Mervyn King berates recidivist Scottish bankers

It was fitting that Mervyn King, governor of the Bank of England, chose Edinburgh to deliver an attack on bankers and chastise the Labour government for its failure to push for any meaningful reform in the financial sector.

After all, two of the UK’s worst-managed and most reckless banks — and the two most recidivist — Royal Bank of Scotland / NatWest (RBS) and HBOS, were headquartered in the Scottish capital. And two of the politicians appear most eager to sweep bankers’ misdeeds under the rug and seek a return to the status quo ante, Brown and Darling, are both Scots.

Speaking at a dinner organised by the Institute of Directors at Prestonfield House, King echoed earlier calls from Professor John Kay that banks considered “too big to fail” — i.e. so large and so interconnected with the economy that their failure would be disastrous for the wider economic system, and therefore should be supported/rescued by government in the event they face potential failure — should be broken up.

Among other things, this would mean the separation of commercial and retail banking from investment banking, along similar lines to the separation brought about by Franklin D. Roosevelt with the Glass-Steagall act in 1933 (a separation ended by President Bill Clinton in 1999).

Kay has already explained how this would mean that only banks that choose to focus on safe, low-return, “utility banking” including deposit-taking and retail and commercial lending, should be eligible for bailouts. However, banks that choose to engage in higher-risk and often socially-useless investment banking activities (“the casino”), such as gambling on exotic derivatives, would not.

King said: “There are those who claim that such proposals are impractical. It is hard to see why. What does seem impractical, however, are the current arrangements. Anyone who proposed giving government guarantees to retail depositors and other creditors, and then suggested that such funding could be used to finance highly risky and speculative activities, would be thought rather unworldly. But that is where we now are.”

In his speech, King seemed aghast that, despite the initial £1.3 trillion of taxpayer and central bank support provided to failed and failing banks, bankers still seem to believe they can carry on as though nothing has changed — and bemoaned the government’s loss of appetite for real reform.

On bankers, King channels Churchill

He said: “To paraphrase a great wartime leader, never in the field of financial endeavour has so much money been owed by so few to so many. And, one might add, so far with little real reform.”

King’s proposals are not really that radical. Paul Volcker, former chairman of the US Federal Reserve, has been calling for something similar in the US. Volcker said:

“The banks are there to serve the public and that is what they should concentrate on. These other activities create conflicts of interest. They create risks, and if you try to control the risks with supervision, that just creates friction and difficulties and ultimately failures.”

“People say I’m old-fashioned and banks can no longer be separated from non-bank activity [but] that argument brought us to where we are today.”

King called for sweeping reforms of the regulatory framework which was introduced by Gordon Brown in 1997 and warned that, in its eagerness to re-privatise part-nationalised banks as quickly as it can, the government is encouraging bankers to resort to the reckless behaviour that nearly destroyed their institutions last year.

King said:

“It is important that banks in receipt of public support are not encouraged to try to earn their way out of that support by resuming the very activities that got them into trouble in the first place. The sheer creative imagination of the financial sector to think up new ways of taking risk will in the end, I believe, force us to confront the ‘too important to fail’ question.”

King’s views on bankers have already been endorsed by the UK’s shadow chancellor George Osborne, who today called for retail banks to be banned from making significant cash bonuses, saying that “Mervyn King is right that we now have a banking system that is more concentrated and more risky than before the crisis. We cannot afford to let it remain that way.”

Citywire today also revealed that leading fund managers have joined the assault on recidivist bankers. It revealed that some of the City’s leading fund managers, including Hermes and Aviva, are telling the banks they should only calculate bonus payouts on what they actually make as profit, stripping out bailout cash from the equation.

However in an article in the Guardian’s Comment on Free section, Gary Younge argues that the obsession with bankers’ bonuses may have clouded the need for root-and-branch reform of the entire financial sector. He said:

“The last year has seen … a resurrection of decrepit institutions and a decaying ideology. Pumping public money into [the banks’] sclerotic veins, we brought them back from the dead. We have literally paid for the right to be exploited by a system we know doesn’t work.”