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New rules would be bad for London

Allister Heath
HOW predictable. No sooner was Barack Obama humiliated by the Massachusetts electorate earlier this week – his left-wing candidate lost Ted Kennedy’s ultra safe seat to a radical conservative – than he announces another war on Wall Street. It is easy to forget in Britain, where Obama remains extraordinarily popular, that his administration is no longer loved in the US.

But one attitude the UK and US public have in common is their hatred of the entire financial services industry (even though its taxes fund such a large chunk of the welfare state and it employs so many people). The Tories endorsed Obama’s attack; virtually every media outlet will follow suit.

So what does Obama actually want? Banks with deposits (all the big firms) will be banned from trading on their own account (though will still be able to take positions on behalf of clients). They will be barred from “owning, investing in or sponsoring” hedge funds and private equity groups. No bank can have more than 10 per cent of total deposits; this would be extended to other assets too.

But wait a minute. Was the financial crisis due to the fact that some banks own private equity firms? No. Would Lehman have been saved by the restriction on size or any other of the proposals? No. Just one firm, Bear Stearns, a pure investment bank which would not therefore be covered by the new rules, was destroyed because of its ownership of a hedge fund which invested in sub-prime mortgages. Would any of these rules have protected

Northern Rock or HBOS? No. Did the losses racked up by the state-sponsored Fannie Mae and Freddie Mac mortgage giants have anything to do with prop trading or hedge funds? No – and neither did the failure of Wachovia, Washington Mutual, Countrywide or the over 100 US banks and many others around that world that have gone bust.

In truth, banking losses were caused by bad property loans – and the purchase of this sub-prime debt by other banks and funds in the belief that they were safe. Wall Street was crippled because it was so leveraged and didn’t hold enough high quality, truly liquid capital. AIG insured packages of sub-prime debt through credit default swaps but didn’t set capital aside in case things went wrong.

Obama’s pseudo-remedies completely miss the point. They won’t save capitalism but will make it less efficient. All the activities that go on today will still take place, albeit not within the same firms and not necessarily in the same countries. Goldman and Morgan Stanley may return to their old, pre-2008 status as pure investment banks; others may lose a chunk of their revenues. Many hedge funds, private equity firms, trading houses and smaller banks will be delighted: if the big firms are crippled, the smaller players may win.

Yet the rules would damage London even more than New York, especially if the Tories impose them here. Hedgies may find it harder to raise finance. Barclays may decide to split; if so, its investment banking division would probably relocate to the US. HSBC will retrench to Asia. RBS’ investment bank may be snapped up by an overseas player. Trading and hedge funds will move to other locations.
Big banks must no longer feel they are too big to fail. The way to change this is to follow’s Obama’s original strategy and find ways to allow big firms to go bust in an orderly way. Oh, I forgot: being sensible doesn’t win elections.

allister.heath@cityam.com