US President Barack Obama’s blast across the mainsails of the financial sector is being widely described as a populist move in an attempt to regain the political initiative after the Democrats’ loss of their super-majority in the Senate as a result of the Massachusetts election. While this may, to some extent, be true — although his lack of political scheming heretofore has had a refreshing flavour — the reality is that Paul Volcker, the Grand Old Man of financial markets who has been the head of Mr Obama’s Financial Advisory Panel, has been recommending a fundamental shake-up of the financial sector for at least a year now.
While the details remain to be worked out, I think that the basic thrust — that banks that take customer deposits which are protected by taxpayer funds have no right whatsoever to run aggressive risk positions — is so obvious it shouldn’t have to be said. Banking, which is primarily about taking credit risk, should be banking; and punting, which is taking all other kinds of risk, including the extravagantly incomprehensible risks that many modern instruments carry, should be punting.
Bankers should be the staid, old, boring fellows I remember from my youth; punters should be the kind of charming ne’er-do-wells you met at the racecourse, some of whom disappeared from sight from time to time never to be heard from again, and some who made fortunes, smoked cigars and regaled you with tales of guts and glory over cheap whiskey.
About 15 to 20 years ago, the two worlds began to merge, and with the scrapping of the Glass-Steagal Act in 1999, the sparks really began to fly. Risk-taking suddenly seemed to become risk-free, as none of the punters went under — that is, until very recently. And all of this under the watchful eye of an apparently responsible set of financial market regulators.
Of course, these regulators had, by then, been completely captured by the financial sector. This regulatory capture began back in the 1980s when President Reagan, attracted to Mrs Thatcher’s laissez faire policies, appointed Donald Regan, the then chairman of Merrill Lynch, to head the Treasury. Now, this is not to accuse Mr Regan, or any of his contemporaries who succeeded him, like Robert Rubin or, more recently, Hank Paulson, of dishonesty or nepotism or any other nefariousness.
The simple truth is that when someone works day in and day out in a business, his entire belief system becomes: what’s good for Merrill Lynch (or Citigroup or Goldman Sachs) is, of course, good for America (and, in due course, the world). And so regulation, which is intended to ensure that financial markets work in a way that is best for the largest good, became meta-regulation, where it focused on how to create the greatest good for Merrill Lynch (etc. etc.) since implicitly this would be the greater good.
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Examples abound — in April 2004, for instance, the CEOs of the five largest investment banks, led, incidentally, by Hank Paulson, convinced the SEC to exempt “their brokerage units from an old regulation that limited the amount of debt they could take on. The exemption would unshackle billions of dollars held in reserve as a cushion against losses on their investments… In loosening the capital rules, which are supposed to provide a buffer in turbulent times, the agency (the SEC) also decided to rely on the firms’ own computer models for determining the riskiness of investments, essentially outsourcing the job of monitoring risk to the banks themselves.”
Voila! Regulation by the regulated — clearly not a sound model for stability, as the meltdown of 2008 has shown. More power to Mr Obama for telling it like it is. This is no time for tweaks and twists. It is time for a real change. It is time for the financial sector profits in the US, which shot up to nearly 5 per cent of GDP in 2007, from a 25-year average of 1.5 per cent, to shrink to a more normal level. And for the shadow banking sector — the punters — to come under much closer scrutiny, with limits on leverage, scale and complexity. And for the credit rating agencies (and other under-the-radar providers of grease to the wheels of finance) to come under regulation, akin, somewhat, to what has been proposed by the Krishnan committee here in India.
And if this shake-up results in continued volatility in markets and disarray amongst the rich and famous, well — you can’t make an omelette without breaking eggs.
It’s a new morning in America and more than time for breakfast.