There has never been a better time to cut finance down to size, but Washington and London have ducked the chance to do so
- guardian.co.uk, Wednesday 17 June 2009 18.30 BST
- Article history
Two years ago, Gordon Brown used his last Mansion House speech to praise the City for its enterprise and verve. Labour's light-touch regulatory regime had, he boasted, created the right environment for London to become the world leader in financial services.
There will be a bit less of that sort of talk when Alistair Darling addresses the Square Mile's great and good tonight. We must learn the lessons of the past, the chancellor will insist. There must be no repetition of the behaviour that led to the most serious financial meltdown in living memory. Anyone who thinks we can carry on as before should think again.
In reality, though, the government is planning no more than a slap on the wrist for the discredited bankers. The message from London – and from the Obama administration in Washington today – is that the chance for radical overhaul has been ducked. The chancellor has made it clear he retains faith in the tripartite system of regulation that failed so badly in the run-up to the crisis and believes the first line of defence should be tougher scrutiny of banks by their own directors.
But, as Vince Cable noted today, it was self-regulation that got us into this mess and it would be madness to return to business as usual.
Obama has fallen into the same trap. The president has announced that the Federal Reserve, America's central bank, is to have a bigger role in supervision. That sounds tough but in fact creates the conditions for a classic conflict of interest. The running of the Federal Reserve in Washington reflects the views of the 12 regional reserve banks, each of which have nine-person boards, two-thirds of whom are elected by local banks. To be fair, bits of the Obama blueprint are welcome. He wants greater constraints on leverage and restrictions on securitised products; both are good ideas, but they do nothing to change the status quo.
So what's wrong with the softly-softly approach? First, this has been a financial crisis of extreme severity, with global economic ramifications. Second, it was not a one-off event, but instead the culmination of a period of speculative excess that spawned smaller, but still serious, financial upsets around the world in the preceeding years. Finally, the systemic weaknesses of de-regulated finance suggest that a failure to act decisively now to put financial capital back in its cage will lead to the problems of the past two years re-surfacing before long.
The past two years have seen a belated interest in the work of the US economist Hyman Minsky, who warned in the 1970s that left to its own devices the financial sector would move from stability to fragility, making the economy vulnerable to painful debt deflations. Unfortunately, Minsky's ideas do not seem to have penetrated the Treasury, either in the UK or the US.
Darling is right to say that lessons must be learned. The big lesson, though, is that we permit banks that are "too big to fail" at our peril. One of Roosevelt's first decisions in 1933 was to pass the Glass-Steagall act, which legally separated retail from investment banking. That could be achieved today either by taking the banks into public ownership, breaking them up and then returning them to the private sector. Or it could be done through a draconian use of capital requirements, which would make it prohibitively expensive for what are primarily retail banks to dabble in the more exotic financial instruments. But the chances of either happening look remote. Two years into the crisis, the carnage caused by the follies of finance is strewn around the global economy; taxpayers have bailed out the City and Wall Street; and the banks are even bigger than they were before. Never has there been a better moment to cut finance down to size.
Sadly, unforgivably, governments have bottled it.
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