Monday, July 9, 2012

Transparency, not Glass-Steagall needed to reform finance post-Libor scandal

As the world-wide consequences of the Libor scandal are being identified, the complete evisceration of trust in banks, their leaders, financial regulators and politicians comes before even the loss of money.

It is well known that the only way to restore trust in the financial system is by providing transparency.  It is only with transparency that market participants can Trust, but verify.

There are numerous supporters of Glass-Steagall who think that reinstating the separation between investment and commercial banking will cure the problems in the banking system.  This ignores the fact that Glass-Steagall was repealed because by the mid-1990s modern finance had evolved to render it ineffective.

Lost in the call for reinstating Glass-Steagall is any acknowledgement that it would not have prevented our current financial crisis, or JP Morgan's credit default swap trade -  it was suppose to hedge the commercial banking book or quite possibly the Libor scandal.

In a Financial Times column, former Barclays CEO Martin Taylor tells a story about losses on exposures to Russian debt in 1998.  Apparently, under Bob Diamond, BarCap exceeded its exposure limits and as a result, Barclays when the losses occurred Barclays 'looked reckless' and its share price was hammered.

Mr. Taylor asserts that had Glass-Steagall been in place, the whole situation would have been different.

Maybe.  The losses resulted from buying Russian debt.  Glass-Steagall would not have prevented this debt from being purchased.

Your humble blogger would assert that had Barclays been required to provide ultra transparency and disclose on an ongoing basis its current asset, liability and off-balance sheet exposure details most of the losses would have been avoided.  Market participants could have exerted discipline as the size of the bet exceeded what was reasonable and prudent and started to become reckless.

In his Telegraph column, Liam Halligan calls for reinstatement of Glass-Steagall.  As documented by your humble blogger on several occasions (for example, see here and here), Mr. Halligan has also called for transparency.

What follows is a condensed version of his column substituting transparency for Glass-Steagall.
Finally, the British political classes are starting to get it. Finally, a head of steam is building. Over the past week, calls to impose [a requirement that banks and structured finance securities provide ultra transparency] have become louder, more authoritative and part of mainstream debate. 
Pressure for the introduction – or reintroduction – of [transparency] could soon become irresistible, however much the politicians wiggle and the investment bankers deceive.

Until now, it’s been mainly nerds like me who have advocated [for ultra transparency]. 
Given the vested interests that would lose from this change, we’ve been lampooned for our “hot-headed” views. 
Yes, our message is awkward. Life would become difficult (and less lucrative) for a lot of powerful people, were we to prevail. Yet we “Ultra Transparency-ers” are right. We have history, logic and common sense on our side. And now – thanks to Barclays’ ex-CEO Bob Diamond, and “Liborgate” – we also have political momentum. 
The global economy faces grave dangers.... 
Back in the UK, meanwhile, Liborgate seems to have caused the first tremors in what all responsible people must hope is a political earthquake. Ever since the sub-prime crisis began in the spring of 2007, most British political leaders and regulators have resisted serious banking reform. 
Sir John Vickers’ measures, years in the making, have now been exposed for what they are – an elegant political compromise, with not a chance of reining in London’s rapacious investment banking culture, so all but guaranteeing another crisis a few years down the line. 
While hopelessly weak in and of themselves, even Vickers’ proposals ... have been watered down by the Government. Legislation implementing Vickers has yet to be passed and, anyway, won’t come fully into effect until 2019. 
This Government’s failure to insist on genuine banking reform, the subsequent Vickers dilution, the legislative delay and ridiculously long implementation period once the proposals become law, taken together, reflect extremely badly on David Cameron and George Osborne....
Yet the current situation calls for the Conservatives to show real resolve, not focus on political parlour games. The manner in which the Tories have handled UK banking reform since coming into office has revealed not only a glaring leadership deficit, but shocking complacency and a lack of financial acumen. 
[Ultra transparency] was incrementally removed in the UK and US during the late 1980s and 90s. Financial markets have lurched from crisis to crisis ever since. No other single act did more, in fact, to cause “sub-prime”, and transform it from a banking crisis into a broader fiscal and economic crisis too.... 
Re-imposing [ultra transparency] would prevent investment banks from betting with ordinary deposits, exposing them to the full force of the market. At a stroke, our banking system would be far safer and the “too big to fail” issue largely resolved. 
That would be anathema, of course, to the “banking titans” who rely on government cash for survival and from whom politicians, in turn, receive campaign donations and cushy jobs once their political careers have expired. Yet now, after several years of bank-induced economic torpor, and this shocking Libor scandal, our deeply corrosive banking status quo is finally under serious threat.... 
The investment bankers insist [ultra transparency] is irrelevant. “Lehman was a pure investment bank”, they say, “and that failed”. Yes, but had the entire banking system not been riddled with bad bets and leverage, Lehman’s collapse wouldn’t have posed systemic dangers. The core banking system would have been sound.... 
In recent days, as public disgust at Liborgate has grown, so have the cries for structural reforms.....

The British public is desperate to see measures that tame our banks and make our financial system safer. We’ve reached a historic crossroads.
 
Nick Clegg needs to forget Lords reform and focus on what really matters. The Liberal Democrat leader should get Cameron and Osborne in a room, and go hell for leather on genuine banking reform. Argue, cajole and insist, Mr Clegg. Threaten to bring the Government down if you have to. But [ultra transparency] needs to happen and someone needs to get it done. There really is no alternative.

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