Mervyn King

When it comes to bank reform the Obama administration has constantly rejected any action that might be construed as radical. This is despite the radical nature of the problem. The crisis last year exposed to all of us just how vulnerable the entire economy is to the peculiar and often predatory activities of the country’s largest banks. That these banks screwed up royally is beyond dispute. That they contrived through their collective incompetence to sink the world economy into such a deep recession that many of us feared a repeat of the 1930’s is also beyond dispute. That they destroyed trillions of dollars of wealth – both for their shareholders and for those unfortunate enough to exist within their orbit – is unequivocally one of the worst examples of disastrous management in history. All these things have had enormous and ongoing ramifications: the cost to us all is almost incalculable and will reverberate for a generation at least.

The implosion was epic.

It called for radical reaction.

“When three current, or former, chief central bankers all agree I think we should take notice.”

But all we have seen is deference and an almost supine attitude towards the banks. Every time a radical solution has been proffered it has been set aside politely as potentially ‘destabilizing’ for those precious financial markets whom we dare not ruffle. Poor things, these bankers have sensitive feelings and might get scared if we thrash them the way they deserve it.

Remember the call for nationalization? It was set aside as being ‘un-American’; as being too radical; as being … well, upsetting. Upsetting for whom? The little dears who run the banks and their shareholders. Those nice folks on the trading desks who funnel all that money into their bonus pools.

So instead of surgery we were given something roughly equivalent to the old ‘take an aspirin and see me in the morning’ routine. We, or rather those in power, did as little as they could.

First they slowed down the conversation and avoided anything that could disturb the bankers whose jitters were charted daily in all the financial media. We all started to speak more softly and in more understanding tones about the vast complexity of finance and banking – all that sea of toxic waste was misunderstood. It wasn’t toxic if you looked at it correctly. We, on the outside, simply were not in the position to make snap judgements about the value of those CDS’s, CDO’s, MBS’s and the other denizens of the alphabet soup down on Wall Street. So we were told by the likes of Tim Geithner. As he tried to calm down the firestorm of anger we discovered not only that our best and brightest bankers were dumb as all hell, but that they seemed to think we would pay for their trillion dollar errors without exacting a reciprocal cost. Which we did. Urged on by the likes of Geithner, Summers and the other ‘experts’ who ran in fear of the industry’s woes.

The next ploy, after the soothing talk, was to institute that famous set of ‘stress tests’ to evaluate the soundness of the top banks. That the tests were rigged in favor of the banks is obvious when we examine the measures of economic distress used. What is less known is that the regulators who administered the tests had little hope of getting enough support, time, or information from the banks to make the tests anything but a flimsy cover for a pre-determined fix. There was no way that those tests would have produced a result that could have fueled the call for nationalization, or even any other form of milder intervention.

Instead we forked over gobs of cash at favorable rates to plug the gaps that the banker’s incompetence had blown throughout their various balance sheets.

Then we all sat and watched while the Federal Reserve Board and the Treasury department contrived to flood the economy with enough cash – liquidity in banker speak – to float the universe. We all gamely pretended that this cash would end up as loans to regular folks who, after all, were the ones providing it. But those of us who understand a little more knew that would never happen: the banks were always going to hoard the cash. They’re scared, and frightened people tend to sit on safe piles of cash. So no sooner had the Fed doled the cash out than the banks stuffed it straight under the mattress – or their equivalent, which is the Fed’s own vault. So much for stimulating lending.

Then we had to endure the recriminations and faux effrontery as AIG traders were paid extortionate bonuses not to leave the business they had ruined and then handed over to us to bail out.

After that came a round of accounting ruses designed to help the poor banks report profits even though there were none. Along with that came other accounting changes to turn preferred stock into equity – which is simply re-branding one form of capital and calling it something else, as if semantics were a way of injecting cash. We were led to believe that this ruse suddenly implied the banks were well capitalized. Believe it if you wish. I don’t. But even better: test it for yourself. Apply semantics to your next bank statement. Talk to it. If you urge it hard enough perhaps you can put a lot of zeros after all those ones you see. Nonsense. From where I come from adding cash usually requires some to be handed over, not simply to change the name of what’s there already.

But that only serves to show how little I know.

All the while this tinkering was going on we watched as the Fed held interest rates so low they scarcely register on anyone’s scale. That’s good for us, but it’s better for the banks who have to borrow: it helps them make profits. And that’s what the administration was hoping would happen.

You see, the strategy all along has been to buy time. Do nothing radical, and buy time. Time heals, as we all know. As long as the taxpayer safety net was in place the banks could earn, or as I just suggested rig, profits and thus replace the capital they had blown on the gambling schemes that had threatened to sink them.

That’s what happened – banks started to report profits and the administration breathed a great sigh of relief. It had managed to avoid doing anything disruptive. The great financial markets started to repair themselves and by the late summer we had all begun to forget those calls for reform that had seemed so urgent late last year and early this.

Were the banks grateful for being left untouched?

Not one bit.

First they started to resist, mightily, the administration’s one real reform: the introduction of a consumer protection agency within banking. It would, we were told, stifle innovation. Given the fruits of the last great wave of financial innovation – toxic derivatives – most of us probably would agree that less rather than more innovation from these clowns is preferable. But money talks and banks have lots – courtesy of us. So Congress has begun to water down consumer protection, and the likely legislation, when, and if, it is signed into law will afford plenty of leeway for the industry to continue to produce impenetrably worded and dubiously useful products for our benefit.

Second they all started to announce that they were going to reward themselves for a job well done. Bonuses are back with a vengeance. This after only a year since the entire industry had to be saved from its own stupidity. Nothing is a better statement of the shattering hubris of bankers than the indignation they all express when we, the folks who saved their skins, question the social value of those bonuses. It is also a statement of the political security that the banks feel that they can flaunt their pay in our faces even while unemployment keeps rising and the tab for bailing them out remains unpaid.

That security is provided by the administration’s demonstrable bias towards the banks. Nowhere throughout this sorry saga has there been a line drawn in the sand. Every time a crisis appeared the solution chosen was then one most beneficial to the banks. Not once was the public anger allowed to lap over into action. Instead we have been treated to a steady diet of public statements about how wrong those bonuses are coupled with a deeply compliant and non confrontational attitude behind the scenes.

The inevitable result of this inaction, and the unwillingness to ruffle those magical markets, has been to compound the problems that gave rise to the original crisis.

The flood of liquidity sloshing about will, unless it is syphoned off via restrictive policies, flow through the traders hands into whatever scheme they next create, making another bubble a near certainty.

The ongoing taxpayer safety net remains in place, at no cost to the banks. So the socialization of bank losses and the privatization of bank profits rumbles on – as those insulting bonuses indicate. We are still on the hook for the banks inability to play nicely or safely with our money. Remember this: we provide blanket insurance to the financial industry nowadays, we underwrite their capital. If they screw up again we will pay. But we exact no fee for this unbelievable benefit. None. We are reduced to ineffective complaints about pay and bonuses. Complaints that are treated with derision by the industry.

And not least: all of the big banks have become bigger. Our problems are much larger than before. If you thought bailing our the banks was expensive last year, just wait for the next bail out. We all learned how dangerous a bank that is too big to fail is – just one can destroy an economy as large as ours, which is why we can’t let it fail. Imagine the damage an even larger bank could do.

Which brings me to this:

Break up the banks.

The only practical way to resist the banking industry’s control over us is to legislate them away. Compel them to deconstruct themselves into smaller and therefore manageable pieces. There is no other way to avoid being bankrupted by the gambling they all do. It is urgent that we force the big banks to scale down in the way that Standard Oil was broken up in the past.

I had given up on this possibility – as usual the Obama administration sent out word that it wanted to avoid a clash with the industry.

Then I read that no less a free market guru than Alan Greenspan advocates just that – break up the banks he argued in a recent speech. Next came his predecessor, Paul Volcker – break up the banks he suggested in an interview this week. But both these men are out of power. They are not sitting in on the policy meetings, so even though their voices carry weight, they will not be able to carry the day. They need help from the inside.

Enter Mervyn King.

He is the current head of the Bank of England.

His mantra?

Break up the banks.

His ill tempered and forceful speech to a banking industry conference this week has set the world on fire. His advocacy of radical surgery will be very hard to ignore since he actually can force action.

The big banks, not just here, but worldwide, have grown to the point where they dictate economic policy. We run scared every time they sneeze. They syphon off capital that should be flowing to industry and to consumers and channel it into ever more arcane and useless vehicles that serve no social value whatever, And they expect us to pick up the pieces every time they screw up.

Enough.

It’s time for some old fashioned capitalism.

Make them pay for their own mistakes.

Let them fail. Let the bankers go bankrupt on their own dime not ours.

For us to be able to allow such a failure, we need the banks to be smaller. A lot smaller. We can break them up. We could even continue to underwrite the socially valuable parts – the consumer and business lending operations, or ‘commodity’ banks deserve our help since they help fund the economy. The gamblers … well let them rot in their own mess.

So don’t just break the banks up. Separate the businesses along the old commercial [good] versus investment [bad] banking lines that used to exist before deregulation muddied the waters.

This makes sense because the two kinds of banking are as different as night and day. Society needs dull and boring commercial banks. We don’t need those gamblers with their securitized mumbo jumbo and derivatives a-go-go that seem to serve only the pay checks of the gamblers themselves and their coterie of hangers- on like the accountants, lawyers, and rating agencies who all have a hand in that same till.

When three current, or former, chief central bankers all agree I think we should take notice.

It is time for Obama to channel Teddy Roosevelt and break up the banks.

But I’m not holding my breath.