| 08 November 2009
I decided to give the G20 St Andrews meeting on Friday and Saturday a miss,
since nobody thought anything would be agreed even in advance of the meeting,
and sure enough, it wasn't. The closing communique is bland even by the standards
of those always very banal documents.
The highlight of the occasion was Gordon Brown's ringing declaration of war
against the banks, something not without irony in a week when his government
splashed out another fifty billion pounds it hasn't got in their direction.
But of course everyone knows that there won't be any new taxes on banks: it's
important not to damage them further when they are just starting to get back
on their feet. This was a blatant piece of electioneering, aimed at taking advantage
of popular indignation about bankers' bonuses, and should make for a nice blip
in the government's opinion poll ratings.
The other leaders present listened politely, but there was no agreement on
action against the banks. 'We call on supervisors to ensure that banks retain,
as needed, a greater proportion of their profits to build capital to support
lending; -- to ensure that compensation policies and practices support financial
stability and align with long-term value creation; we commit to incorporate
urgently within our national frameworks the FSB standards, and call on firms
to implement these sound compensation practices immediately.' That was the nearest
the meeting could come to positive action.
What is worrying, though, is that there has come to be a consensus at G20 level
that banks can't be allowed to be: 'Too big to fail.' Hmmm. Meaning that they
will try to make banks smaller (what Gordon and the EU are doing in the UK market).
But who says they are too big too fail? They aren't. What the politicians mean
is that they can't handle the political backlash of a major bank failure. They
say that a major failure would cause a global financial collapse, and therefore
they have effectively nationalized large swathes of the banking sector.
What nonsense! The failure has come from the politicians, who have failed to
allow failure, and are now having to deal with the consequences of their folly.
Let's pick it apart a little. There are three constituencies who can suffer
in a bank failure: the depositors (who are mostly also borrowers through mortgages);
the shareholders; and the wider financial community, who are intricately linked
with each other and a failing bank through inter-bank lending.
We can immediately dismiss the shareholders as an issue: they will lose their
money whether a failing bank is nationalized, saved, or fails. The depositors
are protected in most countries by industry or governmental deposit insurance
schemes, and the few countries that didn't have such schemes have now made sure
to put them in place in response to last year's panic. That leaves the inter-bank
market, and that's where governments fear meltdown. But it has to be repeated
time and time again that the inter-bank market has become a risk only because
governments have allowed moral hazard to reach such proportions through their
own actions.
There will be some useful improvements as a result of last year: counter-party
settlement risk is being dealt with in most sectors by having independent, separately
capitalized settlement agencies, as is currently happening in foreign exchange,
and has already happened in most parts of the securities markets; equity capitalization
will be improved; the rating agencies will be subject to much greater scrutiny
(really they should be abolished and turned into a global organization, perhaps
as part of the WTO); 'living wills' or disaster scenario planning will become
de rigeur for large banks and should be enforced by central banks; and the mechanisms
for prudential banking supervision will be much improved in many countries,
including the UK and the USA.
Having encouraged all these steps, governments should then fold their arms,
stop interfering, and make it absolutely plain that they will never again save
a bank. Of course they will have to continue to offer liquidity to markets when
it is needed, and they should help banking takeovers with tax breaks and liquidity,
as used to be done in cases such as Continental Illinois. But please, please,
let a big bank fail, and preferably as soon as possible. Once the nasty medicine
has been drunk, the industry will pull itself together and start to behave in
a grown-up kind of way. Right now, bankers are like drunken teenagers at a party
where the bar is open all night and the grown-ups have gone to stay with friends.
What do you expect will be the result?
Of course it's not going to happen. Politicians will continue to meddle, trying
to construct a banking sector that cannot fail, bankers will continue to take
the money and ignore the advice, there will be another credit boom, and there
will be another bust. The only unknown is when.
You have been reading an entry on the following blog:
Jeremy Hetherington-Gore Unleashed
Jeremy tackles the difficult issues head on!
Contact: jeremy@lowtax.net
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