Disentangle ‘utilities’ from the ‘casino’, says Kay

In Blog by Ian Fraser1 Comment

14 September 2009

The campaign to separate “utility” banks from the “casino” of financial markets has stepped up following an intervention from John Kay (pictured), a leading economist and author of “The Long and the Short of It“.

By focusing on their post crash regulatory efforts on building a framework for lumbering financial conglomerates that bridge the “utility” / “casino” divide but which are incapable of surviving without state aid, the politicians and regulators will only prolong the crisis, says Kay.

In a paper for the Centre for the Study of Financial Innovation Kay says there is no such a thing as “too big to fail”, and warns that the billions of pounds already pumped into the fragile financial sector have seriously distorted the market. The money is at risk of encouraging dangerously unethical behaviour in some banks.

Kay, a fellow of St John’s College Oxford, said: “Companies [such as Citigroup and RBS which are the biggest recipients of state support] represent a concentration of unaccountable private power, answerable neither to an electorate nor to a market place.”

He believes policymarkers ought to enact a modern day version of the US’s Glass-Steagall Act, which separated retail and small business lenders from investment banks following the crash of 1929 but was formally repealed by Bill Clinton in 1999.

In Kay’s scenario “narrow” or “utility” banks would focus on the more boring activities of lending to individuals and small businesses and would be obliged to fund themselves through retail deposits. Such banks would be required to hold a high level of liquid assets in government bonds, and governments would guarantee to rescue them in the event they got into difficulties.

But Kay believes that institutions engaged in investment banking activities, which borrow crazy sums in order to perform proprietary trading largely so that their own executives can enrich (or impoverish) themselves, should still be allowed to exist. But he said the government should make it quite plain that, if such banks get themselves into difficulties, they would be given the Lehman treatment and left to go to the wall.

Citing spurious reasons — including that some “utilities” such as Northern Rock and HBOS failed during the crisis — the FSA chairman Lord Turner and chancellor of the exchequer Alistair Darling have already rejected this proposal. Turner has said it is “not feasible.”

Professor Simon Johnson, professor at the Sloan School of Management at MIT and a former chief economist at the IMF this morning warned that the seeds of another financial crash already sprouted. If major banks are allowed to keep making crazy bets that are ultimately backed by taxpayer guarantees, they are certain to return to the recklessness that caused the 2008 crisis. “They will run up big risks, they will fail again, they will hit us for a big cheque,” he told the New York Times.

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