Say farewell to gentlemanly
capitalism Tim Curzon Price foresees a new era in which finance will be as tightly regulated as pharmaceuticals Ever since social arrangements became complex enough to write into laws, we have regulated the behaviours that have the potential to mess up our common lives. Look at the Book of Deuteronomy. It’s all there: health and safety (diet and hygiene), taxation, bankruptcy, neighbourly envy, sexual conduct... and finance too. The Old Testament is pretty draconian: no lending for interest within the tribe — but as much as you like outside the tribe. Lawmakers understood even then that easy credit, with its potential to exploit gullible optimism and generate bubbles, could rock a society to its core.
The 21st century’s first credit crisis is not over, but the acute phase is now understood. Financial institutions are laden with untradable, badly priced debt that they can’t resell. Governments everywhere have shown that they’ll do anything to avert a confidence run on the whole system. Liquidity is being pumped in, and the immediate cost is coming in the form of increased inflation. All that money chasing goods that not even Chinese factory capacity can provide fast enough means higher prices. Inflation is a stealth tax — it hits those who can’t negotiate their incomes upwards in line with prices, such as pensioners on fixed annuities, the subsistence poor and anyone else who is outside the developed world’s commercial economy.
The history of financial regulation since Moses’s day has been a generational cycle of loosening, crisis, tightening; loosening, crisis, tightening. We’re about to get down to some serious tightening again. Alan Greenspan, now less the guru and more the pied piper who enchanted us into the magical realm of ever-increasing asset prices, worriedly noted two weeks ago: ‘Those of us who look to the self-interest of lending institutions to protect shareholder equity have to be in a state of shocked disbelief... But I hope that one of the casualties will not be reliance... on financial self-regulation.’ Greenspan is about to have his hope disappointed. Banking will come out of this crisis looking like a regulated utility. Something like this last hit banking in 1929: US legislators of that era set the scene for finance through to the Thatcher–Reagan deregulations of the 1980s. The Glass–Steagall Act of 1933 separated commercial and investment banking. The idea was that consumers needed the protection of regulation and social insurance for deposits. Corporations, and the rich, could go to the lightly regulated investment banks for grown-up caveat emptor business among consenting adults. This sector would not be given the guarantees of bailouts, and in exchange it could be lightly regulated.
We now know the history of that cycle. A first generation of financiers, shame-faced and in political disgrace, made modest fortunes out of the public eye and by respecting the new constraints of their trade. The next generation, trained by their timid predecessors, strained at the leash of regulation; they grew bold, dabbled in unregulated Eurodollar markets and forced the end of the Bretton Woods monetary system and dollargold convertibility. This is the generation that offered support and expertise to Reagan and Thatcher when banking deregulation made it on to the political agenda. In Britain, it is the generation that enjoyed the first fruits of the brave new world after Big Bang in 1986.
The third generation, at the peak of their careers today, grew up to understand the true spirit of deregulation — even so far as to push it beyond the spirit, if not the letter, of the law in constructing Byzantine off-balance sheet structures, like Northern Rock’s Granite, that allowed regulated banks effectively limitless capacity to lend money. Limitless capacity created limitless desire, leading to all the perverse incentives to missell we have now discovered.
So should we just roll back the deregulation of the 1980s? Should mortgages, consumer banking, pensions and credit cards all become hyper-regulated, with products, fees and terms approved by the state — while the rich, the risk-loving and the corporate live by their wits in hedge-fund heaven? In this scenario, consumer-facing regulated banking grows to look like selling drugs to the NHS: risk-averse, innovation-shy, bureaucratic. But the unregulated alternative is more like drug-dealing in a dark alley: dangerous, and sometimes delivering real highs.
Such a settlement seems to offer social pooling of risks in sensitive sectors, while giving a place for the huge global flows of modern finance. It promises to preserve both the consumer and the City.
But the trouble with this solution for today is moral hazard, which occurs whenever a contract sets up a temptation to misbehave — pretending your camera was stolen while on holiday in order to claim it on your insurance was a popular form when I was a student. Moral hazard occurs once morality has gone out of the window. In 1929, perhaps the state could still rely on gentlemanly capitalists, but today we will have to address the root cause of moral hazard: the ultimate insurance policy of the taxpayers’ guarantee that whatever banking does, it will be bailed out. This crisis has shown us that the supposedly grown-up bit of the banking industry actually operates with the social safety net of system stability. It is too big to fail, and it is no longer — if it ever really was — gentlemanly enough to stay within its bounds.
So goodbye, gentlemanly capitalism; goodbye, light regulation. The two were inextricably linked. What will the state now do? It will deem that any transaction which might benefit from the ultimate guarantee of taxpayer bail-out through ‘lender of last resort’ or ‘buyer of last resort’ shall be completely regulated, from beginning to end. The fees earned, the prices charged, the identity of the parties and the value of the asset — all these will be subject to regulatory disclosure and control. Darling and Brown will implement this to improve their chance of winning the next election; Obama or Clinton or McCain will do it to deliver on campaign promises.
Think of the new world of finance that will emerge as being like the pharmaceutical industry. The snake-oil salesmen of old sold dreams of a healthy future. We insured ourselves against our collective gullibility by hyper-regulating medicine. New products take 17 years to gain regulatory approval; they go through testing in every detail; their use is constantly monitored; quack doctors get struck off. Companies like GlaxoSmithKline have one foot in the laboratory, the other in the regulator’s anteroom. It is honest business and very rewarding, but without much cut and thrust. Subprime has revealed the snake-oil nature of today’s ungentlemanly finance. We have models for dealing with the mis-selling of dreams for huge private gain. Not as draconian as Deuteronomy, but it will feel dull.
So what will happen to the City, its star traders and bright quants? The best thing about tighter regulation will be an end to the gross misallocation of talent that the financial boom has witnessed. These competitive, intelligent, driven people can at last be freed to do better. What would Britain rather have created these last ten years — Granite or Google?
Tony Curzon Price is editor-in-chief of openDemocracy.
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