“We don’t want to change and we’re not going to,” it says. “You lot can try but we’re not budging till we have to. And we know you haven’t got the energy to shift us.”
The big beasts of Wall Street are probably right. Nothing in the response to the financial crisis so far suggests the political establishment will have the guts and drive to reform finance in a way that really bites.
But Senator Blanche Lincoln at least tried – for all the good it did her. The Obama administration, Treasury and others have left her to hang in the wind.
Why? Lincoln’s proposal to make banks house their derivatives dealing desks in separately capitalised entities is modest enough. Like the Volcker Rule, it is a step in the right direction, though it falls a long way short of the revived Glass-Steagall Act that is really needed in the US – and other countries.
The Lincoln plan even echoes the derivative product companies that Wall Street banks themselves set up in the 1990s to enable them to deal in derivatives with triple-A counterparty ratings.
What real arguments are there against Lincoln’s idea, other than that it does not go far enough?
It might be a hassle for the banks to implement – but weigh that against the taxpayer’s right to know it will not have to bail out derivative risks. And banks are remarkably good at setting up new entities and moving things from one balance sheet to another – when it suits them. Plenty of underemployed structured finance bankers would relish the job.
We are told the Lincoln proposal would impair banks’ ability to manage their risks. Not at all. The banks’ treasury departments should anyway have a customer-supplier relationship with their own derivative dealing desks.
Are we supposed to believe that large retail banks that do not have an in-house investment bank are incapable of managing interest rate or other risks? Of course not – they can buy these services from an investment bank. All deposit-taking banks should have to do the same.
The truth is that investment bankers have lost their bottle, as they say in England. They’ve lost the stomach for the fight. The commercial fight, that is – they still have plenty of appetite for political lobbying.
For much of the past 15 years, investment bankers in many firms have complained about being shackled to lumbering commercial banks. These boring, old-fashioned institutions, they moaned, just didn’t get it – didn’t understand shareholder value, or why investment bankers needed to take so much risk, or get paid so much.
In the past two years, the wind has changed. The cold blast of risk has made the investment bankers awfully grateful to be inside nice, warm commercial banks that the state has to protect – rather than at Bear Stearns or Lehman Brothers.
So they are going to cling on for dear life to those double-A rated balance sheets and that implicit state support.
The irony is that if the commercial and investment banking sectors were separated again, as they should be – and as they were during the most successful periods for the US and UK economies, not to mention those of other developed countries – the financial markets bankers would be much happier.
Rehoused in a new sector of smaller, much more competitive investment banks-slash-hedge funds, they would soon remember how much they enjoyed the competitive life, the unfettered profit motive, the thrill of risk.
Many who have made the shift to boutiques already, such as in the European bond business, are loving it. And how many people do you know who’ve left a successful hedge fund to return to banking?
However, this is just a dream. Back in the real world, the banks have shepherded politicians and the media into the easy option of moderate reform that leaves the banks bigger and more protected than ever.
Hence the grinding noises greeting the Dodd Lincoln financial reform bill. Another part they’re groaning about is the requirement for more OTC derivatives to be cleared and traded on exchanges.
There may be bespoke contracts for which publishing pricing would be impractical. But it’s also certain that a great many things could be exchange-traded with a proper price quotation system that aren’t at the moment. Bonds of all kinds, interest rate and currency swaps, CDS… these are nearly always standard products.
And as for clearing, it is simply a more orderly form of risk management. The banks and companies say “if we had to collateralise that, we wouldn’t be able to afford to do it”.
But that means the trades are going on at the moment, with a less stringent form of collateralisation. Who is taking the extra risk? The banks.
Since the banks are willing to bear this risk, why could they not simply lend money to their corporate customers to finance the margins required by a clearing house?
These loans would be clearly documented and separate from other finance, so that they could be quantified.
What would be gained? An exacting, independent eye would be cast over every transaction and its risk assessed. Transparency would be shed on the banks’ real exposures to derivatives and their customers – things that are hidden at present.
And no transaction that is economically viable at present would be prevented by the new, more stringent system. Yes, we can.