Bank shares have nose-dived since President Barack Obama announced Thursday that he was going to shake up the US financial system. He wants to force banks to divest those parts of their business that are not the core of their lending operations, that speculated on their own account. It was such “casino activities,” says the White House, that underpinned the market madness that led the global financial system to the brink of total collapse.
From now on, promised the president, there would be no such thing as a bank that was “too big to fail”. Never again would US taxpayers have to prop up ailing financial institutions. Depositors on Main Street would remain protected but in future a bank that ran into trouble would be allowed to go the wall.
Two events appear to have triggered Obama’s tough talk. The first was this week’s Democrat drubbing in the contest for the late Sen. Edward Kennedy’s Massachusetts seat. This would seem to have thrown the president’s hard-fought health reforms into considerable doubt now that the Democrats have lost their senate majority. The second is that Wall Street bankers give every sign of returning to the excessive bonus culture that encouraged the generation of unacceptable risk.
Banks that were either bailed out directly by the US government or protected in the short-term by its asset guarantee program, have been making big profits again. This has a lot to do with the way in which the Federal Reserve has been pumping liquidity into the system. Initially designed to keep banks solvent, the longer aim was to prime the credit market so banks would restart lending to hard-pressed businesses. This has not, however, happened. Faced with increased capital adequacy ratios, financial institutions have chosen rather to rebuild their balance sheets while using cheap government money to resume speculating on their own account.
Obama’s proposed reforms have much about them of the 1933 Glass-Steagall act which besides introducing deposit insurance also forbad Main Street banks from running brokering and investment banking activities. Years of lobbying saw the law done away with in 1999. That move, argue economists, prepared the way for the 2008 debacle. The president can expect another hard-fought battle in Congress. It will, however, be hard for Republicans to defend a banking system that has palpably failed. The administration will be hoping to push them onto a back foot.
The mystery, however, is why Obama did not make this announcement earlier. For a start, the Democrats might just have held Massachusetts. Also cracking down on big banking cannot involve US institutions alone. There needs to be international consensus on how the financial system needs to be reordered in a prudential manner. It is far from clear that the administration has yet set about seeking to create such agreement. The British government, for one, was clearly surprised at the Obama announcement. It has itself imposed a one-off tax on bank bonuses. Big banking already leaps jurisdictions whenever it suits. What is needed is a fundamental change with international coordination.
