chairman Mervyn King (just try to imagine Bernanke saying this sort of thing), BoE Deputy Chairman Paul Tucker, BoE Director Andrew Haldane, and FSA Chairman Adair Turner all calling for radical moves in bank regulation. In the blue corner, we have George Osborne and some banks.
If the regulators get what they are aiming for, that will put the fluffed reforms in the US (and Basel III for that matter) into a new perspective, for if the regulators of the world’s largest financial centre adopt a radical line, it is a little harder for Wall Street and Washington to pretend there’s no alternative to the patchwork approach of Dodd-Frank.
The IBC may in fact be a smidge less aggressive than the regulators: it is known to be investigating the option of requiring the investment banking and retail banking components of universal banks to be capitalised in separate subsidiaries, rather than split apart completely:
Adopting such a structure would be likely to cost the banks hundreds of millions of pounds to implement and administer (because of capital and funding requirements attached to each new subsidiary) and any recommendation to do that would face fierce lobbying from some of the so-called ‘universal’ banks which call London their home.
Those universal banks would be RBS (now 83% state owned after its near-implosion and already in the course of restructuring), HSBC (a semi-detached part of the British banking community that moved here 30 years ago, after 100 plus years in the Far East, and keeps the option of moving back to a Far East domicile under continuous review), and Barclays, which is heavily committed to the universal banking model, and relatively firmly domiciled in London, though with extensive American operations.
So, when you read “some of the so-called ‘universal’ banks which call London their home”, take it to mean “Barclays”. When we look at the lobbying efforts that kicked off in earnest back in September, we do find Barclays’ fingerprints all over them; at first, steered politely by the outgoing English CEO John Varley, then, when that didn’t work, abrasively, and effectively, by Bob Diamond, the incoming American CEO.
Formally, that phase all culminated in the governmental capitulation to the banks that was the Project Merlin announcement, in February, though Diamond’s ebullient defiance at the Treasury Select Committee in January signalled that he knew what would be in Merlin a month before the rest of us. Along the way, the lobbying pressure was so intense that it elicited resignation threats from all the members of Independent Banking Commission
The Pamphlet: “City Limits: the progressive case for financial services reform”
Now we have the first intervention in the debate by a self proclaimed, and as we see, clearly misbranded “progressive” think tank. It is a very remarkable instance of spin. The title page proudly displays the logo “Open Left”, an initiative of Demos which, according to the Demos website,
is asking the challenging questions about Labour’s record in Government to identify unfinished business and new areas of reform. Open Left is seeking to rediscover the Left’s idealism, pluralism and appetite for radical ideas. The project is engaging with the new generation of MPs elected in the 2010 cohort and the voices of the Left beyond the party: in the wider labour movement, in the cooperative movement, amongst voluntary and community organisations and the left-wing blogosphere.
So this is going to be some hair-raising pinko tract about banks, right? Not so…
The pamphlet gives us the background:
The public blames the bankers en masse for the financial crisis that began in 2007 and the subsequent recession. This suits the politicians as it shifts the blame away from them and gives an opportunity to load additional taxation on the sector. Indeed, some opinion formers have argued that there is a need to ‘rebalance’ the UK economy away from financial services.
So that’s a pretty straightforward agenda: make sure as much blame goes to parties other than banks for the crisis and the recession so as to avoid taxing or fining the obviously scapegoated financial sector. Despite its goal, objectivity:
It seeks to improve the clarity of thinking on the debate on the future of the banking sector in Britain…
…A clear-headed look at the facts is required, undistorted by the prism of the public mood, in order to ensure that policy changes actually have the desired effect.
…a sceptical observer might worry that the pamphlet is pretty outrageously compromised from the outset by the source of funding for the report:
I am particularly grateful to: the City of London Corporation for its financial support and helpful suggestions…
Perhaps you can deduce who controls the City of London Corporation, from its voting rules, if you make a wild guess at which industry employs the most people in the City of London:
Each body or organisation, whether unincorporated or incorporated, whose premises are within the City of London may appoint a number of voters based on the number of workers it employs.
…thus, the report’s lopsided set of information sources may not be a huge surprise:
This work has benefited enormously from the support and experience of numerous practitioners and experts, from the top of high finance to frontline retail workers…
Evidently the author has spoken to…well, mostly bankers, then. I count one quotation from a “frontline retail worker”, or junior banker, one from an expert in regulation (who might actually be a banker); the rest are all senior bankers.
So much for the Introduction. Now for the Summary of Findings, which, for a progressive outlet, has a remarkable overlap with, of all things, the Financial Crisis Primer, the dissenting minority report issued by Republicans on the Financial Crisis Inquiry Commission, on which Yves had this to say:
The intent is pretty transparent: to discredit an effort at fact finding into the roots of the crisis, what was hoped to be a Pecora Commission, by making it appear partisan and launching an alternative narrative to muddy the waters.
The pamphlet’s Summary of Findings has this (my annotations of comparable passages from the US Republican dissent in bold)
The analysis in the first two chapters of this pamphlet shows that there were four main causes of the crisis – or four factors without which the crisis would not have happened. These are:
· the lax regulatory regime, which resulted in loans that were too risky to be made, primarily in the US housing market (compare Financial Crisis Primer page 1)
· the ability of these loans to be securitised, repackaged and sold around the world (compare Financial Crisis Primer page 3)
· a failure by management in some, but not all, institutions to understand the nature of the risk they were taking on (compare Financial Crisis Primer page 4)
· in those institutions that did not understand the nature of the risks they faced, a failure by the regulators to correct their mistakes. (compare Financial Crisis Primer page 5)
The importation of stale, long-debunked bank-lobby talking points, from the US, continues in the pamphlet’s next section (“What Happened”) with this explanation for the rise of subprime loans:
Although such subprime mortgages existed in the UK, they existed to a far greater extent in the USA, where lighter regulation allowed high-risk individuals easily to acquire socalled ninja (no income, no job, no assets) loans, particularly to buy houses. Indeed the US government had actively encouraged greater lending to low-income families for this purpose.
Next, one spots an outright misstatement of fact:
Many institutions had not fully valued their toxic assets until early 2008.
It took much longer for banks to acknowledge the truth than that. For instance, downgrades of RMBS took place well before downgrades of CDOs. They should have been simultaneous, but they were not. Sure, mass downgrades of CDOs took place in Q1 2008 but the full scale of the catastrophe didn’t emerge until AIG lost its AAA rating and had to take collateral calls. The story was followed at the time at Naked Capitalism between November 2007, through January and February 2008 and all the way to September 2008. As we now know, it was Goldman’s revised marks that triggered the cash call that sank AIG; other banks were still marking their CDOs at 90-95 cents. But Goldman was right.
During the credit crunch, market funding and solvency concerns interacted, mediated by repo of toxic assets: misvaluation was a core issue. This understatement of the deceit around asset valuation during the crisis helps makes a mess of the pamphlet’s account of the crunch. The author of the pamphlet, ex Member of Parliament Kitty Ussher, and now, after a little unpleasantness with Parliamentary expenses claims, director of Demos, was a junior Treasury minister between June 2007 and October 2008, with a ringside seat at the three way discussions between Treasury, Bank Of England, and FSA as Northern Rock collapsed and the credit crunch unfolded. That would seem to make her part of the problem and hence a less than objective analyst.
There’s another important defect in the pamphlet’s account of the crunch. Though risky market-based funding models do feature in the pamphlet’s initial analysis of the crisis (section “What happened”), a whole new bunch of putative crisis causes are suddenly dropped in in the following section (“Causes”), and the point about funding models simply gets lost. That’s very surprising, given the author’s direct experience, and also, very similar to the move the Republicans pulled with their minority report; Yves again:
If you think I am exaggerating how intellectually dishonest this Republican whitewash effort is, Shahien Nasiripour’s first rate account at Huffington Post has more sordid details:
During a private commission meeting last week, all four Republicans voted in favor of banning the phrases “Wall Street” and “shadow banking” and the words “interconnection” and “deregulation” from the panel’s final report, according to a person familiar with the matter and confirmed by Brooksley E. Born, one of the six commissioners who voted against the proposal….Born said that the Republicans wanted to ban two other phrases “of the same ilk,” but she said she couldn’t remember what they were.
How can you talk coherently about the crisis and NOT talk about the shadow banking system, which grew to be at least as large as the official banking system and was the primary object of the various government rescue operations? It’s like trying to talk about AIDS and pretend there is no such thing as intercourse. Similarly, excessive interconnectedness, or as Richard Bookstaber vividly called it, “tight coupling” was another critical driver. AND HOW CAN YOU NOT TALK ABOUT DEREGULATION?!? What is there left to talk about once that is excised? Sunspots?
Indeed. And the Demos pamphlet has the same, umm, problem: the result is a disjunction between the analysis of the UK end of the crisis, in the “What happened” section, and the ensuing analyses and recommendations, which appear to have been throughly nobbled, and by someone familiar with the American spin on the crisis causes.
Rather than plod through the various mundane secondary crisis causes adduced by the pamphlet, I’ll pick out a repetition and variation of the ‘blame the government’ point:
the Clinton and Bush administrations: for actively encouraging Fannie Mae and Freddie Mac to make subprime mortgages and, some have argued, repealing the 1933 Glass–Steagall Act, which separated retail from investment banking
It is in that lukewarm mention of the repeal of Glass-Steagall that I fancy we start to see the hand of Bob Diamond, or someone who thinks just exactly like him. For, according to the pamphlet:
All the above are implicated, although some to a greater extent than others. As discussed in chapter 4, however, the repeal of the Glass–Steagall Act in 1999 does not seem to have had a direct impact on the recent crisis, as most of the firms that faced difficulties were primarily retail or investment banks, not both. The structure of the business was not a predictor of resilience.
The superficial plausibility of this spurious rebuttal depends on the elision of market based funding as a root cause. The biggest single casualty of the crisis in the UK, by a short head, was RBS, which was both a retail and investment bank, and was exposed both to the solvency dimension of the crisis (via its toxic CDOs) and to the liquidity dimension (via its dependence on market funding). That’s one of the two systemically important casualties in the UK. The other, HBOS, had a truly gigantic version of the funding problem, and a dodgy loan book. All of the other casualties (other former building societies) were taken down by the market-based funding crisis that Ussher describes in “What happened” and never mentions again.
What’s more, senior RBS insiders now affirm that the retail bank provided the cash flow for Fred Goodwin’s trip to the casino. Ussher’s dismissal of the IB/retail split as a factor in the crisis tends to favour only the last universal bank, Barclays with a dog in this fight (since HSBC is permanently poised to skip town anyway). And of course one can look further afield: what of Citigroup, or Bank of America or all the universal banks on the Continent that nearly fell over? Is their structure not germane? Or is the US and international evidence only to be cited selectively?
Next we get a section entitled “What could have prevented it”, which is in fact yet another review of causes, partly of the crisis, partly of the recession, interspersed with some recommendations, which are indeed, partly, recommendations, and partly statements of doctrine. This is a mess. The first result is a couple of recession-related recommendations that don’t have much to do with the banking crisis – but do deflect blame for the recession away from the banks that actually triggered it, and towards politicians:
Recommendation 1: The UK government should stand ready to use fiscal tools to take the shine off asset price bubbles, in particular by varying stamp duty to a far greater extent and introducing – and varying – capital gains tax on primary residences depending on the direction the housing market is taking.
Recommendation 2: The government should set a reference rate for the savings ratio and issue a warning designed to unsettle the markets if it is breached in the early stages of a boom.
Then we have two recommendations on corporate governance. If you read a recent post on Fred Goodwin’s rampage, you will conclude that they will make as much impression on a rogue banker as a fart in a thunderstorm:
Recommendation 3: The UK government should work with industry to establish a board-level careers service across different sectors where senior individuals, entrepreneurs and leaders from all walks of life can self-refer to receive assessment, experience, advice and training to make them credible candidates for board positions in future.
The concern that such an initiative might also tend to institutionalize the US-style revolving door, and risk attendant corruption, is blithely ignored. Then we have:
Recommendation 4: Within the financial services sector, the Bank of England as part of its new role to monitor systemic risk should provide an informal and confidential mentoring system for non-executive directors, particularly those from outside the sector, giving them a safe place to test hypotheses and seek analysis and advice.
Though, with the headstrong Fred Goodwin, and others of his cohort in mind (Richard Fuld of Lehman, Jimmy Cayne of Bear Stearns, Stan O’Neal of Merrill Lynch, Bob Cassano of AIG), I have a more practical counter suggestion: have bank CEOs and senior staff monitored by forensic psychiatrists with experience of working with high-risk convicts.
The next section, “An important distraction: the so-called need to rebalance” finally tackles the issue of the relative size of the banking sector in the UK. Highlighting non-bank causes of the recession, in the previous section, now gets its pay-off: cover for the banks.
The UK economy was particularly vulnerable to the loss of consumer confidence that resulted from the banking crisis because of our historic low levels of savings. The situation was not helped by regulatory failings that did not spot the crisis. Some policy conclusions that flow directly from these observations have already been outlined.
Ussher speaks more in sorrow than in anger; irritating of her:
Now is the time to address directly the regrettable fact that the public debate on the banks has been following an entirely different chain of logic. We hear repeatedly from politicians on left and right the argument that the recession was caused by us somehow being ‘over-dependent’ on financial services and therefore peculiarly vulnerable to financial crises, so it is desirable to rebalance the economy so that a smaller proportion of our national wealth is created from the financial services sector – perhaps in favour of manufacturing – to make our economy more robust in the future.
The first part of the counter-argument is a misdirection:
This is a poor argument, for a number of reasons. For a start, the financial services sector is not the largest sector in the UK economy. At its peak it was around 10 per cent of GDP, less than manufacturing (around 14 per cent). It is therefore illogical to argue that there is an over-dependence on the former that requires a rebalancing in favour of the latter.
So remind me: when, exactly, was there last a sudden manufacturing-industry-wide crisis that required a bailout amounting to 70% of annual GDP? The British public (and any other public) is right to be concerned about banks: it’s the public that ends up wearing the risk. It’s not just about bank-triggered recessions, either, though they don’t help improve the public mood. What about the hit to the public purse?
Next we get another conclusion from an unspecified but presumably small data sample:
Second, those advanced economies that had a proportionally smaller financial services sector did not have a shallower recession, so it does not follow that having a relatively large financial services sector makes a country more vulnerable.
What? Check out Switzerland, Ireland and Iceland for various uncomfortable-to-nasty outcomes for small countries with disproportionately large banking sectors.
Recommendation 5 brutally morphs a vague industrial policy:
Better to create the conditions that support value creation, which include an environment where high skill, high value added, intellectual-property-based entrepreneurial activity that is valuable can find a way to grow regardless of the sector it is in, even if it includes the financial services sector.
straight into a plea for subsidy of corporations (such as banks, but perhaps you guessed) by buying up their bonds:
As a starting point, the Bank of England’s policy of quantitative easing should not simply seek to purchase government bonds on the secondary markets but corporate securities as well.
Recommendation 5: In future rounds of quantitative easing, the Bank should purchase more corporate securities and correspondingly fewer gilts.
Impressively cheeky, that one.
Next we get to tax. Apparently the UK receives £53Bn per annum in tax from UK-based banks. So perhaps we should be alarmed when various bankers issue vague threats to leave:
In the words of one global executive, currently based in London:
The 15 per cent income tax rate available in Hong Kong is looking increasingly attractive.
Rumours abound of the Swiss authorities ringing people up on the phone and actively offering to negotiate a more advantageous rate of personal taxation.
Who are these interviewees? The first one might be someone senior at HSBC or Standard Chartered. Do we have to outbid Hong Kong on corporation tax rates? Are we to race to the bottom then, on tax? We know how that movie ends: see Ireland, again. And maybe, just maybe, there is some advantage in having a head office somewhere near your main business line. That might be what’s tugging at HSBC’s heart strings, or Standard Chartered’s, whose business is mostly in Asia; not the tax rates. Better not to get into an unwinnable bidding war.
The second interviewee has heard some rumours. Well, so have I, and mine say that Zug’s full up with expat hedgies, Geneva’s full up with expat hedgies, and they all come dashing back at the weekend anyway for the home comforts of London. There’s more to attractiveness than your tax rate. Let’s see someone carve a whole new anglophone Canary Wharf, City of London, and Mayfair out of the bare rock somewhere in a European time zone. And add a few shops and some nice nurseries, and so on. It might take a while. Short of that, it’s worth noting that when you inspect the tax revenue figures a bit more closely, it turns out that just over a tenth of the £53Bn is corporation tax: that’s (roughly speaking) all that’s at risk if a UK bank changes its domicile.The rest only walks if the staff ship out along with the banks. Where to?
All of which makes this sound more like a whine:
Recommendation 6: Politicians who want to appear tough on the banks but not weaken the sector should restrict their comments to strengthening banks as institutions, rather than weakening bankers as individuals.
wherea this initially vague-seeming admonition ends up coming off more like a threat
Recommendation 7: It is in the national interest to have a strong financial services sector in Britain, as it provides taxation revenue and has direct and indirect economic effects. The government needs to be brave and recognise this. It should set out a clear policy direction to support investment in financial services in Britain, designed to capitalise on strengths and address weaknesses.
This whole tax bluff has been tried before, by that man Bob Diamond again, in his evidence to the Treasury Select Committee. Bob flourished the imposing £2Bn of tax revenue brought to the UK this year by Barclays, but somehow didn’t have to hand the fact that corporation tax only made up £113Mn odd of the total. So he never had to explain why a redomiciling of Barclay’s, say, would leave the UK worse off by more than the £113Mn of corporation tax, while leaving the other £1.9Bn of personal tax revenue largely in place. Nor did he have to sketch out how he’d explain to the regulators and politicians in its new domicile exactly why the £113Mn of corporation tax Barclays produces, or even, in better times, many multiples of that, is such great risk compensation for the implicit commitment to provide, in the worst case, last-resort backup for a £1.5Trillion balance sheet.
The same riposte applies to the argument made by the pamphlet on behalf of the whole banking industry.
Cheer up! Only five more recommendations to go, since I’m skipping two. Next, pay, with a concession that regulators might indeed think this is partly their business:
The greatest sense of public injustice arose from the suggestion that bankers were paid for failure in the run-up to the crash; it is important therefore not to conclude that all high levels of pay are wrong.
To avoid these dangers, among others, it is right for supervisory authorities to consider pay and bonuses as a legitimate part of their purview. Companies that incentivise short-term gain over long-term success are likely to have cultures that celebrate excessive risk-taking.
So we have a pay code proposal, which doesn’t quite make it to recommendation status.
The effect of the code will be to cap cash bonuses at as little as 20 per cent of the total award, with the rest paid out in deferred share awards, which can be cashed in only after several years.
But 20% of a sufficiently large number still leaves the banker incentivized to take risk! See Fred Goodwin again: his long term incentives, more than 2 million shares of RBS, would have been worth north of £40Mn at the highest price achieved during his tenure. His salary and cash bonus was £10Mn; pension, until his last minute renegotiation doubled it, £8Mn. I make the cash and pension to be about 30% of the total comp – not so far off this new recommendation. But Sir Fred still drove RBS right off a cliff. Anyway, the recommendation isn’t even as specific as the proposed pay code:
Recommendation 8: The government should raise a higher level of tax on discretionary bonuses (as opposed to other forms of performance-related pay) above a certain value that are not linked to contracted medium-term outcomes.
Still, one of the bankers does make a great point:
It is in the interest of currently employed bankers to limit the number of ‘acceptably qualified entrants’ so as to maintain salary levels. There is an argument that there is a huge cartel effect going on.
Though the resulting recommendation doesn’t exactly grab the problem by the throat:
Recommendation 9: The proposed new competition authority should have its mandate extended to consider labour market failure, with a primary focus on access to highly paid professions.
And finally, finally, we are through to the real meat of the pamphlet: the discussion of bank scale and size and the TBTF problem. First we get a highly theoretical Bob Diamond type recommendation:
Recommendation 10: In the event of failure, those owning a bank should find their holdings are worthless; debt holders should be converted to equity, any restitution fund should not accrue huge surpluses, and living wills should seek to protect consumer interests not only in the event of failure but at the onset of difficulties.
This isn’t so easy, in practice. Who owns bank bonds? Is it, to any systemically significant extent, other banks, perchance? What about the complexities of multinational banks? What about the manpower requirement if a bunch of banks all go belly up at once (a pattern for which there is precedent)? This is all glossed over, and, one suspects, makes this recommendation ready to be thrown on the “too difficult” pile the next time there is a systemic crisis.
The preamble to the next recommendation wheels on another favourite Bob Diamond talking point, “diversification”:
There are two arguments advanced for breaking up the retail banks in Britain. The first is that smaller banks are less of a problem to resolve if they go under. This is true. The USA, for example, has a large number of small institutions. Bank failures at this level are common and the consumer compensation scheme is able to cope with them, albeit at high cost to the individuals involved. However, there is a problem with this approach, namely that small institutions are often weaker. They are unable to diversify and lack efficiencies of scale.
BoE director Haldane, quoted here, shows how one might undermine the “diversification” argument. And Yves has debunked banking economies of scale here. Once again the pamphlet ignores the factor common to the small bust UK banks, funding model, and draws an unwarranted general conclusion about the robustness of small banks:
The UK experience bears this out: the fall-out from the financial crisis saw the demise of Bradford & Bingley and Dunfermline Building Society and a number of smaller institutions as well as Northern Rock.
Anyhow, after a survey of retail bank competition, we get:
Recommendation 11: There is no immediate case for splitting up big UK retail banks.
Whatever. This is a lesser point. The big one comes next, with a preamble:
the experience of the recent crash indicates that there is little evidence that banks were either more vulnerable or more likely to make bad risk judgements if they had both retail and investment arms. It is just as possible to take on too much risk when signing a deal with a retail customer (indeed that is how the crisis started) as it is when signing deal with a wholesale customer.
Except – it takes months of sustained incompetence and thousands of infantry to sign up a billion or two of 30-cents-on-the-dollar retail loans, whereas to load the bank up with a toxic CDO took, at the height of the frenzy, a small team of idiots and a couple of weeks of bungled due diligence. There’s more:
Politicians are wrong when they draw a distinction between a ‘safe’ retail bank and a ‘casino’ investment bank. In the UK, Northern Rock, Bradford & Bingley and Dunfermline Building Society all had to be rescued; none was involved in investment banking. Similarly Lehman Brothers and Bear Stearns, both of which collapsed, did not have mainstream retail operations. Indeed research published by the European Central Bank is clear that a diversified model of banking is less risky than a specialised one.
Or you refer to Haldane again, for quite a different take on “diversification”, which, as we saw in a recent post, is yet another of Bob Diamond’s talking points:
…speaking at the CBI conference in London, Diamond said: ‘There is no empirical evidence that big is bad – in fact, quite the opposite. Banks dependent on a single market or product can be a greater risk, as we saw with Northern Rock.
By contrast, the global universal banking model, which integrates retail, commercial and investment banking, is well diversified by business and geography, well diversified by clients and products. And it should carry less risk, by virtue of that diversification, if it’s well run.
Altogether, this pamphlet is beginning to feel a banking-regulatory version of “Being John Malkovich”, except with Bob Diamond in the starring role. He would really like the next point, where the service the pamphlet tries to do to Bob’s cause is abundantly obvious, especially when you compare it with Bob’s words above:
In government, the Banking Commission chaired by Sir John Vickers appears to be considering breaking up investment and retail. I argue that there is no clear logic for this.
Recommendation 12: There is no evidence to support a case that investment banks should be split from retail banks.
That’s true, I suppose, if you heroically ignore 50 years of crisis-free banking in the US under Glass-Steagall.
Next we get a quick pop at the IBC’s apparently preferred subsidiarization idea, which apparently won’t fly because of its capital intensiveness, and because of EC law.
Summary: the pamphlet thinks the structure of British banking is just fine as it is. No breakups, no subsidiarization. You can probably guess which UK bank CEO likes that idea most, by now.
Since I’m a merciful man, I’ll skip over recommendations 13 & 14, which are about keeping the EC at bay, giving a glimpse of the City’s hostility to Brussels. Let’s cut to some of the final words:
There will always be financial crises.
Which again airbrushes out US history, 1933-1985, and begs questions. How frequent, how intense and how expensive are these crises to be, then? Are the tax receipts worth it? How does that fit in with the massive implicit taxpayer support? Let’s go back to the only bit of Ussher’s analysis I found useful (“What Happened”), with all manner of moral hazard in plain sight at the height of the crisis (my italics):
But with the markets understandably deaf to pleas by distressed banks for more cash, it had to be the government that offered UK firms a life-line in order to prevent further instability in the market that would ultimately impact consumers: on 13 October 2008 it announced that £37 billion would be used to recapitalise RBS and the merged Lloyds TSB/HBOS in return for appropriate ownership stakes.
By the end of February 2009, the government announced that it had reached agreement in principle with RBS to insure toxic assets worth £325 billion for a fee of £6.5 billion, plus a commitment to lend more into the economy, under a new asset protection scheme (APS) open to all companies. At the same time a further £19 billion was injected into the company.
A week later, Lloyds TSB had also come to the table, with an agreement in principle to insure £260 billion of its assets for a fee of £15.6 billion plus commitments to increase lending to business. But by November, partly as a result of the implicit protection provided by these in-principle agreements, market conditions had improved enough for Lloyds TSB to instead raise on the private markets the capital it needed to compensate for the increased risk it held on these assets.
RBS did proceed with the APS, although with the value of assets protected reduced to £282 billion and a larger ‘first loss’ to be borne by the company. As a result, by the end of 2009, the government’s shareholding in RBS had risen to 75 per cent, with its overall interest – including the protected assets – at 84 per cent.
The expense, the risk to the sovereign’s finances, and the encashing, by banks or investors, of the implicit or explicit taxpayer guarantee, are the core of the case against big banks domiciled in London. If there are always going to be crises, and the state is always going to be on the hook for them, do the tax revenues still leave us ahead, over a good hearty boom-bust cycle? The answer in Ireland was definitely a big fat “no”. Why is the UK any different? And then, what about the permanent lost real-economy output, alluded to by Haldane:
Put in money terms, that is an output loss equivalent to between $60 trillion and $200 trillion for the world economy and between £1.8 trillion and £7.4 trillion for the UK. As Nobel-prize winning physicist Richard Feynman observed, to call these numbers “astronomical” would be to do astronomy a disservice: there are only hundreds of billions of stars in the galaxy. “Economical” might be a better description.
It is clear that banks would not have deep enough pockets to foot this bill. Assuming that a crisis occurs every 20 years, the systemic levy needed to recoup these crisis costs would be in excess of $1.5 trillion per year. The total market capitalisation of the largest global banks is currently only around $1.2 trillion. Fully internalising the output costs of financial crises would risk putting banks on the same trajectory as the dinosaurs, with the levy playing the role of the meteorite.
Perhaps, for starters, the UK should split up its one big local universal bank, Barclays, and let the market decide what the investment banking part, “Barclays Capital”, is worth, shorn of a little bit of its “diversification” by separation from its now-dwarfed parent “Barclays Bank”; and let authorities in the prospective new domicile decide if the tax revenues are worth the risk of hosting it. That might make the Chinese authorities ask the same question about HSBC.
No wonder Bob Diamond and friends are busy lobbying, and how interesting that the chosen vehicle is a “progressive” think tank. Funny thing, the same sort of co-option by banks is happening in American progressive think tanks. So there’s a precedent for this sort of thing in the US, too.
Demos calls it “Conservative Progressivism”. American blogreaders, of any political persuasion, who fancy stretching their imaginations, are encouraged to try picturing that. If you don’t manage it, take heart: it just means “shills for banks”.