You know how it is when you have two friends who you know really ought to get along, but just don't. They share many of the same ideas and beliefs; in a parallel universe they would be the best of friends. But for some reason you can't put your finger on they just don't see eye to eye. It is a feeling I can't get out of my head about Mervyn King and Lord Turner (pictured together left). Having listened to both of their views on what needs to be done to the biggest banks in order to ensure the financial system is more healthy and functioning in the future, I can't help but think all this needs is to bash their heads together a couple of times and they will pretty much agree with each other. As I alluded to in my column this morning, the fact is that despite all the rhetoric from both of them (Turner in his discussion paper today, King in his speech on Tuesday night) they are both after the same end: to have a banking system in which it becomes impossible to have one institution that is either too big to fail or, worse still, too big to save. In their hearts they want smaller banks with more clearly defined purposes. Where they differ is in the means by which this will be done. Whereas King appears to favour a pretty direct, straightforward approach, potentially creating a law to lay down boundaries between what constitutes a simple high street bank and what an investment bank is, Turner would rather impose such significant capital and liquidity restraints on the biggest banks to encourage them to do the breaking up themselves. The upshot would still be similar: in the end, many of the bigger banks (or, to be more precise, their shareholders) would be incentivized to slice themselves up into smaller parts, perhaps ensuring their prop trading function is separate from their consumer banking arm. – Telegraph
Dominant Social Theme: Smaller is better.
Free-Market Analysis: So the idea is that smaller banks will take less risk. In America this concept was codified as Glass-Steagall and investment and commercial banks were split off from each other. In Britain, this bifurcation was never fully achieved. Thus it is we wonder if the issue is really big banks, small banks, investment banks or commercial banks. We have a feeling it is something else entirely – an issue that rests squarely with the activity of the central bank, in this case the Federal Reserve.
The Federal Reserve is one of the world's most active central banks and to date the world's most powerful. It is the Fed that prints the high-powered money that makes the world move and the global economy grind along to the degree that it does. And it is America's banking sector that feels the disproportionate brunt of the Fed's actions and over-the-top money printing. It is not, in our opinion, profligate commercial and investment banks that made the current mess. They were victims, to a degree (institutionally speaking anyway)
The temptation is always to blame inadequate regulation for what regularly occurs in the markets. Because central banking is such an important and protected activity, fingers are pointed in a million different directions. Back in the 1930s, it was thought that big banks would have to be broken up by function, and they were in America anyway.
Now in both America and Britain, there is talk of breaking up banks into discrete functions. America's Paul Volcker, the tough guy of the 1970's Fed is said to be backing a re-division of commercial and investment banks. This is silly because it is not the banks that are at fault. Central bank money-printing fools banks into issuing credit for bad projects as well as good ones. Toward the end of a bubble, even worse decisions are made. People naturally assume that credit markets take into account the variables necessary for good decisions. But what if the market itself is signaling buy when in fact the signals are a sham, based on excessive money printing?
We remember the finger pointing that took place recently between Republicans and Democrats in the states regarding who was to blame for the latest financial crisis. It was said as it has been said before, that lack of proper regulation was at the heart of the debacle. But regulations have only one constant: They change over time whereas central banking money stimulation remains same.
It is the ability to print huge amounts of unnecessary money, thus distorting the entire economic system that is responsible for the current global difficulties. A private gold and silver standard, market-based, would provide the solution, not further tinkering with various structures. In fact, absent central banking monetary stimulation, the banking industry itself would subside and become far less important in the scheme of things. Then Western leaders wouldn't have to pay so much attention to it.
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