In My Money Week column this week, I've been arguing there is still time to break up the banks. Here's a taster....
Nearly two years on from the collapse of Lehman Brothers, and there is still little sign of fundamental reform in the way the global banking industry works. In the US, President Obama has allowed the regulation of Wall Street to be watered down so much that it won’t make much difference. The Europeans have lost interest. And the banks have gone back to behaving pretty much exactly the same way they did before the crisis struck.
Despite that, the British should ignore the rest of the world. Even if no one else is prepared to attempt it, the UK should press on with splitting up its biggest banks. Britain is a relatively small economy. It simply can’t afford to shoulder the risk of another calamitous banking collapse – and should get on with doing something about it, even if no one else wants to.
In the immediate aftermath of the credit crunch there were plenty of calls for a radical break-up of the banks. We were constantly told that there would be no return to the wild risk-taking, the bonus culture, and the short-termism, that characterised the financial markets for much of the past decade.
But, two years on, there is plenty of evidence that everything has gone right back to the way it was. The banks are paying out big bonuses. They are trading in high-risk sovereign debt, even when it is obvious many of the countries whose paper they are buying are bust. They are expanding enthusiastically.
In the US, President Obama, last week ducked the challenge of serious change. The financial reform bill that emerged from Congress was watered down so much by the big banks and their lobbyists that it is not going to make any real difference to the way the industry works. Instead of prohibiting the big banks from trading derivative on their own account, and investing in hedge funds, it merely limited their ability to do so, and not very effectively either. The big Wall Street banks - Bank of America, JPMorgan Chase, Citigroup, Wells Fargo, Goldman Sachs and Morgan Stanley – have emerged two years after the credit crunch with an even tighter lock on the American capital markets.
Neither has the European Union done any better. It has proposed new legislation on the hedge funds and private equity funds, its two favourite targets. But since the hedge funds didn’t create the crisis, that is about as relevant as blaming our cricket team for the failure of our footballers to perform better at the World Cup. It simply misses the point. The Swiss central bank has talked about splitting up its two giant banking groups – UBS and Credit Suisse – but has so far failed to actually follow up its words with actions.
It would be easy for the UK to give up. If the rest of the world isn’t getting serious about financial reform, then it is hard for the one, smallish country to do it by itself. Easy, but wrong. In fact, the UK should press on with splitting up retail and investment banking.
The Chancellor George Osborne has already established a commission to study precisely that issue. We don’t yet know what it will conclude. But whatever the outcome, it is too risky for the UK to allow the City to carry on as before.
There is no reason to worry about the foreign banks. If JP Morgan, Deutsche Bank, or Credit Suisse want to have big offices in London that is fine. It doesn’t matter in the least to British taxpayers if they take wild and crazy risks. If they make money, they will have to pay taxes on the profits, either in corporation tax, or as income tax on the bonuses they pay to their staff. If they lose money, then it is American or German or Swiss taxpayers who will have to bail them out. For the British, that is a heads-we-win-tail-you-lose deal. There is nothing to complain about in that.
But the British banks are a different matter. As the Governor of the Bank of England Mervyn King put it in a speech: “If a bank is too big to fail then it is simply too big.”
True enough. The UK is a medium-sized economy, with an out-sized financial sector. RBS grew to be one of the biggest banks in the world, trading in every corner of the globe, but when it ran into trouble, it was the British government that had to pick up the bill.
It was affordable once – it won’t be affordable a second-time around.
Banks such as Barclays, mainly through its Barclays Capital division, and HSBC, are simply too big to be under-written by the British taxpayer.
The solution? Force them to split out their UK retail arms from their investment banking and global operations. When a bank fails, the risk to the UK economy comes from ordinary depositors losing their money. If an investment banking division, mainly trading derivatives on Wall Street or in Singapore, collapses, it doesn’t matter very much to the economy in Woking or Wigan.
Of course, the banks will fight it. The business model of collecting money from millions of ordinary depositors, then deploying all that capital in the world markets has worked very well. It has paid for a lot of bonuses. But the risks ultimately gets transferred to the taxpayer – and they are no longer sustainable.
The rest of the world may be ducking the challenge. It will be hard to be the only country demanding serious change. But the UK should stick to its guns. If the don’t like it, allow them to re-locate elsewhere. It would be better to allow one or two of the big UK banks to switch their headquarters to the US, or an offshore centre, than run the risk of another calamitous collapse.