“Breaking” the Banks
The FT runs an interesting piece today advocating a three-way split for financial institutions. Rather than the simpler two-way division between investment and commercial banking that many, including the Bank of England’s Mervyn King, have proposed, a three-way division would allow for the separation not just of the “casino” (investment banks, market makers) from the “utility” (commercial/ retail banks), but also from the “customers of the casino” (asset management).
By spinning off the asset management and proprietary trading component, the thinking goes, the investment banking sector would be subject to less risk (which means, ultimately, less risk for taxpayers) and would eliminate the potential for conflicts of interest that arise when a financial entity both makes a market and trades in that market. The asset management companies could then be cut loose to compete more directly and transparently with other firms of a similar type, like hedge funds and mutual funds.
Now, aside from the obvious fact that none of these constructive solutions seem to have a prayer of being seriously entertained by policymakers—either in the US or the UK or even in the European continent—it does raise the important question of just how much breaking up is too much? Should we then go a step further and separate trading desks that trade in equity markets from those that trade in bond markets? And then those trading investment-grade bonds from those trading junk bonds? How about separating banks that take deposits from firms from those that take deposits from individual people?
I’m not saying that any of these things is necessarily the logical extension of the three-way split proposed, but I am raising the question: what is the basic, fundamental standard that tells us when two activities should be separated and when they should not?
I absolutely think that at least a two-way split between depository institutions and riskier financial institutions is necessary. But beyond that, what is the proper operative standard? I don’t necessarily have all the answers. But unless we think critically and proactively at a philosophical or theoretical level, rather than respond reactively to the current circumstances, we can be guaranteed that in 10 or 20 years when new types of business practices have arisen and new types of financial instruments have been developed, we will be staring crisis in the face once again.
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For me, the issue starts with naming. Are we breaking up institutions in the “Financial sector” who have several aligned busniess lines? Or are we finally taking “Banking” out of the parts of the “Financial Sector” that it should never have been in, because depository based lending (which is what most people think of as “banking”) really shouldn’t be aligned with risk intensive investment management.
Once we answer that, then we’ll have something to discuss in terms of procedures and how to cleave the gourd, so to speak.
I would say that it is legitimate to lump together all of these activities as being part of the world of “finance,” and then we can broadly define finance as the field of managing and allocating wealth. This includes saving, investing, lending, borrowing, converting, exchanging and trading that wealth in various ways. In the same way we can talk broadly about the retail industry, which would include many types of goods and services that are sold directly to the end-using consumer.
that’s the question, inflation or deflation, right? I vote deflation. We’ve just seen the biggest inflation of our lifetimes, and the correction is consuming our phantom money supply for years to come. We should ask a Japanese suburban apartment owner who bought around ’90 to chime in and tell us the score, but, of course, we wouldn’t listen, because, this time, it’s different.