by Jerome a Paris
Wed Nov 28th, 2007 at 06:52:31 AM EST
Now that it's probably too late for this (massive) round of excessive risk taking by banks, Martin Wolf asks the right questions about how to deal with banks:
Why does banking generate such turmoil, with the crisis over securitised lending the latest example? Why is the industry so profitable? Why are the people it employs so well paid? The answer to these three questions is the same: banking takes high risks. But the public sector subsidises this risk-taking. It does so because banks provide a utility. What the banks give in return, however, is gung-ho speculation.
Either the banking industry should be treated as a utility, with regulated returns, or it should be viewed as a profit-seeking industry that operates in accordance with the laws of the market, including, if necessary, mass bankruptcies. Since we cannot accept the latter, I suspect we will be forced to move towards the former. Little can be done now. But when the recovery begins, we must impose higher capital requirements.
Banks play strategic functions in our economies, and thus cannot be allowed to fail. Knowing this, they take more risks than they would otherwise (to earn more when things go well, with the certainty to minimize losses when things go wrong). Governments do know that, and do try to regulate banks, but given the potential gains, banks employ legions of smart people dedicated to finding loopholes in the regulation of the day - and who get rewarded handsomely to do so.
Aswe know, there is no morality in business. Whatever you can get away with is good - and in banking when you get to keep a good chunk of it, you do whatever it takes...
The New Deal found a solution with unsubtle, strict regulation (notably separating commercial and retail banking from investment banking). These limits have been taken down in the past 20 years, in the name of "efficiency", and at the obvious cost of resiliency - and at the expense of citizens and taxpayers. They need to be brought back in. Increasing capital requirements is just one small part of it.