Tim Roberts, fund manager at Cavendish Asset Management and a specialist in the North American market, comments on President Obama’s threat of a “Glass-Steagall” type of separation, which would separate the activities of deposit-taking banks from investment banking.
President Obama’s announcement goes far beyond what the markets can stomach from the volatile banking sector, and the creeping political tenor of financial debate. These new measures may be presented as advancing a progressive agenda, but to many they cement only an increasingly politicised one.
Attacking the heart and soul of Wall Street is not the answer, and will not necessarily prevent other crises in the future. The problems of 2008 had a long incubation period propped up by external influences, namely sustained and easy access to capital and a nod-and-a-wink approach to mushrooming assets such as real estate.
The focus on complex trading and financial instruments only serves to mask the underlying dysfunction behind the current crisis: over-leveraging. Losses are bad, but the systematic inability of an economy to absorb those losses, due to high gearing, is devastating.
Reform needs to focus on making such levels of gearing unattractive or impossible, yet this has already been largely addressed through stricter capital adequacy requirements. We can prevent from happening again the sorts of complex transactions that exacerbated the 2008 crisis, but should recognise that tomorrow’s challenges will likely arise from an entirely new source, and in a set of very different economic conditions.
It is worth remembering that the CDOs roundly blamed for exacerbating the crisis were judged by most at the time to be low risk. In a woeful analogy with investment returns– "acting on the principle of past risks, is no guarantee for the future”.
Put simply, hindsight is no substitute for foresight. Nor is punitive, retrospective judgement a criteria for assessing future dangers to the system. Financial innovation has played a key role in growing global economies over the last few decades, and recent events, though painful, have hardly reversed these gains.
Limiting trading activities and the growth prospects for banks will instead simply damage long-term economic prospects for everyone, hurting in turn those who have paid dearest for the crisis. The consumer may have tired of paying for Wall Street’s excess and been angered by the rudest, remorseless return to health that followed.
Smothering Wall Street will only hamper economic recovery, meaning that access to capital becomes harder for private businesses and consumers, while institutional and private investors battle with an anaesthetised market already highly fragile. Investors in particular will be penalised for backing the very banking mergers that saved financial institutions from collapse, and from the even greater economic havoc such failures would have wreaked.
Having governments and policymakers standing over the banking sector’s shoulder, judging risk on its behalf, will only damage the prospects for all.