Obama, banks: The myth of the capital cushion evaporates
There's a great scene in Monty Python's Life of Brian which explains a lot about President Obama's sudden turn to a Glass-Steagall solution: a blasphemer is about to be stoned to death for uttering the word Jehovah....
Blasphemer: Look, I don't think it ought to be blasphemy, just
John Cleese: You're only making it worse for yourself!
Blasphemer: Making it worse? How could it be worse? Jehova,
This sums up more or less accurately the positon between the banks and regulators as they've curled their genteel vowel sounds around the words "capital cushion". "All we need to do, old boy," they've assured us "is raise the amount of capital banks have to hold. That'll sort things out".
And the governments and regulators bought it, until now.
They would penalise risky banks by raising their capital cushion, from the 4% RBS scraped by on, to the 9% they imposed during the crisis.
Pay excessive bonuses? Higher capital. Too big to fail? More higher capital. External macro-economic risks building up? Higher capital still.
Eventually the banks just look like the Monty Python guy in his toga: everyone knows you can't stone a man to death twice and, on this principle, it began to dawn on politicians that this ready remedy, so elegant, so replete with market principles, was not going to work.
Capital holdings by banks would end up so excessively high that all the dynamism and profitability would be squeezed out of the system. Eventually the banks would just say: "Jehova, Jehova, Jehova! - How much more capital can you force us to hold"
This is why, in many countries, they are now turning to direct intervention to restructure the banking sector. Having treated the whole Glass-Steagall principle of separation between speculation and depositors' money as itself blasphemous, they have begun to realise the long-term cost to the state of extending an implicit guarantee of bailout to the entire sector.
The money banks are making right now is all predicated on state intervention. The state (via its "independent" central bank) creates money and lends it at 0.25%. The banks lend it out at - well, take a look at the offered mortgage rates in the papers: 4%, 5% - take your choice. They can even lend it back to the government at above 3%. And because there is an implicit guarantee that any bank that fails will be saved, the market has priced that in - cheap money for banks will be a feature of the next 10 years, not just short term. Meanwhile, though, the banks are compounding things by refusing to lend the money to the mainstreet. The money lent by US banks has fallen every month for the past nine months.
This is virtually risk free profit and is the root source of all the money that is now going to swill around Lamborghini showrooms and Swiss Watch manufacturies and the New England coastal property market.
I date the change in attitude to an influential paper, Banking on the State, by Andrew Haldane of the Bank of England. This set out in clear, philosophical terms, why the two centuries of power-shift between banks and the state might have to be reverse. Note the timescales: Haldane himself harks back to the 12th century AD at one point, to illustrate how banks can exist as subservient to both society and the state.
President Obama's move last night opens a new chapter. Up to now all talk of a financial new world order has been just that, talk. Now - with the British Conservatives and the Bank of England's governor (the latter tacitly) supporting a Glass-Steagall 2.0 style law here, the game is on.
For if you deprive the speculative half of banking of access to the deposits of ordinary customers - and still more if you make it illegal for all those cosy plaforms to exist where hedge funds raise their money from depositors, using the banks as a mere pipeline, you really make the Basel II capital limits a secondary issue.
Let's be clear: if Obama's proposals go through in their philosophically pure form, as designed by Paul Volcker, then invesment banking goes back to being a functional but subordinate part of the finance system. In its heartland.
There will be strong arguments deployed as to why this is a bad thing, but we are not exactly hearing them flood the airwaves this morning. The banking world is stunned.
People on the very desks that would be deemed unlawful in mid-town Manhattan were turning round over their skinny-lattes to each other and saying yesterday: "This is about Martha Coakley and Massachusetts, right? 'S not gonna happen, right?" Nobody saw it coming.
The move, of course, places a major question on Gordon Brown's table. By comparison the Banking Bill going through parliament is not so far-reaching. But you've got now Mervyn King and potentially Adair Turner pushing at the edges for a more decisive solution to the "too big to fail" problem. And the Conservatives and Libdems. Plus serious, non-ideological voices in the economics community, like former IMF man Simon Johnson.
Wierdly, after 18 months of the most minimal and timorous reform moves, we now not only have a bonus tax here, a levy in America, but suddenly the philosophical outline of a Glass-Steagall type solution coming out of Washington and the Tobin Tax on the table in Europe.
And none of it was pushed by activist groups or mass demonstrations: it's arisen out of the simple realisation that the capital cushion idea is not going to stop another boom-bust cycle on its own; and that cycle has already begun; and if another bust happens there is no ammo left in the clip. And that populations and electorates are going to be, mad as hell and are probably not going to take it anymore.
In the face of this the state, and politicians have quite simply decided that the banks will have to be restructured and finance made to pay for the risk free business environment it enjoys. The main political debate now will be about how you make this happen.