Why is the effort to reform the global financial system failing? The previous posts in this series reviewed the failure to reform central banking. This final column looks at the fading prospects for a meaningful reform of commercial banking and then examines the ‘scapegoats’ used by governments. We show how the three major players have made a pact to kill any reform that’s meaningful.
Throughout the developed world, the crisis has redrawn the lines between the market and the state – to the advantage of the state. We are entering a new age of collectivism, where the state and its agencies will exercise a large measure of control over the financial system – even if it remains nominally in the private sector. Given present political realities, this era is likely to last for a considerable time. Of course, that is not the official story. The party line is that the new regulations promote and support safe, sustainable, consumer-friendly, commercial banks and other financial institutions and markets. Yet in reality this is a smokescreen for a return to a larger measure of state direction. Certainly the 29 ‘mega-banks’ now called ‘G-sifis’ (global systemically important financial institutions) are being gagged in red tape.
The looming failure of bank reform
Instead of reform, we get ever more regulation. Yet this has basic weaknesses:
What is its objective? There is no unambiguous, common-sense definition of ‘financial stability’. In practice, political pressures mean it is likely to be defined in a counterproductive way: as the absence of bank failures. This is a recipe for freezing the structure of finance just when it should be totally overhauled.
Strong boards and governance arrangements will be more important than ever. Yet the boards of big banks remain weak. They have no means of disciplining a powerful CEO. Regulations will tend to weaken bank governance.
Non-executive directors (Neds) of banks spend an inordinate amount of time educating regulators about how their banks actually operate. To quote one of my Ned friends: ‘Our regulators have never been bankers. They are civil servants. Their assessment of the riskiness of bank assets and strategy can often be questioned.’
Others report that regulators enjoy their power, and treat bankers as guilty until proved innocent. Soon they will doubtless have power to request accusations of criminal liability be brought against bankers if they engage in what the UK Parliamentary Comission calls “reckless” behaviour. So bank boards will be even more obsessed about pleasing the regulators and spend far too much time second guessing what would or would not get their approval.
As recent developments have demonstrated, the inherent difficulties of implementing such a complex regulatory apparatus naturally leads down a slippery slope to more financial repression.
‘Structural’ measures, such as splitting retail from investment banking, would offer a prospect of meaningful change, but subjecting a global institution to different structural measures in different countries and jurisdictions creates further complications. Structural reforms offer no magic bullet. In any case, they are not going to be implemented.
The recent report of the UK Parliamentary Commission on Banking Standards (‘Changing banking for good’) provides an outstanding account of what has gone wrong with the culture of banking, and especially the culture of the City of London (and it is nice of them to cite my evidence on several occasions). The analysis of what went wrong, its approach to fixing things – to make individual responsibility in banking a reality, especially at most senior levels – and its restatement of basic principles are exemplary (though it is of course all pitched at the UK national level in which the entire exercise is set and had to be, given the political constraints, whereas The Money Trap argues that a real solution can only be found at the global level) .
But one fears that implementation of reforms will again lead to skewed incentives: making bankers that engage in “reckless” behaviour liable for criminal sanctions if their banks call on public support, combined with the absence of any cap on pay and bonuses, seem likely to result in the growth of an ultra-cautious, yet even more richly rewarded cadre of senior bankers who will do anything to avoid risk and will be anything but competitive.
Three scapegoats
At the international level, equally, governments have little incentive to push for meaningful reforms. After all, they have convenient alibis or scapegoats:
1. The China scapegoat
The common view that the high savings of China and other surplus countries were responsible for the financial crash, by fuelling the preceding asset boom and the US external deficit, is debatable. Rather, the roots can be traced to a global credit and asset price boom, fuelled by monetary policies and bankers’ aggressive risk-taking and facilitated by the lack of any discipline on government policies. If this is the case, even if the scale of current account imbalances were to be permanently reduced, that would not make the financial system or the global economy any safer. However, the so-called Asian ‘savings glut’ offers a scientific-sounding rationale for Western governments and financial elites to evade responsibility and blame Asians.
2. The euro scapegoat
Problems of the eurozone give another wonderful scapegoat for central bankers and governments outside the eurozone to avoid responsibility for what has happened in their economies and financial systems, postpone tackling the real problems, and in particular avoid any serious consideration of the international monetary system. The obsession with the euro (in the UK it has become socially unacceptable to say a single word in favour) means that the IMF, whose job it is to look after the international monetary system, dissipate its energies on euro problems. Watching the agony of the eurozone, many economists reject out of hand proposals for all schemes for wider international monetary cooperation.
3. The regulation scapegoat
The new regulatory apparatus being given to cenral banks – supposedly designed to monitor and guard against credit cycle risks, as well as supervising the risk profile of individual financial institutions – will enable politicians to blame central banks when things go wrong again. This presents governments not only with another alibi but also with incentives to take more risks. Lo and behold, this is exactly what they are doing.
The public sector is taking huge risks – including much of the economic risk involved in financial intermediation; the private financial sector is bludgeoned into submissive obedience with multiple rules and exhortations, including threats of prison sentences; the real economy, buffeted by contrary impulses, proceeds by ‘fits and starts’.
Part 3: Why reform is failing
Part 3 looks at reform of banking
Why is the effort to reform the global financial system failing? The previous posts in this series reviewed the failure to reform central banking. This final column looks at the fading prospects for a meaningful reform of commercial banking and then examines the ‘scapegoats’ used by governments. We show how the three major players have made a pact to kill any reform that’s meaningful.
Throughout the developed world, the crisis has redrawn the lines between the market and the state – to the advantage of the state. We are entering a new age of collectivism, where the state and its agencies will exercise a large measure of control over the financial system – even if it remains nominally in the private sector. Given present political realities, this era is likely to last for a considerable time. Of course, that is not the official story. The party line is that the new regulations promote and support safe, sustainable, consumer-friendly, commercial banks and other financial institutions and markets. Yet in reality this is a smokescreen for a return to a larger measure of state direction. Certainly the 29 ‘mega-banks’ now called ‘G-sifis’ (global systemically important financial institutions) are being gagged in red tape.
The looming failure of bank reform
Instead of reform, we get ever more regulation. Yet this has basic weaknesses:
What is its objective? There is no unambiguous, common-sense definition of ‘financial stability’. In practice, political pressures mean it is likely to be defined in a counterproductive way: as the absence of bank failures. This is a recipe for freezing the structure of finance just when it should be totally overhauled.
Strong boards and governance arrangements will be more important than ever. Yet the boards of big banks remain weak. They have no means of disciplining a powerful CEO. Regulations will tend to weaken bank governance.
Non-executive directors (Neds) of banks spend an inordinate amount of time educating regulators about how their banks actually operate. To quote one of my Ned friends: ‘Our regulators have never been bankers. They are civil servants. Their assessment of the riskiness of bank assets and strategy can often be questioned.’
Others report that regulators enjoy their power, and treat bankers as guilty until proved innocent. Soon they will doubtless have power to request accusations of criminal liability be brought against bankers if they engage in what the UK Parliamentary Comission calls “reckless” behaviour. So bank boards will be even more obsessed about pleasing the regulators and spend far too much time second guessing what would or would not get their approval.
As recent developments have demonstrated, the inherent difficulties of implementing such a complex regulatory apparatus naturally leads down a slippery slope to more financial repression.
‘Structural’ measures, such as splitting retail from investment banking, would offer a prospect of meaningful change, but subjecting a global institution to different structural measures in different countries and jurisdictions creates further complications. Structural reforms offer no magic bullet. In any case, they are not going to be implemented.
The recent report of the UK Parliamentary Commission on Banking Standards (‘Changing banking for good’) provides an outstanding account of what has gone wrong with the culture of banking, and especially the culture of the City of London (and it is nice of them to cite my evidence on several occasions). The analysis of what went wrong, its approach to fixing things – to make individual responsibility in banking a reality, especially at most senior levels – and its restatement of basic principles are exemplary (though it is of course all pitched at the UK national level in which the entire exercise is set and had to be, given the political constraints, whereas The Money Trap argues that a real solution can only be found at the global level) .
But one fears that implementation of reforms will again lead to skewed incentives: making bankers that engage in “reckless” behaviour liable for criminal sanctions if their banks call on public support, combined with the absence of any cap on pay and bonuses, seem likely to result in the growth of an ultra-cautious, yet even more richly rewarded cadre of senior bankers who will do anything to avoid risk and will be anything but competitive.
Three scapegoats
At the international level, equally, governments have little incentive to push for meaningful reforms. After all, they have convenient alibis or scapegoats:
1. The China scapegoat
The common view that the high savings of China and other surplus countries were responsible for the financial crash, by fuelling the preceding asset boom and the US external deficit, is debatable. Rather, the roots can be traced to a global credit and asset price boom, fuelled by monetary policies and bankers’ aggressive risk-taking and facilitated by the lack of any discipline on government policies. If this is the case, even if the scale of current account imbalances were to be permanently reduced, that would not make the financial system or the global economy any safer. However, the so-called Asian ‘savings glut’ offers a scientific-sounding rationale for Western governments and financial elites to evade responsibility and blame Asians.
2. The euro scapegoat
Problems of the eurozone give another wonderful scapegoat for central bankers and governments outside the eurozone to avoid responsibility for what has happened in their economies and financial systems, postpone tackling the real problems, and in particular avoid any serious consideration of the international monetary system. The obsession with the euro (in the UK it has become socially unacceptable to say a single word in favour) means that the IMF, whose job it is to look after the international monetary system, dissipate its energies on euro problems. Watching the agony of the eurozone, many economists reject out of hand proposals for all schemes for wider international monetary cooperation.
3. The regulation scapegoat
The new regulatory apparatus being given to cenral banks – supposedly designed to monitor and guard against credit cycle risks, as well as supervising the risk profile of individual financial institutions – will enable politicians to blame central banks when things go wrong again. This presents governments not only with another alibi but also with incentives to take more risks. Lo and behold, this is exactly what they are doing.
The public sector is taking huge risks – including much of the economic risk involved in financial intermediation; the private financial sector is bludgeoned into submissive obedience with multiple rules and exhortations, including threats of prison sentences; the real economy, buffeted by contrary impulses, proceeds by ‘fits and starts’.
Written on June 19, 2013 at 8:12 am, by robert
Categories: Banking, Homepage, News and Comment, Official Money, RP's Diary