Turner is right to reject Glass-Steagall

Allister Heath
TO my surprise, I found myself agreeing with a lot &ndash; though not all &ndash; of what Lord Turner, chairman of the Financial Services Authority (FSA), had to say to the Treasury Select Committee yesterday.<br /><br />He is right that it is impossible to impose maximum size limits on banks. He was also right that we shouldn&rsquo;t introduce a UK version of the now defunct Glass-Steagall Act, a US law that separated investment banking from retail and commercial banking. And he was right that banks that engage in riskier activities should hold more capital, though his view that big banks should automatically hold more capital than small banks (he called this a tax on size, presumably to pander to the Committee&rsquo;s prejudices) was less sound.<br /><br />Lets take all of these in turn. Northern Rock, Bradford and Bingley, the Dunfermline Building Society and other bailed-out lenders were very small. Yet they were deemed &ldquo;too big to fail&rdquo;, which means that even a banking industry populated with corporate midgets would still be in line for a bail-out next time things go wrong. Clearly, a belief that small is good makes no sense. Imagine how bad customer service would be if all banks were limited to, say, 100,000 customers. There would be no competition. The 100,001th customer would be turned down and the remainder treated like dirt. The City&rsquo;s competitiveness would also be destroyed.<br /><br />Next, Glass-Steagall. Not one of the bank bail-outs in the US, in the UK or anywhere else would have been prevented had an act of its kind been in place. There is a vast academic literature from economists including Eugene White of Rutgers, Randall Kroszner and Raghuram Rajan of the University of Chicago, and Carlos Ramirez and Alex Tabarrock of George Mason University. It shows that unified banking is safer and less prone to collapse than artificially segmented institutions. In an astonishing paper, Tabarrock actually argues that Glass-Steagall was the product of an epic attempt by the Rockefellers to raise the costs of their rivals, the House of Morgan. George J Benston of the University of Georgia is the author of the best overall book on the subject: anybody who still thinks the act was a good idea should read The Separation of Commercial and Investment Banking: The Glass-Steagall Act Revisited and Reconsidered (it is out of print, but Tabarrock&rsquo;s paper is at www.qjae.org/journals/qjae/pdf/qjae1_1_1.pdf).<br /><br />Banks need to hold greater capital than they did previously &ndash; and this capital should be much more liquid. It also makes sense for institutions that only engage in basic, bread and butter services to hold less capital, and for investment banks with large proprietary trading wings to hold more to absorb potential losses. But fairness is important. A small building society that lends vast amounts to the volatile commercial property market will be a much riskier proposition than a well-managed investment bank that doesnot engage in highly-leveraged proprietary trading. And even most prop traders posed less of a systemic risk than the average stodgy lender.<br /><br />The other good news is that while Turner will look at remuneration structures at banks, he will not regulate the level of pay. For all his populist language, yesterday&rsquo;s remarks were surprisingly thoughtful. And that, for a change, is surprisingly good news.<br /><br />allister.heath@cityam.com