As implemented since the financial crisis began, banking reform is a costly waste of effort

In his Telegraph column, Jeremy Warner looks at the UK's ongoing bank reform efforts and concludes they are a costly waste of effort.  This is not surprising because the Japanese model for handling a bank solvency led financial crisis specifically excludes real reform.

Regular readers know that your humble blogger thinks there were only two worthwhile elements in the US effort to reform banks and the financial system.  These were the Consumer Financial Protection Bureau and the Volcker Rule.

The Japanese model explicitly ruled out reform that would have required that banks provide ultra transparency and disclose on an on-going basis their current asset, liability and off-balance sheet exposure details.  Doing so would have a) revealed the true state of the banks' solvency, b) have saved the real economy by bringing market discipline to the banks and forcing them to recognize all their losses and c) ended the era of big cash bonuses to bankers while the banks were rebuilding their book capital levels.

Instead, we get the rearranging the deck chairs on the Titanic type of reforms that Mr. Warner sees as a costly waste of effort.

The same cannot be said of banking reform, much of which is only an expensive waste of effort. 

The Government has already dealt with failings in banking supervision by deciding to get rid of Gordon Brown’s hopelessly misconceived Financial Services Authority and reuniting prudential oversight with its natural home at the Bank of England.

The US had both of these under the Federal Reserve and this did nothing to prevent the financial crisis in the US.

The reality is that with ultra transparency there is no reason to house monetary policy and bank supervision together.

Your humble blogger has already written extensively how the skill sets necessary for being good at implementing monetary policy are the exact opposite of the skill sets necessary for being good at bank supervision.  As a result, it is much better to keep the two organizations separate.

Yesterday we were presented with yet another White Paper on financial reform, this one intended to give substance to the Vickers proposals for changing the architecture of the banks themselves. 

What’s proposed is essentially just the G20 agenda for winding up problem banks, but with bells and whistles attached – a capital surcharge, depositor preference and, most controversial of all, ring-fencing of ordinary retail banking from wholesale banking....

Conspicuous by its absence is the requirement that banks provide ultra transparency.

But if we take the banking crisis now tearing the eurozone apart as an example, there is not a single thing in this White Paper which would have prevented it.

This is the fundamental flaw, with the exception of the CFPB and Volcker Rule, with all of the reforms:  they would have done nothing to prevent the on-going financial crisis.

Only transparency acts in such a way that it prevents a financial crisis.

To the contrary, the problem banks that lie at the heart of Spain’s real-estate bubble would all have fallen within the ring fence which yesterday’s White Paper claims will make banking so much safer. Large parts of yesterday’s reform agenda are just costly window dressing, a triumph of political posturing over economic sense....

I don’t want to argue that everything in yesterday’s White Paper is a bad idea. Much of the international reform agenda it reflects is entirely sensible as a long-term goal..... More questionable is the speed with which all this is being introduced. 

It’s only natural to want to hem the bankers in with safeguards after the recklessness of the past, but in the short term it is neither necessary – bankers are so chastened by the bust that they have become ultra-cautious anyway – nor is it even benign. 

By making bankers hoard capital and liquidity, it tends further to crimp any hoped-for recovery in credit conditions. 

The point was touched on in a speech this week by Paul Tucker, deputy governor of the Bank of England, in which he suggested that much of the money printing of quantitative easing had served only to help the banks meet tougher liquidity requirements, rather than, as intended, helping to revive credit conditions. With luck, the “funding for lending” initiative will help correct things a little. 

Banking reform is a worthy cause, but let’s get through the present crisis, which threatens to get very much worse before it gets better. And let’s make sure we get it right, rather than imposing headline-grabbing irrelevancies.

Hence the reason that ultra transparency needs to be adopted now.  Banks will have plenty of time to rebuild their book capital levels after adoption of the Swedish model and ultra transparency ends the financial crisis.