WE are about to enter the third stage of governments’ response to the credit crunch: first there was the firefighting, then the so-called stimulus packages and now comes the regulatory crackdown. There has to date been much pontificating but very little actual reform of the rules governing the global financial system. Banks have been nationalised left, right and centre, sure, and regulators have forced financial institutions to hike their capital reserves, but that has largely been it. Many of the other changes – such as bonuses based on long-term wealth creation, rather than short-term gains, of the sort introduced by the likes of UBS – are welcome, but have largely come about through fear of a change in the law.
This lack of actual regulatory reform is about to end, for better and for worse. Some of the new practices (such as longer-term compensation, the eradication of off-balance sheet vehicles and more liquid capital reserves) will be highly beneficial; others will be worse than useless. Brussels is gearing up for a destructive and counter-productive onslaught, no surprise given that it understands global finance even less than those who thought that sub-prime debt was as safe as gilts. The EU’s early proposals fail to understand how hedge funds and other alternative investment funds operate; if Brussels gets its way, the City will face its very own Sarbanes-Oxley, a disastrous set of rules that miss the point, do nothing to reduce the risk of scandal and send hedge fund managers scuttling to Switzerland, Dubai and Singapore.
In the US, Barack Obama is about to outline a mixed bag of proposals, which are likely to include forcing banks that securitise an asset to retain 5 per cent of the risk. This is a mistake: securitisation per se is not the problem, it was the way it was conducted, the incorrect assumptions involved and the cluster of intellectual errors underpinning many of the products and models used to value them that was the issue. Other reforms likely to be unveiled tomorrow include giving the Fed more powers to oversee top firms; granting the government the right to take control and break-up in an “orderly” way troubled financial companies deemed too big to fail; and setting up a regulator for consumer financial products. Most of these reforms go the wrong way, enshrining into law the bail-out culture of the past 18 months, rewarding those like the Fed that are most responsible for the crisis and doing nothing to reintroduce the fear of failure into Wall Street boardrooms and consumers. All of which is bad; but lets await the final proposals to pass judgment.
There remains much talk of a return to a Glass-Steagall-style separation of investment and retail and commercial banking. Fortunately, that is not a route that the present UK government wants to go down; and in the US, firms such as Goldman Sachs were last year told to become bank holding companies, consigning the last remaining Glass-Steagall separation to history. But this doesn’t mean the idea has gone away, not least in the Tory party, which should know better. Such a reform would not have prevented the demise of Lehman Brothers, AIG, HBOS, Northern Rock or Bradford & Bingley; it would have done nothing to avoid the sub-prime contagion. Given how much needs changing in the City, it is bizarre so many intelligent people are fixating on such a useless policy.