Obama is right to bash the bankers - discuss

Obama is right to bash the bankers
Intelligence Squared Debate
29 Jan 2010

PRO

VOLCKER AND OBAMA’S REFORM HITS THE BULLS EYE: IT DIRECTLY TACKLES THE INHERENT DANGER

There’s a clear economic logic in insuring that from now on the basic utility aspects of banking – making ordinary loans to businesses and households and managing the nation’s payment system – is kept quite separate from the casino aspects of banking – all those credit default swaps, synthetic derivatives and special purpose vehicles which make up the hugely profitable but risky “proprietary trading arms” of the big banks. It was those "proprietary" activities that fuelled the bonanza in all those super dodgy mortgage-backed securities that led to the credit crunch of 2008. The new ban on insured, deposit-taking banks engaging in proprietary trading is a good first step on the road to total separation of these two activities.


THE REFORM IS GROUNDED IN THE LESSONS OF HISTORY

Between 1933 and the 1980s, finance was remarkably stable – and this was an era when the spheres of banking were kept safely separate by the Glass-Steagall Act in the USA and by various rules and regulations in the City of London. But then, when free-market Thatcher abolished the separations in London in 1986 and Clinton put the last nails into the coffin of Glass-Steagall in the late 90s, it was farewell stability; hello financial crisis. So even if economists find it hard to explain precisely why the separation worked, we should trust the historical evidence: the separation did work and Volcker's plans are a welcome return to responsible thinking.


THE REFORM RESTORES CRUCIAL ELEMENTS OF ACCOUNTABILITY AND CONTROL

Finance in the first decade of the 21st century had become too complicated to control; indeed, the sheer complexity of deregulated finance was a big part of what led to the crisis. Financial firms had lots of competing regulators with no one quite knowing what activity should be regulated where. What deregulation should have taught us is that financiers are endlessly creative at finding new ways to take gambles, and that we need protection from that sort of creativity. That’s where the ban on proprietary trading comes in: it returns us to some kind of transparency. By splitting proprietary and deposit-taking functions, regulators know who should be doing what, and keeping financiers to the rules becomes possible once again. In fact, Obama could go further in reestablishing transparency and insist on full disclosure of derivatives positions – something that would have really helped in spotting how much trouble Lehman's collapse was going to cause.


PUTTING A SIZE LIMIT ON BANKS IS AN ESSENTIAL ANTIDOTE TO THE "TOO BIG TO FAIL" PROBLEM

The terrible thing about big banks is that they can hold the whole economy hostage: "bail-us out or we'll sink you" is their basic message. And you can be sure that once they know they're in that position of strength, they'll use it...by taking on the sorts of risks you do when you know that failure goes unpunished. Obama's plan proposes to extend the size limits that already apply to deposit-taking banks to other parts of the financial system. With a well-implemented size limit, the government should be able to stare down the "let-me-fail-if-you-dare" threat that was used to such effect by Wall Street in 2008.


BANKS SHOULD BE SMALLER ANYWAY

Banks are pretty clearly too big and insufficiently competitive - how else can you explain the $1.2 trillion in "excess" profits that the sector has made in the last decade according to Deutsche Bank? Nor is it true that giant global businesses need to rely on giant global banks. That notion is "pure poppycock", says The EpicureanDealMaker blog, which is written by a New York banker in mergers and acquisitions. As he points out, "institutional clients make a point of using more than one investment or commercial bank for virtually all their financial transactions, no matter what they are. In fact, the bigger the deal, the more banks the customer usually uses. This is because banking clients want to make sure none of these oligopolist bastards has an exclusive right to grab the client by the short and curlies."


THE LEVY IS A GOOD WAY TO KEEP BANKS' RISK-TAKING UNDER SOME SORT OF CONTROL

Now that the casino aspects of banking are to be separated out, it seems an inspired idea to have a pop at the casino – especially since the casino operators have benefited so much from taxpayer bailouts. It’s good to think the taxpayer is getting some return, and good to know that the levy, by being based on the amount banks have lent above some minimum threshold, is designed to be more expensive the more risk a bank has taken on. More money for the taxpayer and less risk-taking by banks – what on earth is wrong with that? The only problem is that the levy does not go far enough: at 0.15% of assets above $50bn, it is designed only to recoup over many years the amount spent on bailouts, whereas it should be a permanent part of the landscape.


THIS ISN'T POPULISM, IT'S DEMOCRACY IN ACTION

The financial industry lobbied furiously during the boom-time to be allowed to carry on with their risky lending practices, and they have spent hundreds of millions on lobbying since then to make sure the gravy-train does not stop. The finance industry currently employs three lobbyists for every member of Congress. Along with the healthcare lobby, it is the biggest, best funded and most powerful group in Washington. Obama is at last getting tough with them – a long overdue reassertion that the good of all should be prioritised over the pay-packets of the few. Even if it took a defeat in Massachusetts to get Obama back on track, this is a splendid example of democracy at work.

CON

OBAMA’S REFORM MISSES THE TARGET ALTOGETHER

Proprietary trading by deposit-taking banks had little or nothing to do with the present crisis. The crisis came from the US mortgage market, which was the most heavily regulated part of the finance industry. The fund managers who bought the overly-complex securitised mortgage products could still have done so whether they acted as arms of deposit taking banks or not. In fact, the main source of the trouble had little to do with the big banks anyway: Lehman Brothers was not that big; Northern Rock in the UK was a small mortgage lender with no proprietary trading operations whatsoever.


THERE WAS A MUCH BETTER WAY OF ADDRESSING THE PROBLEM, ONE THAT WOULD ACTUALLY WORK

The root cause of the present crisis shouldn't be guessed at by making spurious comparisons with earlier historical eras. It was quite obvious: financial firms were able to take on too much risk, and didn’t have sufficient resources to cover it. The simple solution is to regulate leverage – that is, limit the amount that banks can lend out to a strict percentage of their safe, liquid assets. Even better, follow the proposal put forward by Britain’s Lord Turner, and grant central banks the power to vary the permitted leverage, tightening the limits at times when credit looks as if it may be getting out of control.


LIKE ALL POPULIST POLICY, THIS REFORM SOUNDS GREAT BUT CAN'T ACTUALLY BE IMPLEMENTED

There are just too many activities that a bank performs for its deposit clients or its borrowers that are indistinguishable from prop trading. When a bank trades a security for a client, it will hold that security for some period of time. When it makes a market, it needs to provide liquidity in this or that instrument and so expose itself to market movements. When it offers a fixed rate loan or a mortgage, it insures itself against exposure to interest rate movements with a derivative. In all this, how can a regulator tell what is prop trading and what is sound banking? You'll always be able to dress up the first as the second. Nomi Prins, a former director at Goldman Sachs, says that the way banks shift money from one part of their business to another is so opaque that the ban on proprietary trading will be impossible to police. "Bank of America, for example, has its fixed income, currency and commodities trading figures merged together, making it impossible to see the contribution of Merrill Lynch’s sizeable trading activities, as well as the line between proprietary and possibly customer-oriented trading." Making rules you can't police adds to the regulatory confusion that got us into this trouble in the first place. And anyway, it'll just push the banks to do their proprietary trading elsewhere: London, Singapore and Geneva just can't wait.


LARGE BANKS ARE POSITIVELY SAFER THAN SMALL BANKS

Obama wants to limit the size of all financial institutions. But the Great Depression saw linked runs on hundreds of small banks. Indeed, one of the real problems during a financial crisis is that no one knows if a counterparty will be good for their money. The more transactions happen within a single firm, the less uncertainty there is. The European-style "universal banks" like Deutsche Bank and Societe Generale combine deposit-taking, investment, trading, advisory and even insurance roles. They have been more resilient to crisis than specialised and quite small operations like Lehman Brothers. It all points to Obama's populism: design a plan that bashes the foreigners, undermines global solutions and appeals to stereotypes of the big bad corporation.


A GLOBAL ECONOMY CAN’T DO WITHOUT BIG BANKS

Even if a giant corporation spreads some of the financial risk between financial institutions, they still want to be dealing with major global banks. When Kraft Foods looks to raise $7 billion of debt to finance its takeover of Cadbury's, you can't expect it to have to go cap in hand to hundreds of small deposit-taking institutions to put a loan together. Business on a global scale is efficient and the path to economic growth everywhere. You need smoothly running capital markets to oil the wheels of globalisation, and artificial barriers to bank size will put a break on prosperity for all.


THE LEVY WILL BE CIRCUMVENTED - IT JUST MAKES MONEY FOR CORPORATE TAX LAWYERS

The levy is going to be based on banks' total US assets. But it is a simple matter for legal departments of banks to make assets appear where in the world they want. If Goldman Sachs in the US lends a hedge fund shares in Kraft Foods for the hedge fund to short them, that'll appear as a taxable asset under the levy. But assets and income can be moved around - a Goldman Sachs vehicle in the British Virgin Islands can enter the lending agreement with the hedge fund and no tax will be incurred. The levy just throws money at lawyers and reduces transparency. What is needed is a global regulatory system that does away with this wasteful game of cat and mouse.


OF COURSE IT'S POPULISM: OBAMA DESPERATELY NEEDED A BIT OF PUBLIC THEATRE

Obama’s first year in office has been a bit of a disaster: his healthcare plans have gone nowhere, unemployment has reached its highest for a quarter of a century, his approval rating has plummeted to around 50%. Then there was this January’s electoral humiliation, deep in supposedly Democrat territory, when an unknown Republican won Ted Kennedy’s old Senate seat in Massachusetts. So, with November’s mid-term elections fast approaching. Obama needed a media stunt which would appeal to working-class Americans, and take the focus off his failures. This populist assault on the money men of Wall St was just the ticket, especially with JP Morgan and Goldman Sachs reporting huge profits and bonus pools again. Indeed, Goldman delayed announcing record results until the day the Obama plan was announced, so diverting attention away from its embarrassment of wealth. In reality, we should actually be saluting the restoration of bank profits as the great achievement of the last few years and recognizing that a big part of repairing bank profitability has come from their proprietary trading desks. Which is why one might worry about Obama’s populist assault, were it not obvious that the administration isn’t really serious about getting tough. It’s shadow punching. Timothy Geithner, the Treasury Secretary, has on many occasions flatly repudiated the stated ambitions of the plan’s architect, Paul Volcker. Ben Bernanke, the Wall Street-friendly chairman of the central bank, looks certain to be reappointed. This is exactly how you'd expect an administration to behave when it was trying to say to Wall Street: "don't worry - we're just appeasing the mob".