Regulation madness won’t stop the next crisis
“Now we’re all socialists,” Newsweek magazine proclaimed in its coverage of the Euro-7, the major summit meeting of Europe’s economic powers this past weekend. The message from the summit was that predator capitalism was being replaced by kitty cat capitalism – complete control of global financial markets. Part two was the substitute for meaningful action: punishing tax havens, as if Switzerland were responsible for the global economic crisis.
Hangovers may produce the best intentions, but it’s not easy thinking clearly with a splitting headache. Is this really a crisis of regulation? In the United States, every bank is monitored by eight separate agencies. In Germany, it’s the state banks (from the Bremer Landesbank to the KfW Banking Group) that are among the most stupid speculators. But the matter goes further than that.
How is a regulator supposed to know which new financial instrument (let’s say for example the “Gilt-edged Solar Secure Sustainability Certificate”) is really necessary or frivolous? How does a young cabinet under-secretary justify prescribing its operations to a Mr. Ackermann? (Trans. Note: Josef Ackermann is the Swiss-born CEO of Deutsche Bank). Not even a Chairman of the Board has this sort of knowledge nor does he have the authority to do so. How else was Hypo Real Estate able to put 600 billion Euros worth of red ink on its balance sheets? (Trans. Note: Hypo is a Munich-based real estate holding company comprised of several mortgage banks).
Ten regulators in every boardroom is not the answer. The real problem, as described by British economist John Kay, was the wondrous transformation of the modern bank into a utility company with an online gambling casino attached. Since the year 1500, we’ve seen the bank as a provider. It borrows money in the short term and loans it in the long term. It takes our deposits and dispenses it – well insured – as loans and mortgages.
The gambling casino was located, so to say, one floor beneath the teller’s cages. The people down there literally gambled with people’s deposits. With one Euro of their own money, they bought 100 Euros worth of paper and began shoving it back and forth between banks – always with a handsome markup attached. “They forced garbage on each other,” wrote Kay.
A plan to increase oversight of the roulette wheel won’t get rid of the game; that’s why the gambling casino has to be thrown out of the bank. Let banks again engage in the boring business of making profits on the margin between interest they pay on savings accounts and the interest they charge on loans, with minimum reserve requirements to ensure the loans won’t grow out of control. That’s how it was just after the crash of 1929 in the United States under the Glass-Stegall Act. The investment bank’s vaults were hermetically sealed into the 1990s. The major bubbles of 2000 and 2008 didn’t burst until after the Act was abolished.
The separation between the bank and the casino has to be reestablished after this crash so the gamblers who dream of becoming financial acrobats know from the outset that deposits to Citi- and Commerzinvest banks aren’t insured by the taxpayer, and that they can no longer force the bank’s depositors to accept high-risk paper cobbled together with a magic wand in the basement. And the financial sector that made the kids with Harvard MBAs so wealthy in New York and Frankfurt? It will shrink, but to the benefit of mankind because there’ll be far fewer MBAs in the future and more engineers and software geniuses.
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