Was it simply perverse? Investment banks were designing bonds especially, or so it appears, for the purpose of betting against them. Has Wall Street evolved to such a level that its interests are now diametrically opposed to the interests of the rest of the economy? One famous guru reckons this is precisely what has happened. Forget the war in Europe between banks and regulators. This time round the war is beginning in America, and the SEC has bombed the financial world’s equivalent of Pearl Harbour. As for the exodus of bankers from the UK, unless they have found a new refuge on the planet Mars, it seems they have nowhere to exodus to. War has been enjoined.
Saint Vince has a stock answer to the question that won’t his ideas for penalising banks lead to an exodus of bankers from these shores. Last year, when taxes on the super rich rose, applications from Britains to expatriate to Switzerland fell. See David Prosser in the Independent today. At the end of last year, this column led with a story suggesting that talk of a banking exodus to Switzerland is a joke. “There is more office space in Canary Wharf than in the whole of Switzerland,” or so said Tim Dawson from brokerage firm Helvea AG. see: Bankers’ impending exodus is a joke.
But the ideas being touted and discussed in the UK are just a sideshow. The law suit between the SEC and Goldman Sachs is the real heart of the battle.
In an interview on CBS News Michael Lewis, author of The Big Short, said that when Barack Obama told bankers to keep their noses out of his financial reform bill, they didn’t oblige. Instead they well and truly put their noses, or is that their snouts, in the trough. The US government’s law suit against Goldman Sachs, suggests Lewis, is its response.
“It’s a warning shot across their bows,” said Lewis, and that it has effectively launched a “culture war”, not only against Goldman Sachs, but other Wall Street firms too. He said that the “financial system has evolved to a point where its interests are diametrically opposed to interests of economy at large.” And now the regulator is striking back.
It doesn’t really matter if Goldman Sachs did anything that was illegal at the time. All is fair in love and war. When Clinton was president, and then when George Dubya was president and his Treasury Secretary Hank Paulson was former Goldman Sachs CEO, and when Blair was PM, governments were in love with banks. Now it is war, and little things like banks following practices that were legal at the time will not stop law suits.
It seems a part of the problem is that whereas in the equity market, regulation is tighter than a tourniquet, the bond market has been left alone. Lewis said that the bond market has been the “Wild West until now”.
What is striking about the SEC complaint, said Lewis, “is that it is essentially alleging behaviour that is ordinary in bond markets. In bond markets it is very easy to rip off your customer and it happens often.” It is a practice he described as “perverse”.
And so, suggests Lewis, it is common practice for banks such as Goldman Sachs to design bonds which it then bets against. “Did it think they were going to get sued by the SEC, no,” he said, but added: “Did they think the market was going to go bad, yes. But I think that at that point they thought they were going to make a lot of money from the market going bad.”
Mr Lewis reckons only a return of a Glass Steagall type act can save the day. You may recall, this was the act passed in 1932 which meant the activities of a commercial bank and an investment bank had to be separated. A bank can be one or the other, not both. The Bill Clinton regime repelled the act. For some reason, which is strange to fathom given the tide of popular opinion, the UK government has come out against the idea of a new Glass Steagall act, arguing that such an act would not have saved Northern Rock, for example. (Maybe the real reason for its opposition is that the then chancellor, a certain G Brown, supported the Clinton move.) But their resistance to the idea misses the point.
A new Glass Steagall would mean more than keeping the investment and commercial banking activities separate. If lawmakers have any sense they will ban the practice of banks betting against instruments they design. Banks would either advise clients, or they would be proprietary traders, but never both.
Lewis said there is something flawed in Wall Street. Maybe some banks realised they had to pay traders less money, but feared if they did that they would simply lose the traders to another bank. If that is right, then only a third party imposing regulation can fix the problem.
Last year, FSA Chairman Lord Turner said: “Much of what banks do is useless.”
The Investment and Business News view is that capitalism needs variety and failure in order for economic evolution to progress. When banks are too big to fail, this impedes economic evolution, and enables them to get away with practices that in a truly competitive environment would have been impossible. For that reason, banks should be smaller, and if you believe in capitalism, you should also believe in a new Glass Steagall.
© Investment & Business News 2013