'' When the RBS failed, my predecessor Alistair Darling felt he had no
option but to bail the entire thing out...Not just RBS on the high street, but
the trading positions in Asia, the mortgage books in sub-prime America, the
property punts in Dubai...I want to make sure that the next time a chancellor
faces that decision, they have a choice. To keep the bank branches going, the
cash machines operating, while letting the investment arm fail.'' George
Osborne, Feb 4th 2013.
George Osborne chose JP Morgan’s international processing
centre to announce his proposal to ‘electrify’ the ringfence between retail and
investment arms of UK banks, giving government a reserve power to split a bank
should the fence be breached. Amidst the brouhaha that followed, it is perhaps
worth asking whether separation resolves many of the problems which led to the
crisis anyway.
Osborne’s announcement itself was more political pantomime
than theatre, overwrought with cheap symbolism and reliant upon audience participation.
The backdrop bore the
JP Morgan logo portraying Osborne as the brave hero, the very epitome of a man
fearless of audience and setting, prepared to deliver his devastating message mano-a-mano with the bankers in the
heart of their territory. The speech drew predictable ‘boos’ from the yahoos in
the stage-boxes as the BBA
trawled out the usual line that this would mean less lending to businesses
and a diminished role for London as a financial centre; points made with such
monotony that one has to wonder whether Anthony Browne has a draw string on his
back.
The shock and disbelief of the industry are of course staged,
but essential to the overall act. The banks need to look like they’re feeling
some pain so that the British public avert their vindictive gaze, satisfied
that revenge has been exacted. Similarly Osborne needs a setting which projects
his own strength but doesn’t risk public embarrassment, which is why this
speech took place in the polite back office lagoon of Bournemouth, not Canary
Wharf among sharks who are likely to bite; all vital as the economy teeters on
the brink of austerity-fuelled decline. But behind this performance, the pre
and post Vickers process has been lobbied heavily by the banking industry. Key industry
actors would have been aware of Osborne’s intentions. Some may even have had a
role in shaping the parameters and smoothing out the rough edges (note
Osborne’s speech only says government will have ‘the power’ to separate, not
that it ‘will’ separate – ominous if we remember how large corporations may use
their political power and influence to avoid being split). When the
amendments were announced, not an eyebrow was raised on the markets: the share
price of Barclays and RBS dropped only modestly and in line with the index,
suggesting that much of this was anticipated anyway.
But this all raises a bigger question. Let’s suppose we had Glass
Steagall not Vickers’ fence, would we be safe from another crash? My opinion is
probably not.
The causes of the crisis were/are manifold: the scale of
banking liabilities relative to national GDPs; the interconnectedness of
banking institutions that accompany that scaling up; the complexity of many
innovations which connect these institutions and thus produce system fragility;
and the opacity of the accounting information which produces uncertainty at
times of stress. Central to all of these problems is the over-supply of credit.
The problems of the 2000s can all to a greater or lesser extent be thought of
as what happens when banks discover that they can a) lend money against a
secured asset without first having to take deposits and b) discover that they
can readily produce or access assets against which they can borrow. That is a circuit; the
cogs and wheels of the bubble machine.
Modern Monetary Theory (MMT) has something to say here. MMT implies that banks don’t gamble with
existing deposits, rather they make loans (assets) first and in doing so create
deposits (liabilities) as the sum lent is credited to the borrower’s
current account (this is the double entry balance sheet accounting identity). Banks
then finance those deposits (or liabilities) crucially after the loans have been issued (the cashflow accounting identity).
During the boom years they were able to do this relatively simply through central
bank reserves or the short term markets, securing their loan with their newly
acquired asset. But as the crisis bit, asset quality (or perhaps more
accurately the perception of asset quality) deteriorated: the AAA mortgage
backed securities, the Southern European sovereign bonds, etc that had been
accepted as collateral by private lenders, all of a sudden lost that particular
property. The story of the crisis therefore is really a story about the shortage
of good, rehypothecatable collateral and the inability of banks to finance
their liabilities while their asset position deteriorates. This is why the ECB
and other central banks are working so hard to reignite the interbank market by
accepting more and more dross from bank balance sheets as collateral for loans
in the absence of willing private counterparties, or swapping them for ‘good’
assets which are. Central banks have in no small way become ‘rehypothecators of
last resort’.
From this perspective, it doesn’t really matter if
investment and retail banking operations are separate. The national and global economy
relies on its investment banks just as much as its retail banks. The modern
economy needs institutions that finance larger businesses, arrange M&A
activities, underwrite share issues and develop hedging products for
multinationals. These functions will always need to be propped up by the State
if the institutions that perform those functions begin to teeter. The fundamental
problem therefore is not the presence or absence of a retail arm, but the scale
of the liabilities and the interconnectedness of those investment banks as the
speculative activities are bundled in with their more ‘functional’ activities.
The separation of wholesale and retail may have worked in
the 1930s, but it is inadequate now. It matters little whether the investment
banking arm of a universal bank buys mortgages off its in-house retail arm or
the retail arm of another universal bank. The macro/systemic effects are the
same when scale and interconnectedness come into play. Here at CRESC Towers
we are reminded of Moliere’s quip that nearly all men die of their remedies and
not of their illnesses. One can’t help feeling that Osborne’s pantomime toughness
and unwillingness to tackle this primary problem of scale and
interconnectedness at the wholesale level, may just provide the diversion that
banks need to continue business as usual.
Stanley
