Why the world of banking must go back to basics
Deregulation got us into the mess we are in today, says John Kay, a former director of the Halifax. We must ensure our high street banks never again.
In 1991, I became a director of what was then the Halifax Building Society. Economic conditions for mortgage lenders were worse than in the current credit crunch. House prices had fallen, interest rates reached 14 per cent and a recession left many households struggling to meet mortgage payments. The business sailed through with slightly lower profits. There was no threat to savers and investors, mortgage lending was maintained and no one even thought of seeking help from government.
In 1997, I voted for the biggest giveaway in the history of the world. Shares worth almost £20 billion were distributed to members when the building society converted to a public company. The bank subsequently merged with Bank of Scotland – I ceased to be a director in 2000 – and HBOS came into being. Last year, the business was taken over by Lloyds and the shares are now worth very little.
In retrospect, conversion – the transformation of the world’s largest and most successful mortgage lender into a failed bank – was a serious mistake. But what happened at Halifax was only a microcosm of what happened across the financial world. Deregulation and overdeveloped securities markets transformed specialist financial institutions into unwieldy conglomerates.
The credit crunch was not unforeseeable, nor was it an act of God. It was caused by US sub-prime mortgages only in the sense that the First World War was caused by the assassination of the Archduke Franz Ferdinand: these events were the trigger, not the cause. The underlying cause of the credit crunch is unsuccessful speculation by large banks in wholesale money markets. A casino – the banks’ trading activities – has been attached to a utility – the money transmission system that receives our salaries and pays our bills. The losses of the casino have threatened to bring the utility to a halt, and the global economy with it.
Banks, and building societies, used to take deposits and use the money to make loans. There was always a wholesale money market, because some banks were better at taking deposits and passed the excess on to others which were better at making loans. But the wholesale market grew to a size that dwarfed the underlying flows of cash from and to the customers of the banks. In the 1980s, banks increasingly securitised loans – they would sell packages of mortgages to other financial institutions. They would package and repackage these loans into ever more complex financial instruments. In the end, it became impossible to see what the underlying risks actually were.
In 2007, lenders began to question the value of the securities they held, and many of them became untradeable. If the value of the assets that banks held was uncertain, so was the value of the banks themselves. The credit crunch unfolded as fear and uncertainty spread from one asset category to another.
If the source of the problem is the association of the utility with the casino, there are two potential solutions: to regulate the activities of the casino to protect the utility, or to separate the utility from the casino. This week, Lord Turner and the Financial Services Authority (FSA) will make proposals for better regulation. But the notion that closer supervision will rein in the activities of global banks sufficiently to ensure that the events of the past two years can never recur is a fantasy.
We need instead to separate the utility from the casino. Financial conglomerates are a bad idea. Bad for customers, because they are riddled with conflicts of interest. Bad for their shareholders, and for those who work in them, because the organisations are victims of tension between the buccaneering culture of the investment bank and the bureaucratic processes of retail banking. Bad for taxpayers, because investment bankers can use the threat to retail banking to hold public authorities to ransom…
Canadian banks are not without their own conglomerate aspects.
Update: Some stats here from AIG, including the Bank of Montreal (oops, now Beemowe, a “Financial Group“; I think that may make some of the thrust of the above article). If you can make sense of the, er, data.
Via Norman’s Spectator.