MSE News: Chancellor to back "ring-fenced" banks

Former_MSE_Helen

This is the discussion thread for the following MSE News Story:

" The Chancellor is today expected to approve a shake-up to make high street banks safer in a bid to protect taxpayers ..."

Read the full story:
Chancellor to back "ring-fenced" banks

Consumerist

It's not clear to me how this segregation of operations will help protect bank customers. Was it not sub-prime mortgages (i.e. retail banking) wrapped up in parcels with other investments (sources not clear) that led to the crisis when borrowers could not meet payments?

Perhaps someone could explain how the proposed "ring fencing" is going to help when all that should have been needed was prudent lending by the retail arms of banks.

talexuser

As far as I can make out, the bubble of bad debt was analogous to the crash of 29 in that it put at risk the retail side of the banks with our savings, and salary payments.

After that crash the Yanks put in the Glass Steagall act which protected the retail banks from speculation losses of the investment side.

This worked very well for 60 years until Bill Clinton, carrying on the de-regulation of the Reagan/Thatcher era under pressure from the mega-rich got rid of it.

Now we find ourselves bailing out the banks again. So bringing something back of the same ilk THAT ACTUALLY WORKS seems a pretty good idea.

coppertiger

The chancellor's plans for reform cannot come a moment too soon. However, it should be borne in mind that it was not lack of debt ringfencing that caused the economic collapse, but the exposure to debt.
As an example take the situation with Europe's ongoing consolidated annual debt position - currently 72% of EGDP (European Gross Domestic Product) - historically it has bounced around for the last ten years between 63% and 74%. Debt in itself is only a problem when the underlying collateral or access to it dries up.
When Gordon Brown decided on a route of fiscal stimulus through Quantative Easing (method tried by Japan 20 years ago which also failed) all he was doing was injecting cash to replace the vacuum left by repayments on subprime investments drying up.
The debt exposure is still there, and until September this year by which time reconsolidation proposals have to be finalised by major financial institutions who have exposure to the debt, the debt will still be there going into the following financial year.
This is why economic growth figures (for government at least) are so important, because they indicate the likely repayment of the collateralised debt obligations.
Ringfencing anything is of little value whilst rules governing exposure to debt by investment banks have no strength. High street banks also expose to investment risks, through their borrowing and investment strategies with the general public and business. And that is one of the key issues that George Osborne has to investigate more closely.
Suffice to say, there is not room to go into the details here, but most companies are allowed to offset part of their balance sheet liabiliies through a form of swaps (derivatives). Most often used when capital expenditure on large scale is required. Banks (high street) initially supply the funding, with the swaps done to limit interest rate exposure during the repayment term.
That is a problem that ringfencing will not solve, since if the firm hits financial difficulties the bank will then be in competition for repayment with any other creditors the company has done business with.
The whole system, in short, is a total mess. The only way to solve it in the short term is to introduce financial laws (similar to the Glass-Steagal) that effectively "limit" exposures to underlying debt.
Bottom line - do not borrow (much). build up your balance sheet and pay for what you can afford. Businesses (including banks of any flavour), and governments need to get this concept of affordability firmly fixed in their mindsets.
Limiting exposures through prudent fiscal management is the only way any organisation (or government) will ever solve problems associated with indebtedness.
Investment banks too have the ability to reduce exposures through how much they are allowed to risk of investments to them. If for instance they had to hold (as an example) 50% of turnover in low risk investments such as bonds and long term stocks of top performing companies. 25% in medium risks, such as emerging countries and stable commodities with strong growth trends, and finally only 25% of investment in the high risk areas of derivative and exchange type investment (of which consolidated debt obligations are a part of).
Limiting exposures through exposure management is the best way of protecting the bulk of a business of any flavour. Ringfencing will not solve anything long term, all it will succeed in doing is delaying the ineviatable result of over-exposure to high losses.
One thing that is always overlooked is the fact that in poorly performing economies, the general public becomes a debt risk themselves - and if the high street banks are ringfenced from support avenues - who will then rescue the banks when customers are exposed to a poor economy.
In our present climate that is something well worth thinking about since markets always bounce quicker than economies.

pqrdef

As I understand it, the theory (Mervyn's theory anyway) is that bankers and their shareholders will be more prudent in their investments if they don't have the thought in their heads that they've got the government over a barrel.

But involvement in retail banking isn't the only reason to have to bail out a bank. There's also (as Mervyn has repeatedly said) the too-big-to-fail syndrome - the scenario where an investment bank can't be allowed to go to the wall because of the damage that would be caused.

However, the megabanks seem to have fought off the threat of being broken up. Too-big-to-fail is still here and the government is still over the barrel. So this ring-fencing looks like a smoke-screen to divert attention. Everybody will claim that the banks have been reformed, and Mervyn will show his gratitude for his gong by shutting up.

And don't be too surprised if we start hearing that ring-fenced retail banking is terribly unprofitable and they've really got to charge fees for current accounts.

talexuser

pqrdef wrote: »

And don't be too surprised if we start hearing that ring-fenced retail banking is terribly unprofitable and they've really got to charge fees for current accounts.

Yes, I think that is likely. For the forseeable future I think everyone should spit on the floor whenever the bank bosses are mentioned and remember forever the mess they created for the rest of us while walking away from their failures with rich tax payer rewards.

Reaper

It seems a futile exercise to me. It is often said that letting the investment bank Lehmans go under was a mistake that made the crisis worse.

If the lesson governments have taken away is that investment banks need to be saved as well as retail banks then any kind of division between the two is pointless.

talexuser

Depends who's saying that that letting Lehmans go under was a mistake! Maybe the same people saying de-regulation was a great idea because management are so clever that they would only ever increase the wealth of their shareholders and unnecessary rules got in the way?

I couldn't care less if Lehmans or others go under as long as the rest of the system continues to work and and the rest of us don't have to pay for it again in years of manipulated inflation and reduced public services.

Reaper

talexuser wrote: »

I couldn't care less if Lehmans or others go under as long as the rest of the system continues to work

The problem is that it might not. It is felt that it had a domino effect making other banks go under. Banks stopped lending to each other, investors panicked and tried to withdraw, and the very next day the enourmous AIG ($1 trillion assests) teetered on the edge and only a huge bailout saved it.

Not everybody accepts it was a mistake, but it is a widespread view. Here is a typical article discussing it plucked from Google:
http://www.politicsdaily.com/2009/09/15/biggest-mistake-of-the-financial-crisis-lehman-bros-bankruptcy/

Consumerist

pqrdef wrote: »

And don't be too surprised if we start hearing that ring-fenced retail banking is terribly unprofitable and they've really got to charge fees for current accounts.

Wake up for heaven's sake.

The banks already charge for banking; it's just that the less fortunate minority are paying those charges. That minority is already increasing in proportion and will probably continue to increase over the coming months until the banks will be forced to share the load anyway. This will then be hailed as the end of "free banking"

talexuser

Reaper wrote: »

Here is a typical article discussing it plucked from Google:
http://www.politicsdaily.com/2009/09/15/biggest-mistake-of-the-financial-crisis-lehman-bros-bankruptcy/

Huffington is a typical right wing neo conservative propagandist. I would expect such arguments from the mega rich who benefit from the staus quo and effectively want to gamble and pocket when winning and get compensated by the taxpayer when losing. Talk about mega benefit scroungers!