"We don’t want to change and we’re
not going to," it says. "You lot can try but we’re
not budging till we have to. And we know you
haven’t got the energy to shift us."
The big beasts of Wall Street are probably right. Nothing in
the response to the financial crisis so far suggests the
political establishment will have the guts and drive to reform
finance in a way that really bites.
But Senator Blanche Lincoln at least tried – for
all the good it did her. The Obama administration, Treasury and
others have left her to hang in the wind.
Why? Lincoln’s proposal to make banks house
their derivatives dealing desks in separately capitalised
entities is modest enough. Like the Volcker Rule, it is a step
in the right direction, though it falls a long way short of the
revived Glass-Steagall Act that is really needed in the US
– and other countries.
The Lincoln plan even echoes the derivative product
companies that Wall Street banks themselves set up in the 1990s
to enable them to deal in derivatives with triple-A
What real arguments are there against Lincoln’s
idea, other than that it does not go far enough?
It might be a hassle for the banks to implement –
but weigh that against the taxpayer’s right to
know it will not have to bail out derivative risks. And banks
are remarkably good at setting up new entities and moving
things from one balance sheet to another – when it
suits them. Plenty of underemployed structured finance bankers
would relish the job.
We are told the Lincoln proposal would impair
banks’ ability to manage their risks. Not at all.
The banks’ treasury departments should anyway have
a customer-supplier relationship with their own derivative
Are we supposed to believe that large retail banks that do
not have an in-house investment bank are incapable of managing
interest rate or other risks? Of course not – they can
buy these services from an investment bank. All deposit-taking
banks should have to do the same.
The truth is that investment bankers have lost their bottle,
as they say in England. They’ve lost the stomach
for the fight. The commercial fight, that is – they
still have plenty of appetite for political lobbying.
For much of the past 15 years, investment bankers in many
firms have complained about being shackled to lumbering
commercial banks. These boring, old-fashioned institutions,
they moaned, just didn’t get it –
didn’t understand shareholder value, or why
investment bankers needed to take so much risk, or get paid so
In the past two years, the wind has changed. The cold blast
of risk has made the investment bankers awfully grateful to be
inside nice, warm commercial banks that the state has to
protect – rather than at Bear Stearns or Lehman
So they are going to cling on for dear life to those
double-A rated balance sheets and that implicit state
The irony is that if the commercial and investment banking
sectors were separated again, as they should be – and
as they were during the most successful periods for the US and
UK economies, not to mention those of other developed countries
– the financial markets bankers would be much
Rehoused in a new sector of smaller, much more competitive
investment banks-slash-hedge funds, they would soon remember
how much they enjoyed the competitive life, the unfettered
profit motive, the thrill of risk.
Many who have made the shift to boutiques already, such as
in the European bond business, are loving it. And how many
people do you know who’ve left a successful hedge
fund to return to banking?
However, this is just a dream. Back in the real world, the
banks have shepherded politicians and the media into the easy
option of moderate reform that leaves the banks bigger and more
protected than ever.
Hence the grinding noises greeting the Dodd Lincoln
financial reform bill. Another part they’re
groaning about is the requirement for more OTC derivatives to
be cleared and traded on exchanges.
There may be bespoke contracts for which publishing pricing
would be impractical. But it’s also certain that a
great many things could be exchange-traded with a proper price
quotation system that aren’t at the moment. Bonds
of all kinds, interest rate and currency swaps, CDS…
these are nearly always standard products.
And as for clearing, it is simply a more orderly form of
risk management. The banks and companies say "if we had to
collateralise that, we wouldn’t be able to afford
to do it".
But that means the trades are going on at the moment, with a
less stringent form of collateralisation. Who is taking the
extra risk? The banks.
Since the banks are willing to bear this risk, why could
they not simply lend money to their corporate customers to
finance the margins required by a clearing house?
These loans would be clearly documented and separate from
other finance, so that they could be quantified.
What would be gained? An exacting, independent eye would be
cast over every transaction and its risk assessed. Transparency
would be shed on the banks’ real exposures to
derivatives and their customers – things that are
hidden at present.
And no transaction that is economically viable at present
would be prevented by the new, more stringent system. Yes, we