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The problem with 'boring' banks

Matthew Bishop
Matthew Bishop is the U.S. Business Editor of The Economist and, with Michael Green, he is co-author of the book, The Road from Ruin: How to Revive Capitalism and Put America Back on Top. He tweets at @mattbish

Barack Obama is not a gratuitous bank basher. Indeed, in last week's State of the Union address he was at pains to point out how much he likes them. "A strong, healthy financial market makes it possible for businesses to access credit and create new jobs," the President explained. But he does want banks to stick to boring things, like lending to business, not nasty, risky things like playing on the stock market.

President Obama wants to have his cake and eat it - a financial sector that supports growth without taking excessive risks -- but his regulation plan means that he will end up with neither. Boring banks will lend less at higher interest rates, which will be bad for business and bad for jobs. Worse, taking the risk-taking out of banking is not going to make the financial system any safer. He needs to think again.

America has a deep-rooted suspicion of big, powerful banks. Since the dawn of the Republic, federal and state governments have tied the banks up in red tape and tried to stop them taking risks. Even in the financially exuberant days of the roaring twenties, Congress passed the McFadden Act that blocked interstate banking for half a century. After the Great Crash of 1929, it was no surprise that tough new rules to make banks boring again were a central plank of FDR's New Deal legislation, including the Glass-Steagall Act that slid off the statute books in 1999 and which many, including Paul Volcker, want to reinstate, at least in spirit.

The deregulation of banking over the last thirty years has been an exception in American history. And the fact that this era has culminated in such a spectacular crash has, for many, vindicated the old ways of doing things. Hence the president's yearning for the good old days.

Yet the story is not so simple. The strict regulation of the banks in the 19th century did not just hamstring the economy, it also displaced risk-taking finance into unregulated institutions, what we now call the 'shadow banking' system. The choice for customers a hundred years ago was simple - put your money into a bank, where your deposits were protected from bank runs by a kind of mutual support scheme rather than a government guarantee, or save with a so-called banking trust that could do things like play on the stock market and, therefore, give you better returns.

In theory, customers carried the risk of losing everything if they chose to use the trusts. In practice, when the banking trusts blew up in 1907, they nearly dragged down the whole financial system and had to be saved. The only difference from the crisis of a century later was the bail-out was led by the banking colossus JP Morgan, rather than the Federal government. But the lesson is clear - savers and borrowers will desert boring banks in search of better returns. The risk to the financial system will not go away by making banks boring, it will just be displaced somewhere else.

But what about Glass-Steagall, which is supposed to have ushered in an era of crisis-free banking for the latter half of the 20th century? Yes and no. While the banking system did not suffer any meltdowns, this was a period that saw the 1987 stock market crash, as well as the savings and loan crisis and the collapse of Long Term Capital Management, both in the 1990s, and the dotcom crash of 2000. Glass-Steagall displaced risk, it did not eliminate it.

The Obama plan contains the fundamental flaw that it will do nothing to improve risk-management in the financial sector as a whole. The yearning for boring banking is also anathema to other countries, particularly Germany and France, which have no problem with banks that do risk-taking as well as taking savings and lending. This is a problem because the global financial system is so inter-connected that the only effective solution will have to be global. If America thinks it can put up a cordon-sanitaire around its banks, it is much mistaken.

How to build a global regulatory system that actually helps the financial system to manage risk better is a tough question. Sadly, the bankers of Wall Street have displayed an intransigence about the need for change since the crisis that almost matches their incompetence before the crisis. The one good thing about the Obama plan is that it might shock them into playing a more constructive role in working out where we go from here. Our jobs and livelihoods depend on it.

By Matthew Bishop and Michael Green

 |  February 2, 2010; 5:33 AM ET |  Category:  Economic crisis Save & Share:  Send E-mail   Facebook   Twitter   Digg   Yahoo Buzz   Del.icio.us   StumbleUpon   Technorati  
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I agree with cmecyclist, and I'd add that there's a shift in business and industry that promotes the kind of thinking that prompts bankers to gamble with OPM. For perhaps twenty years now, business and industry have been shifting away from a focus on serving the customer/client/consumer to serving the corporation and its stockholders. We can only hope that this time, when many stockholders have lost their shorts, the idea that serving the executives and stockholders is the greatest good will give way to serving those outside of the corporation.

Posted by: jlhare1 | February 2, 2010 11:40 AM

"Boring banks will lend less at higher interest rates"

Wake up, do you think we don't see what the spread between the interest we get and the interest we pay is now?! You are just another greedy mendacious crybaby whining for more, and you will keep on doing it until you explode from your own bloat.

Posted by: chaos1 | February 2, 2010 11:10 AM

Thanks, angryman.

And I'm a very left liberal.

See the laws are ALREADY in place to protect the citizens but big businesses tries whatever they can, spending huge amounts of money, to get around the spirit of the laws by finding technical loopholes so that they don't have to play fair or to pay their fair share so that they can grab as much as they can for themselves.

They are trying to "maximize" profits, not to share with those less fortunate, but for higher incomes. (And yes, I am familiar with business practices where generally the biggest expenses in a company are paying the salaries.)

They're simply greedy. Why does ANYONE "need" a million or more a year income?

Posted by: cmecyclist | February 2, 2010 10:46 AM

Krugman is much more nearly correct:
http://www.nytimes.com/2010/02/01/opinion/01krugman.html?em

Canadian banking is a good model for our savings bank business. Separate that from investment banking, and let the latter do whatever they want with their own money.

Posted by: raschumacher | February 2, 2010 10:35 AM

CMECLCLIST, You are DEAD-ON BALLS ACCURATE!! Well said!!

Posted by: Angryman | February 2, 2010 9:31 AM

Oh those poor boring banks!

Look. If banks are going to hold our hard earning money, I don't want them to risk it.

The situation is that the rich bankers can now take high risks and earn all the big profits while if they lose it, it's covered by the government - which our OWN money! So if the banks lose OUR money, it's covered by OUR own money. Thereby, we have to pay it twice - in the long run.

If the bankers and other people want to put money into high risk vehicles - then they should get out of banking.

See, the REAL problem is that the rich want more without taking the risk of losing their own money. They would rather use OPM and reap the profits while if they lose it, oh well, they get their fat salaries anyway. Meanwhile, the U.S. citizens are STILL stuck with the 500 BILLION Savings & Loan scandal (Thanks Reagan and Bush 1!) as well as the earlier Bank scandal that we're also still paying off.

When are the rich REALLY going to start taking RESPONSIBILITY for their risks and actually suffer the consequences when they screw up without having the U.S. Government cover their a**es which is also known as "too big to fail" and having the taxpayers pay for their greed and mistakes.

I am so sick of the BS, it disgusts me.

Posted by: cmecyclist | February 2, 2010 7:05 AM

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