Five Years after Lehman, Still Looking for Good Banking

Since 2008, “big finance” has been reaping profits again, but growth remains low. The sector remains an unstable factor for the economy. It is better to regulate it without bridling its inventiveness.

Among the many questions surrounding this still-new century, the one surrounding finance — its role, size and regulation — looms large. Five years after Lehman Brothers filed for bankruptcy, the government is still groping, and the results are not very satisfactory. The genie cannot go back into the bottle. Francois Hollande is not alone in stating this. Finance is still considered to be too big, opaque and sheepish, the mother of bubbles and crises, and in clear danger. Nevertheless, the knowledge that designs what could be “good” finance goes on.

The only real certainty was that the bailout of the banks in the aftermath of Sept. 15, 2008 was the right choice. Public opinion is mistaken in believing that “we gave billions to the bankers and nothing to laid-off workers.” Not saving the banks would have unleashed a depression — the financial crisis has been limited to a recession — and the money lent out to the financial sector has since been repaid at a profit. The U.S. aid program — Troubled Asset Relief Program — has spent $421 billion, a sum that has been recovered so far, according to statements made by the Treasury this week.

But beyond that negative argument of “avoiding the worst,” the dangers continue. Big finance has amassed huge profits, but healthy and robust economic growth is still not there. The sector, which remains fragile in large part, regularly leads to bad surprises like Cyprus. The more transparent official banking becomes, the more prosper opaque establishments of “shadow banking.” And we discover that the heart of the bailout mechanism, the central banking facilities, provoke volatility in credit and values in emerging countries and stymie their growth. Finance remains an intrinsic factor of instability for the world economy.

The first explanation put forward is the excessive timidity of governments — from Washington to London or Paris — swamped with lobbying from the super banks. The new regulations, deployed in three directions, are still too lax. Capital ratios — based on the height of reinforced capital loans — have tripled with the so-called Basel III standards. However, the banks are complaining, arguing that it is restricting their lending to businesses. This is not true for the well-managed banks — like BNP Paribas, whose total credit has gone up — but the argument carries weight with the authorities. The second axis is the separation of conventional banks and investment banks. Some laws are being developed but the air-tightness of the two sectors is far from certain because doubts persist on the utility and the feasibility of these laws. The last axis is building some lifeboats in case of another default. This policy of “resolution” can only be applied at the level of the European Union in Europe, but Germany is dragging its feet in front of a banking union that might make it cover a large part of the losses.

It must go faster and stronger, but the will for regulation comes up against game theory — competition between countries pushes governments to do less — and its internal contradiction: Too much regulation of official banks pushes them toward “shadow banking.”

The other explanation of the persistent dangers of finance comes from excess credit, its pro-cyclical speculative nature, its propensity to create bubbles. Can we limit this self-realizing euphoria of the markets that makes all the stakeholders act in the same way — from the high then brutally to the low? In a much-discussed intervention at the meeting of the central banks at the end of August in Jackson Hole, economist Hélène Rey of the London Business School emphasized the strength of the grand movements of flow in world capital — always together and in the same direction. She revealed that the cause is partially the dollar, the Federal Reserve’s policies of lax refinancing, which flood the entire world with inexpensive liquidities in flooding American “global” banks in order to save them. European banks, which refinance the Fed, again hand off the baton. This demonstrates how we remain in a dollar world five years after Lehman.

What to do? We must not wait for the Fed to become the world’s central bank, says Rey. We must stanch the pro-cyclical flows as much at the national level — which refers to tighter regulations — as at the international level, with the International Monetary Fund taking up the role of collector of good policies, even the role of the police. As the freedom of exchange — the swapping of currencies — is not a miracle solution described in the textbooks, a reassessment of the benefits of the free flow of capital must not be excluded. The IMF itself has recognized that control of exchanges is sometimes useful. “The authorities in charge of extremely prudent regulation have a crucial role to play in order to ensure financial stability,” continues Hélène Roy, and in a stronger and more flexible way than now, they must adopt policies that attack the sources of excess credit.

Will that be enough to put the genie back in the bottle? Of course not. Economists still have a lot of work to do to fully understand the practical realities of the financial world. The laissez-faire of orthodox liberalism is no longer an option, but it will still take a lot of research and experiments to engineer a system of finance that corresponds to the needs of the century — global but stable, inventive but useful.