Thursday, 27 February 2014

Saving the City from Itself: a UK-Style Glass-Steagall Act?

This brings us to the salary question for the class of banks that want to be buccaneering when things are good, and yet need to be bailed out when things go wrong. The old saw of "too big to fail". The clearing banks until recent times  were notoriously parsimonious with their salaries and those chaps crossing London Bridge were wearing their one bowler hat that they had bought 15 years before. They had two suits if lucky.

The first cracks came in the 1970s as forex took off and the banks had to start paying their traders markets rates to not have their star traders poached. But poached they were. Then their money market dealers were poached. Then at Big Bang in came equity market makers and corporate finance people who were all paid a pretty penny. The days of banks matching the Civil Service in a race to the bottom on compensation were long gone. 

So what are we proposing here....? in the first instance it has been shown by events post-2008 that banks both in the US and here will do whatever they can to resist restructuring their businesses to remove the risks that caused the problem in the first place. Even in the US banks were cheating in the 1980s to get around Glass Steagall which was not repealed until 1999.

So what was this legislation and what is its pertinence? The Glass Steagall Act was an act the U.S. Congress passed in 1933 as the Banking Act, which prohibited commercial banks from participating in the investment banking business. The Glass-Steagall Act was sponsored by Senator Carter Glass, a former Treasury secretary, and Senator Henry Steagall, a member of the House of Representatives and chairman of the House Banking and Currency Committee. The Act was passed as an emergency measure to counter the failure of almost 5,000 banks during the Great Depression. 

The Glass-Steagall Act's primary objectives were twofold – to stop the unprecedented run on banks and restore public confidence in the U.S. banking system; and to sever the linkages between commercial and investment banking that were believed to have been responsible for the 1929 market crash. The rationale for seeking the separation was the conflict of interest that arose when banks were engaged in both commercial and investment banking, and the tendency of such banks to engage in excessively speculative activity.

What if the UK was to introduce a Glass Steagall Act of its own? The purpose would be to remove the risk factor associated with the types of activities that investment banks have been carrying on that led to the 2008 debacle. Forcing the clearing banks to exit this space would be a first step. As a side effect the salary profile of the clearing banks would change as the high-flying earners of the trading desks and other investment bankerish activities would be removed from the clearing banks' books which would significantly lower the temperature of the dialogue about salaries. 

We could speculate endlessly about what the publicly-guaranteed banks could be allowed to keep doing but the nub of the matter would be separation of commercial banks from  investment banking activities. What might these activities be? Well, I am reminded of the US Supreme Court Justice Potter Stewart when defining the litmus test for pornography and made the classic comment that "I can't define porn, but I know it when I see it". Therefore investment banking activities likewise are frequently self-evident. Once upon a time though it was easy to define these activities as being those that involved exchange-traded securities such as those negotiated on the London Stock Exchange, LIFFE or the LME. These were the least of the problems in 2008. It was the non-exchange traded ethereal, indeed nebulous instruments (frequently derivatives) in a quasi-banking sphere like mortgages that was the Achilles Heel of the system, further complicated by the use of off-balance instruments that eluded the prying eyes of outsiders (and internal risk assessors).  

Frankly there aren't that many clearing banks so such a law's catchment area is easy to define. Lloyds has never had much urge to play in these markets, RBS has largely blown itself up and the accretions from RBS and NatWest's glory days are currently being shed (though that does not mean if not legislated against they would not get back into the sandbox again if they thought they could get away with it). Barclays and HSBC are the two banks that are most effected by a superimposed split of these activities. But why couldn't these two banks demerge their investment banking arms into separately capitalised national "champions" that would fill the gap left yawningly wide by the demise of the Warburgs, Barings and Kleinworts of yore.. (well not so yore as it seems). 

The question here is what would be the effect of enforcing a split upon UK banks, removing their investment bank divisions' prime source of succour (the "too big to fail" guarantee implicit from being joined at the hip with a clearing bank). What can be done to ensure the survival and prosperity of two of the best capitalised local team members left to compete on an uneven playing field created in the image of the bĂȘtes noires, the US investment banks (for several of which I have worked in the past) with their seeming free rein in the regulatory Freistadt of Canary Wharf? Clearly not... but that then leads us on to the subject of a further post in which we look at how a most productive capital markets sector for the investing populace and the British economy can be put together side-by-side with an international financial hub. It may seem a Solomonic task to create a nation-serving capital market. It has been a bugbear of non-City types and politicians for hundreds of years.  However it is not, in my opinion, insuperable. 

1 comment:

  1. The intraday trading is carried on daily basis thus it is necessary to trade appropriately in this market for Stock trading tips.