The Libor crisis should trigger crucial reform
Finally, the British political classes are starting to get it. Finally, a head of steam is building. Over the last week, calls to impose a proper division between investment and commercial banking have become louder, more authoritative and part of mainstream debate. Pressure for the introduction – or re-introduction – of this crucial split could soon become irresistible, however much the politicians wiggle and the investment bankers deceive.
Until now, it’s been mainly nerds like me who’ve advocated a full Glass-Steagall separation. Given the vested interests that would lose from this change, we’ve been lampooned for our “hot-headed” views. Yes – our message is awkward. Life would become difficult (and less lucrative) for a lot of powerful people, were we to prevail. Yet we “Glass-Steagallers” are right. We have history, logic and common sense on our side. And now – thanks to Barclays ex-CEO Bob Diamond, and “Liborgate” – we also have political momentum.
The global economy faces grave dangers. On Friday, Spain’s 10-year sovereign bond yield went back over 7pc. Italian yields topped 6pc. The main reason, of course, was fresh doubts over the supposed “break-through” at last weekend’s Rome summit. After repeated attempts to “stabilize the eurozone”, the inevitable political backlash among the region’s “solvent” northern members is also coming into view.
When they meet in Brussels tomorrow, Eurozone finance ministers will once again spin and posture, as they try to agree the terms of a €100bn bail-out for Spain’s debt-soaked banks. That’s before they consider Greece (and now Cyprus).
Back in the UK, meanwhile, Liborgate seems to have caused the first tremors in what all responsible people must hope is a political earthquake. Ever since the sub-prime crisis began in the spring of 2007, most British political leaders and regulators have resisted serious banking reform.
Sir John Vicker’s measures, years in the making, have now been exposed as what they are – an elegant political compromise, with not a chance of reining-in London’s rapacious investment banking culture, so all but guaranteeing another crisis a few years down the line.
While hopelessly weak in and of themselves, even Vicker’s proposals, imposing a “firewall” between investment and commercial banking, rather than a full institutional split, have been watered-down by the government. Legislation implementing Vickers has yet to be passed and, anyway, won’t come fully into effect until 2019.
This government’s failure to insist on genuine banking reform, the subsequent Vickers dilution, the legislative delay and ridiculously long implementation period once the proposals become law, taken together, reflect extremely badly on David Cameron and George Osborne.
The Prime Minister and Chancellor can kick their Labour opposite numbers as much as they like. Ed Balls especially – the architect-in-chief of the Financial Services Authority, the New Labour folly which effectively put politicians in charge of bank regulation, rather than central bankers – has a lot to answer for, whatever the Liborgate inquiry reveals.
Yet the current situation calls for the Conservatives to show real resolve, not focus on political parlour games. The manner in which the Tories have handled UK banking reform since coming into office has revealed not only a glaring leadership deficit, but shocking complacency and a lack of financial acumen.
The Glass-Steagall divide between commercial banks (that take deposits) and investment banks (that take big risks) was incrementally removed in the UK and US during the late 1980s and 90s. Financial markets have lurched from crisis to crisis ever since. No other single act did more, in fact, to cause “sub-prime”, and transform it from a banking crisis into a broader fiscal and economic crisis too.
That’s because once the depression-era Glass-Steagall legislation was repealed in America in 1999, Wall Street investment bankers were able to use taxpayer-backed deposits to take ultra-risky bets, knowing they’d be rescued if their bets backfired. In doing this, they were following and competing with their City brethren, the UK having earlier removed its “informal Glass-Steagall” – the split between commercial banks and the old merchant banks – as part of the 1986 “big bang”.
Re-imposing the separation would prevent investment banks from betting with ordinary deposits, exposing them to the full force of the market. At a stroke, our banking system would be far safer and the “too big to fail” issue largely resolved. That would be anathema, of course, to the “banking titans” who rely on government cash for survival and from whom politicians, in turn, receive campaign donations and cushy jobs once their political careers have expired. Yet now, after several years of bank-induced economic torpor, and this shocking Libor scandal, our deeply corrosive banking status quo is finally under serious threat.
For all the attempts to smother these realities in Vickers-own-brand fudge, Glass-Steagall already has some very influential backers. Bank of England governor Mervyn King has boomed that its removal, and the “breath-taking” scale of the bank bail-outs, has created the “biggest moral hazard in history”.
“People say I’m old-fashioned,” quips Former Federal Reserve boss Paul Volcker. “They say banks can no longer be separated from non-bank activity – but that argument got us to where we are today”.
John Reed, the Former Citigroup chairman, says a new Glass-Steagall would “go a long way towards building a more robust financial sector”. This is highly significant, seeing as Citigroup was effectively formed by a merger facilitated by Glass-Steagall’s removal. The vocal support of Lord Lawson for a fully-split banking sector is also of great importance, not least because he was the Chancellor who implemented “big bang”.
The investment bankers insist Glass-Steagall is irrelevant. “Lehman was a pure investment bank,” they say, “and that failed”. Yes, but had the entire banking system not been riddled with bad bets and leverage, Lehman’s collapse wouldn’t have posed systemic dangers. The core banking system would have been sound.
“It’s impossible to draw a line between investment banking and commercial banking,” say the money-men. As King retorts: “It’s hard to see why”. The reality is that existing regulations already distinguish between different bank functions when determining capital requirements.
“Conventional banks failed even before Glass-Steagall went”, the investment bankers respond. Of course they did, but the bail-outs were infrequent and tiny compared to those today, as the losses weren’t magnified by leverage.
In recent days, as public disgust at Liborgate has grown, so have the cries for structural reforms. Former Labour City Minister, Lord Myners, has just acknowledged we need “complete separation”. Andrea Leadsom, a talented Conservative MP and former senior banker, now says the government’s “ultimate guarantee of retail deposits .. should not extend to high-risk transactions”.
Professor John Kay, one of the UK’s few world-class academic economists, backs Glass-Steagall. So does Terry Smith, a City businessman with a well-deserved reputation for being proved right on the big financial issues. The late Sir Brian Pitman, too, one of the legends of UK retail banking, used his last ever newspaper interview, with me as it happens, to make the case for Glass-Steagall.
The British public is desperate to see measures that tame our banks and make our financial system safer. We’ve reached a historic crossroads. Nick Clegg needs to forget Lords reform and focus on what really matters. The Liberal Democrat leader should get Cameron and Osborne in a room, and go hell for leather on genuine banking reform. Argue, cajole and insist, Mr Clegg. Bring the government down if you have to. But this split needs to happen and someone needs to get it done.