Glass and Steagall

I’m pleased that all of my whining about bringing  back Glass-Steagall or some variant thereof has had an impact on the Bank of England. No less a light than Mervyn King, the governor of the bank, has takes up the cause.

The Guardian.co.uk reports that at a dinner last night he offered these opinions:

Serving notice that banks would in future be able to expand much less quickly than in the past, he added: “The introduction of simple and robust policy tools into a regulatory regime based on the exercise of constrained discretion would make it easier to resist overly rapid expansion of financial institutions.”

He also asked whether there was a need for a law such as that passed in the US in the Great Depression – the Glass-Steagall Act – that separated retail and investment banking as well as setting up the Federal Deposit Insurance Corporation to guarantee savers’ deposits. “Should there be a Glass-Steagall type of provision to prevent retail deposits from being used to fund investment banking activities?

“There are good arguments in favour – to separate the utility functions of a retail bank taking household deposits and running the payments system from the casino trading of an investment bank, and good arguments against – the difficulty of maintaining a credible boundary between those institutions that are eligible to receive government support and those that are not.”

It’s nice to have company.

Perhaps one of the lessons of AIG might be that we cannot afford too big to fail. In fact, we get caught in a vice of too big to fail and too big to save. We cannot afford to let the bankrupt go down for fear of collapsing the terminally ill system and we have not the resources to save the system so we are committed to nursing it along on the hope that it cures itself.

This makes no sense and we need to unburden ourselves. Moreover, we need the “casino trading” of investment banks. They are the incubator of financial innovation and risk that is vital to a free market. We just can’t abide it in a form that threatens any other than the shareholders should one of its participants err. By the same token, big banks can serve to marshall the mass of funding that a large nation needs as well as serve as a gateway for the financial innovation from the investment banking sector.

Our current financial structure is a highly complex structure. Minor failures can cause complex systems to fail catastrophically. Human oversight will not prevent this from occurring. We need to simplify.