David Prosser: The question Obama can't quite face

Outlook: An institution that takes deposits but also engages in high-risk investment banking can never be truly confident in the integrity of its customers' balances
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What's most striking about today's anniversary of the collapse of Lehman Brothers is that we still have not answered the most fundamental question that the crisis prompted: what do we do about organisations that are too big to fail? President Obama tried to give his faltering financial reforms new impetus last night, but he came no closer to a solution to that dilemma.

That certain financial institutions are too big fail must now be a given. In allowing Lehman to collapse, the US authorities brought the world's financial system to the brink of meltdown – with hindsight, you will find it almost impossible to find a credible commentator today who thinks letting the bank go was the right thing to do.

Certainly, every subsequent crisis at an institution of anywhere near comparable significance to Lehman has prompted a rescue effort, with authorities around the world rushing to ensure that they did not make the same mistake as the Americans. That includes the Americans themselves, who decided within a week of the Lehman debacle that AIG was too important to be left to the same fate, as well as the UK authorities, which, one way or another, ensured the survival of HBOS, Royal Bank of Scotland and then Lloyds.

Yet having taken those decisions, often at huge potential expense to the taxpayer, we have been reluctant to take the most obvious route towards ensuring that such rescues never have to be mounted again. This would be to break up any organisation whose failure would pose a systemic risk into smaller units whose individual failures wouldn't.

In both the UK and the US – and the President made this clear again last night – there is to be no direct break-up of the biggest banks. Instead, the regulatory response to the worst banking crisis in history is to be greater scrutiny of some organisations, more demanding requirements on capital and liquidity, the reallocation of powers – new and existing – between watchdogs, and a further focus on the tempting but ultimately distracting target of bonuses and remuneration.

All of these reforms have merit in their own right, yet they do not solve the fundamental problem. There will continue to be certain institutions that operate with an implicit guarantee from the taxpayer because they could never be allowed to go under. In the case of many of our largest banks, the guarantee is explicit, with the taxpayer promising to foot the bill in the event of depositors suffering losses after a Lehmanesque default.

Those who support the idea of breaking up our biggest banks are really talking about legislation akin to the US's Glass-Steagall Act, which until it was repealed in the late Nineties prevented investment banks from taking retail deposits. President Obama and, back home, Alistair Darling say a return to such legislation would be a simplistic way to respond to the credit crunch. Maybe, but simplicity has its virtue.

It's certainly true that small banks can and do fail too – and that in some cases a dangerous domino effect might be the result – but that's not a reason not to tackle the bigger ones. Nor does the US obsession with giving regulators the power to take over failing banks quickly so as to wind them up without systemic implications obviate the need to consider size.

In fact, if we're honest, the arguments for a return to something along the lines of Glass Steagall are far more powerful than the status quo. Above all, an institution that takes deposits but also engages in high-risk investment banking can never be truly confident in the integrity of its customers' balances.

Why then, are we so reluctant to tread this path? The answer lies in the reasoning behind the US decision to repeal Glass-Steagall 10 years ago – that in a deregulated, global market, it is no longer so easy to separate commercial and investment banking, and many countries do not even try to do so. Or to put it another way, everyone else's banks are at this party, so why should we be forced to stay home?

And maybe we should forgive – or at least understand – some cautious policymaking. After all, a year ago last night, the US Government did say no to the banks. And look what happened then.

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