The great and the good of the banking world will descend on London today. Under discussion will be no less a topic than how do we stop it all from happening again.
Meanwhile, in the US, Barack Obama has already laid down his plan for making the banks behave in future.
So is the most popular man in the world to currently hold the position of President of the United States right. Will his plan do the trick, or has Uncle Barrack made a potentially massive mistake?
In truth there were two things President Obama was hoping to achieve with his plan.
Firstly he wants to restrict the size of banks, to ensure that never again a bank is too big to fail.
Secondly he wants the banks that look after our money to take less risks. You probably know that under the leadership of the previous democrat President, the Glass-Steagall Act was repelled. This was the Act that was passed during the 1930s to separate the activities of retail and investment banking.
There’s a good and a bad side to the Obama plan.
For trying to ensure that banks are never again too big to fail Mr Obama has got the sentiments right. If you believe in capitalism, then you believe failure is an essential part of the system. It’s the means by which the economy can distinguish between the good and bad businesses. It’s the way economic evolution can weed out the ideas that don’t work. Failure is also good because it creates a vacuum that can then be formed by new, more dynamic, businesses. Any system that is made of parts that are so big that their failure would made the whole system collapse, are therefore flawed. An economy that relies on banks that are too big to fail in this way is thus flawed.
For separating investment and retail banking, however, the arguments are less clear cut.
What caused the banking crisis of 2008/09? Answer, it was surely mortgage securitisation. But when we critisise banks for their reckless risk taking, we miss the point. Mortgage Securitisation was supposed to limit risk. Both Alan Greenspan and the IMF hailed mortgage securitisation as a triumph. It failed because banks, just like the people they lent to, assumed house pries would continue to go up, and it failed because banks were seduced. They had convinced themselves mortgage lending had become less risky, therefore they could afford to take more risks. The mistake they made was their failure to understand that risk was correlated and herd behaviours meant banks were making the same errors in unison.
A psychologist could provide a better explanation of what caused the banking crisis than an economist. It is far from certain that the crisis would have been avoided if investment and retail banks were kept separate.
In fact if you go through your history books and look at the dotcom crash, the fall of Long Term Capital Management in 1998 the Asian crisis of 1997, and before that debt defaults in Latin America, it is far from certain there would have been any difference at all if the plans announced by Mr Obama were in place at the time.
The Obama is plan is actually quite dangerous, because it distracts us from the true cause of the crisis
The banking conference in London, which will see finance ministers from across the world, not to mention the likes of the IMF and World Bank, could be more significant.
Ideas under discussion include a kind of new insurance scheme in which banks pay into a fund to be used as means of bailing out the sector in the event of another banking crisis. The fund may be financed by a banking transaction tax.
The big snag with this plan is that bank losses during the peak of the banking crisis were simply huge and were greater than cumulative profits going back years. A fund of adequate size would also have to be enormous, the transaction tax, which remember would ultimately be paid for by consumers, could be punitive.
The problem with banks lies not so much in their size, or in their level of risk taking. The real problem is herd behaviour. Banks are slaves to financial fashion. And when banks all behave in a similar way, it maters not whether they are large or small because, regardless of their size, there is a very real danger they will make the same mistakes in unison.
The forgotten villain in the banking crisis was the Internet. The Internet meant new banking and investment fashions caught hold more quickly and were adopted more widely.
This column is a fan of the Internet. But, there are always teething problems with new technology. And the banking crisis may have been such a problem.
© Investment & Business News 2013