David Cameron: In the pocket of the banks?

In the annual Mansion House speech, UK Prime Minister David Cameron attacked critics of the UK's banks.

Your humble blogger finds this surprising and more than a little troubling as from this side of the Atlantic the preponderance of evidence appears to support the critics.

From a Guardian article on the speech,

David Cameron gave a warning on Monday night that critics of the nation's banks "end up trashing Britain" as he mounted a strong defence of the financial services industry.

There are several problems with Mr. Cameron's observation.

First, the UK and its banks are not synonymous.  If any country is it would be Switzerland.

Second, criticizing the banks for activities like manipulating Libor is certainly not trashing Britain.  In fact, criticizing this type of behavior suggests that Britain sets a far higher standard for what is acceptable behavior.  

Third, by defending the banks, Mr. Cameron has sent the unmistakable message that he has no intention of pushing through regulatory reforms that the banks do not approve.

In his annual Mansion House speech, which is normally devoted to foreign policy, the prime minister took a swipe at the likes of the Liberal Democrat peer Lord Oakeshott, who regularly lambast Britain's banks.

The way to silence the critics it to make the UK banks the model that everyone would want to emulate.

Cameron acknowledged that "terrible mistakes" had been made in the City, but he pointed out that financial services contributed an eighth of all government revenue during the recession.

I think it was two years into the crisis that the Bank of England's Andrew Haldane attempted to estimate the global cost of the financial crisis.  He estimated the cost as somewhere between $4 and $60 trillion.

Given the UK's prominent role in the global financial system, it is reasonable to assume that the UK incurred a cost (think bailout of banks, loss of earnings on savings from zero interest rate policies, lower economic growth, ...).

In fact, it is entirely possible, some might say highly likely, that the cost of the financial crisis to the UK exceeds all of the tax revenue that the financial services sector has paid since the sector was first taxed.

Hence, it is entirely unclear why the UK needs a financial sector that is as big as it currently is (the same could be said about the US too).

"Yes, some utterly terrible mistakes were made and they need to be addressed properly so they can never happen again," he told his City audience.

Manipulating Libor was not a mistake.  It was intentional.

Mis-selling payment protection insurance was not a mistake.  It was intentional.

Requiring unsophisticated borrowers to enter into an interest rate swap was not a mistake.  It was intentional.

Since the beginning of the financial crisis, your humble blogger has maintained that the difference between banks made "mistakes" and banks "intentionally" engaged in bad behavior was opacity.  Opacity provide the veil the bankers hid behind while they intentionally took advantage of other market participants.

"But those who think the answer is just to trash the banks would end up trashing Britain. I say recognise the enormous strength and potential of our financial sector; regulate it properly and get behind it."

The prime minister said the government was introducing tough penalties for those in the financial services industry who break the law and the most transparent rules of the world's leading financial centres on pay and bonuses. 

He also highlighted the government's plans to implement the recommendations of the Vickers report which will ring-fence retail banking from the riskier investment banking.

None of Mr. Cameron's proposed reforms addresses the opacity in the financial system that the bankers use to their advantage.

In fact, the reforms make the financial system even more opaque.  Take ring-fencing for example.  Imagine how complicated the rules for implementing ring-fencing will ultimately be.

Mr. Cameron's proposed reforms substitute complex rules/regulations and regulatory oversight for transparency and market discipline.

With the current financial crisis, we saw that substituting complex rules/regulations and regulatory oversight for transparency and market discipline didn't work.  In fact, the opacity caused by the complex rules/regulations and regulatory oversight made the financial system more prone to crashes.

The fact that opacity in the financial system is not being addressed (and here I am talking about valuation and not price transparency) strongly suggests that the banks and their lobbyists have pre-approved the list of proposed reforms and that the financial sector will not be properly regulated.