A return to financial health is simple: Glass Steagall plus transparency

Financial regulation in the wake of the credit crisis is a simpler matter than the re-moralising advocated by Roger Scruton (Unreal Estates). Simply return to the regulatory environment pre-1999 and press on with transparency in markets
Michael Bullen
16 September 2011

Roger Scruton writes (Unreal Estate) of the need for a re-moralised economy and of changing attitudes, over the years, concerning how a moral economy may best be achieved: from the economic statism of post-war Britain to the Thatcherite revolution, and even to the views of the Prophet. He focuses on the moral requirement to repay money that you borrow and suggests that, with current high debt levels in Europe and elsewhere, we are witnessing a "demoralisation of economic life": however, if this is the case, demoralisation of economic life with respect to sovereign debt is nothing new. There is a long and ignoble tradition of states reneging on debt obligations long before British statism or Thatcherism and perhaps even before the Prophet. What does seem to be a new experience is that so many countries have such high debt levels all at the same time. 

It is uncontroversial to be frustrated by, and even to despair at, the actions of politicians who allowed or were complicit in allowing these high levels of debt to be reached. One may have more sympathy towards some nations than to others, but repaying the debts, even for those nations that are willing and able to do it, will almost certainly take decades: however, Roger also suggests that the trading of bonds is somehow tied in with demoralisation, commenting that "the Prophet was appalled by the sale and purchase of unreal things" and that "debts are no longer regarded as obligations to be met, but as assets to be traded."

It is not clear to me from Roger's article what specific measures he would propose in order to return to a more moral economy. One presumes he would like to see greater effort on the part of political elites and other policy makers to repay the debts as early as possible. However, he does say, in respect of "bubbles of the kind that we have recently seen" that "I suspect...the search for regulations that would prevent them is a futile use of public funds and political energy".

In my view it is enormously difficult to plan a return to what some may view to be a moralised economy. One major difficulty will be in gaining general agreement on what exactly it  constitutes. How to get there will present further difficulties. Roger refers to the Prophet, but it is not clear to me that economies following Islamic financial codes are any more moralised than those that do not, nor are they immune to the economic forces that have caused difficulties for Western and other economies. The economy of Dubai has proved that.

I prefer to focus on measures that can and should be taken even in the event that no such return to a moralised economy  may be envisaged. In particular, there are 2 measures that policy makers must take in order to return to a more secure world economy. Firstly, I disagree with Roger with respect to regulations: in my view, key components to the credit and banking crises in the US and UK were the repeal of the Glass Steagall Act by President Clinton in 1999 and the enactment of the Financial Services and Markets Act in 2000, leading to the introduction of "light touch" regulation in the UK. The new regulatory regime in the US allowed Lehman Brothers to rack up leverage of 30.7 times (probably heavily window-dressed) in its last annual financial statements; and enabled commercial banks to take high risk trading positions in mortgage bond portfolios that would not have been permitted prior to the repeal of Glass Steagall and leading to the failure and near-failure of numerous banks. 

The trend for US commercial banks to take investment banking positions onto their balance sheets was followed in Continental Europe, particularly in Germany and Switzerland and with entirely predictable results.

The much-vaunted "light touch" system in the UK enabled banks such as HBOS and Bradford and Bingley to increase their balance sheets substantially by borrowing funds on international money markets where previously they had been restricted to relying upon their traditional deposit bases. When the international money markets dried up after the collapse of Lehman, HBOS and Bradford and Bingley, among others, went to the wall. The "light touch" regime also allowed UK banks to compete for new mortgage business by offering 125% mortgages, where 95% had previously been the normal ceiling, and allowed mortgages on greater multiples of income than under the previous regime. Countries that did not follow the trend towards reduced regulation and where banks were still regulated under more traditional regimes, such as Australia and Canada, did not encounter housing bubbles or banking industry collapses.

The second measure must be to maintain levels of market transparency and to make improvements where possible. In particular, it is vitally important that sovereign debt should be openly traded. The problems of political profligacy and dishonesty in Greece were first brought to light, not by Greek politicians, not by the EU, not by political or economic journalists, but by traders in international government bond markets who sold Greek debt, and bought protection on other positions, in response to persistent rumours of irregularities in Greek national finances. Local politicians protested vehemently that the Greek economy was being attacked by speculators (always a favoured response for troubled politicians) and Greek Prime Minister Papandreou went on a world tour to drum up support for his "anti-speculator" position. Subsequently it was revealed that there was little evidence of speculation and that much of the trading was by holders of Greek bonds unwinding or hedging their exposures.

It is clear to me that we need more openness in financial markets, not less, and that any measure that holds politicians to account for their actions must be a good thing, whether that measure involves openness of government bond trading or, for example, investigations into alleged secret deals with American investment banks designed to hide massive and unreported indebtedness. Greece is not on the verge of national bankruptcy because investors in Greek bonds sold or hedged their exposures, Greece is in that position because a political culture of lies and deception developed over a period of a number of years. The international government bond market helped to expose that culture.

As an aside, current calls within the EU from Messrs Papandreou and Barroso, among others, for Eurozone bonds to be backed by all nations that are members of the euro can only lead to reduced transparency of national accounting and indebtedness and must be rejected if the Eurozone economy is not to be further compromised by the type of political deceptions that led to the current crisis..


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