Leading article: President Obama shows the way

Saturday 23 January 2010 01:00 GMT

If President Obama's bite proves equal to his bark, his new-found desire to take on Wall Street should provide Britain with a road map for regulatory reform and the freedom to act without fear that our financial services industry will leave for more favourable jurisdictions.

First, let us be clear about what Glass-Steagall-like reforms cannot achieve. They will not, for example, prevent the collapse of banks. Northern Rock and Bradford & Bingley – and, nearly, Halifax Bank – went under during the financial crisis despite having zero exposure to the risky activities on which Mr Obama has focused. Nor would such reforms necessarily prevent another credit crunch. Giant investment banks would still be free to package exotic financial instruments and sell them on – and to risk blow-ups that might stymie liquidity for long periods.

Crucially, however, banning high street banks from engaging in investment banking activities solves the "too big to fail" dilemma. It is right that the state should stand behind the deposits that its citizens make in retail banks. But this requires the taxpayer to underwrite all the risks these banks take. As the rules currently stand, our largest banks are free to make massive, dangerous bets in the knowledge that if the gambles go wrong, the state has no choice but to bail them out so as to protect retail depositors.

So far, the British Government has been timid in tackling this problem. Our banks have been forced to improve their capital reserves and devise "living wills", dictating how they might be dismantled in the event of a crisis. The regulatory authorities are also in for a mild shake-up.

These solutions, however, address the symptoms of the condition, rather than offering a cure. They attempt to stop institutions judged too big to fail from doing so, rather than just getting rid of such institutions altogether. Much better to ensure that in future no retail depositors will be at risk.

For the UK to adopt the principles of Glass-Steagall would be a bold response to the financial crisis. But this is also the easiest way to ensure British taxpayers never again have to pay to save banks that have blown themselves up with reckless speculative investments.

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