Bank reform: The radical way
Please forgive me for not having published a column for a bit. I've been pre-occupied sorting out family stuff.
That stuff isn't quite ticketyboo yet. So the blog will go into hibernation for some weeks (please don't look so pleased).
There will be plenty to talk about when I return - so I hope fervently you will still want to have a conversation with me.
In the meantime, it seems appropriate to discuss what a radical reform of the financial system would actually look like.
I say the "financial system" rather than the "banking system" because arguably the debate has been too fixated on institutional reform of banks rather than the size and scope of the financial system as a whole.
The governor of the Bank of England is widely seen as having joined the radicals' camp - in that, overnight he declared himself the friend of those who wish for sprawling banking conglomerates to be broken up, such that banks' more speculative activities would be separated from those functions vital to the functioning of the economy (see Stephanie Flanders' note on this).
As usual for the governor, it's an exquisitely timed intervention in the debate - in that the Financial Services Authority will be publishing its latest reforming thoughts later this week.
So the poor old FSA is bound to be characterised as sleepy and unimaginative compared with the bold and courageous Bank of England.
And, do you know, I almost feel sorry for the FSA. Because the remedies proposed by Adair Turner, the FSA's chairman, are arguably a greater challenge to the status quo than King's.
In some ways, King's position has not shifted a jot since the crisis began in the summer of 2007.
He has always been fixated on moral hazard, on the idea that it's lethal for the efficient functioning of markets that institutions should be protected from the consequence of their mistakes.
And, as a matter of social justice, very few would fail to share his frustration that taxpayers have bailed out British banks to the tune of a short trillion pounds only to see the bankers making plans to pay themselves fabulous bonuses once again.
His characterisation has been incendiary: "never in the field of financial endeavour has so much money been owed by so few to so many - and, one might add, so far with little real reform".
For him, it is a matter of overwhelming importance that when banks and bankers gamble and lose, they pay the price - that the casino isn't rigged such that the winnings always go to them, while losses are forced on the state, on us.
That said, there is probably no way to avoid the provision by taxpayers to banks of financial protection for those functions that protect our savings, that provide vital credit to businesses and that move money around the economy.
What should be avoided (King would say, and most would agree) is what happened last autumn - which is that we rescued the speculative or casino operations of banks, the parts that generate the spectacular gains and losses, along with the supposed utility parts.
Which is why hiving off the banks' trading activities may well be a sensible way of limiting taxpayers' liability in the long term.
And it is perhaps testament to the lobbying clout of the big banks that the proposal from Paul Volcker, the distinguished former chairman of the Federal Reserve, for the separation of banks' investing and trading functions has not been embraced by Barack Obama or Gordon Brown.
But although breaking up the banks may be a sensible and necessary reform, it's by no means clear that it would be sufficient to correct the flaws that got us into this mess - even when combined with the recent international agreements to strengthen banks by obliging them to hold more capital and liquid assets.
Which brings us to Adair Turner and the FSA.
He would part company with King on an issue of fundamental principle.
The point - and most in the City will find this impossible to believe - is that King is much more the bankers' ally than Turner.
Because King, and others who argue for breaking up the banks, want onerous regulation and heavy supervision to be concentrated on a relatively narrow area of what banks do - those utility activities I've described as being the infrastructure of a healthy economy.
For King, there could be a relatively free, unfettered market for trading and investment banks, so long as the incentives for bankers can be corrected, such that the risks they take are genuinely risks for them, the proprietors of their institutions and professional creditors.
Turner would not agree.
He believes there is no serious alternative to much more intensive interference in all credit markets by the authorities. And he also believes - which is arguably more radical than breaking up banks - that credit markets have become far too big and opaque and that governments should take active steps to shrink and simplify them.
Perhaps his main point of dispute with King would be whether the guarantee against losses provided by taxpayers is really the main contributor to boom-and-bust cycles in credit.
With Keynes and Hyman Minsky, Turner would argue that the heart of the problem is simply that there is always a subjective element in valuing the future stream of earnings from any loan or investment, and that therefore the pricing of financial assets is always prone to overshoots and undershoots, depending on whether there is a prevailing climate of euphoria or despair.
No-one would argue - surely - that the insane dotcom bubble in shares prices of 1997 to 2000 was in any sense a moral hazard phenomenon. There was no taxpayer protection for over-enthusiastic investors who bought shares in "we_saw_you_coming.com" at multiples of 1,000 times notional prospective profits.
Investors paid far too much for "new economy" shares for the same reason investors traded their life savings for a single tulip bulb in the 1630's - hysteria and greed persuaded herds of investors that they were going up forever.
Precisely the same mania afflicted bankers and professional investors who lent colossal sums to over-indebted companies from 2005-7 with few strings attached and bought bonds made out of poor-quality subprime loans that were priced only a bit more cheaply than high-quality sovereign debt.
In the recent credit bubble, the equivalent of the insane heights touched by shares in 1999 and 2000 was the ludicrously low cost - in July 2007, just weeks before wholesale financial markets froze and the credit crunch began - of insuring against possible losses on loans to banks through the use of credit default swaps (CDS's).
The CDS premium for bank debt at the time was as low as it had ever been: it implied there was almost no risk of lending to a bank, when in reality there had never since 1929 been a riskier time to lend to a bank.
This was as much a bubble as had been the dotcom one.
But there is a really important difference between the two bubbles.
The retail and commercial banks on which we all depend are more-or-less prohibited from investing depositors' money in shares, so when share prices collapse there's little impact on their viability or solvency.
But when a credit bubble goes from boom to bust, there is a hideous feedback loop which damages the banks, then the economy, then the banks again: banks suffer losses on their investments and loans; their ability to lend becomes constrained which leads to a slowdown in the economy; which in turn generates greater losses on loans and investments for banks; and so on, till we're all paupers.
It would of course be theoretically possible to stipulate that retail banks benefiting from a taxpayer guarantee should be prohibited from any lending or investing at all, that they should only be allowed to hold high-quality government bonds or cash (which is similar to what the economist John Kay has recently argued).
But that would only protect depositors' money. It would not flatten the credit cycle.
The important point is that it is not just the more obviously tradeable forms of credit, the bonds made out of loans, that are prone to being overpriced and underpriced; banking history is an epic of periodic manias in all kinds of loans.
For Turner, therefore, if it's acknowledged that the big risk that has to be reduced is the susceptibility of the economy to boom-and-bust cycles caused by boom-and-bust cycles in credit, there is at best only a partial cure to be found in breaking up the banks.
The economy would still be inextricably dependent on credit provided by banks and other financial institutions, whether those banks are narrow insured retail banks and uninsured trading and investment banks, on the one hand, or today's conglomerates, such as Royal Bank of Scotland and Barclays.
So, for him, a better prophylactic against the boom-and-bust cycle is to curb what he calls the more socially useless and frothy trading by all and any banks, whether they are pure investment banks like Goldman Sachs or conglomerates like Barclays.
He has, for example, already said that he sees a powerful case for introducing a tax on much of the trading in wholesale financial products.
And, as I understand it, he would also be highly sympathetic to the suggestion of George Soros, the hedge fund billionaire, that there should be a prohibition on so-called "naked" trading in credit default swaps - or that only those holding the debt of a company or institution should be able to take out insurance against that debt.
Which may sound technical and dull. But it would shrink the CDS market by many trillions of dollars, since something like 90% of the market in recent years has taken the form of pure speculation, according to industry statistics.
By the way, if you are one of those who want to see a substantial and permanent reduction in bankers' bonuses, Turner may be your man - because he wishes to see a substantial diminution in banks' revenues, so the bonus pot would inevitably become much smaller.
What is clear to me is that the British financial services industry should be feeling quite uncomfortable.
The City of London is sandwiched between Mervyn King at the Bank of England, who wants to break up the likes of Barclays and Royal Bank, and Adair Turner, who believes its activities should be fettered and constrained to an extent it hasn't experienced for almost 30 years.
Perhaps the bankers are hoping for a Tory government and assuming that George Osborne as chancellor would see off the irksome King and Turner.
If so, that's as likely to pay out as the massive bets many of them took two and half years ago that the banking system had never been sounder.