And then a young trader in the London branch of UBS (formerly known as Union Bank of Switzerland) suddenly goes walkabout and loses a cool $2 billion in 'unauthorized trades.'
I guess he didnt get the memo. You know, the one about responsible investing and the new spirit of self-regulation from the industry that is doing 'God's work,' according to Goldman Sachs. And they should know, cuz doesnt The Big Guy do his investment banking with them...
The point is that despite honeyed assurances from the senior financial poo-bahs, delivered with just a touch of menace so as to remind everyone of how desperate things might be if the last Euro-American core competence gets sold off to the Chinese, the banking sector remains largely unregulated. Its too-big-to-fail behemoths can not be effectively governed, even by stupendously compensated and presumably self-interested executives.
The UBS bankers may well lose their year end bonuses. Rest assured that the wires are humming this morning as they work to depart the sinking ship for other institutions who desire a whiff of their magic. The plot of the movie 'Contagion' comes to mind. Without sensible regulation and firm, coordinated global resistance, 2008 could repeat itself. Again. And Again. JL
Martin Wolf comments in the Financial Times:
Thank you, UBS. As a member of the UK’s Independent Commission on Banking, under Sir John Vickers, I could not have asked for a better illustration of the unregulatable risks to which investment banks are exposed than Thursday’s announcement of a loss of $2bn in “unauthorised trading”. No sane country can allow taxpayers to stand behind such risks.
That is the kernel of the case for ringfencing of retail banking from investment banking, recommended in the ICB’s final report. As John Kay argued on Wednesday: “Only if traditional retail banking is ringfenced can taxpayer guarantees be limited to personal and business depositors, and government funding of the banking system be directed to the needs of the businesses that create jobs and growth. That is the irrefutable case for the Vickers Commission recommendations.”
Needless to say, critics have also condemned the report as irrelevant, damaging, or toothless.
Ringfencing, it is stated, would not have prevented the failures of Northern Rock or Lehman. So what? These proposals have to be set in the context of ongoing changes in the rules on capital, loss-absorbing debt, liquidity, deposit insurance, resolution and settlement. Taken together, these would have both precluded such business models and facilitated orderly resolution.
Ringfencing is relevant, however, because it addresses what is now the biggest danger of all: rogue universal banks. In the FT’s round-table on the report this week, the finance director of RBS stated that: “If you look at who failed in the crisis it wasn’t the broad, universal banks – there’s a diversification benefit of having a full range of products and services [T]he ringfence will potentially cause a loss of some of those benefits. If this was really making the system safer and sounder, then why are the rating agencies putting the banks on notice of potential downgrade actions?”
In the real world, three universal banks failed – Citigroup, UBS and RBS itself. But they did not collapse, as Lehman did. This was only because policymakers did not dare to let them do so. They were “too big to fail”. If banks with combined balance sheets ten times those of Lehman had collapsed, we would now be in another great depression.
Again, the main reason why UK banks risk “potential downgrade” is that they might be resolved without taxpayer support. It is because the provision of retail banking cannot be interrupted without causing gigantic damage, while global universal banks are too complex to resolve swiftly, that taxpayers remain on the hook. This must end. The combination of the measures in the report, with steps taken elsewhere, will move us a long way in this direction, though yet more capital would help, as well.
Now turn to the view that the proposals are damaging. Much attention was attracted by the report’s estimate that the costs to banks might be £4bn-£7bn a year. But at least half of this (probably much more) is due to the withdrawal of implicit fiscal guarantees – or subsidies – principally from investment banking. Who argues that taxpayers should subsidise these activities? Some will bleat about “level playing fields”. My response is that if France wishes to put French taxpayers at risk, that is its folly. Again, some argue that the ringfence will damage the City. As the ICB’s Interim Report showed, the role of British banks in the City is quite modest. The City is an entrepot, not an arena for national champions.
A more significant, though mistaken, argument is that the higher costs imperil the economy. To this there are three answers. First, lending to business or even the domestic non-financial economy, is a small part of the banks’ balance sheets: subsidising the whole, in fond hope of favouring the part, is folly. Second, the connection between credit expansion and sustainable economic growth is, as we can all see, not close. Third, ringfencing will create entities that have to focus on the UK economy, as critics want.
The third line of objection is that these recommendations are toothless. I disagree. The ringfence is not a feeble compromise. It combines the benefits of separation with the benefits of a universal bank.
Full separation suffers from two objections. First, non-financial corporations need the services of both retail and investment banks. This makes a big overlap inevitable. Second, while diversification’s benefits can be exaggerated, the investment bank will sometimes rescue a failed retail bank. This advantage ought to be retained.
Three years ago on Thursday, Lehman collapsed. The lesson taken was that no systemically important bank should fail – one applied to the giant universal banks. That is intolerable. Banks must be able to lose vast sums and, if they still fail, be resolved smoothly. This is impossible for an internally undivided universal bank. The ringfence should transform this, so imposing market disciplines. That must be right.
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