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Sleepwalking into the next financial crisis

venetian maskIt is almost incredible that a nation like ours – which prides itself on being rational, committed to public debate, willing to learn from past mistakes – can be drifting towards the next financial crash with eyes wide shut. Several events in the last few weeks cannot be explained in any other way. The Vickers Commission on Banking passed up the once-in-a-generation opportunity to split the retail arm of the banks from the investment arm, with no implicit taxpayer guarantee for the latter, so that no bank would be too big to fail and there would be no bailout for reckless speculation. The Vickers cop-out means we have learnt nothing: it will still next time be a huge bail-out or systemic collapse. There have been no checks imposed on bankers’ pay or bonuses, no deterrent to their recklessness, no increase in bank lending to businesses, no constraints on taxic derivatives, no regulation of the credit-rating agencies to remove conflict of interest, no action taken against offshoring or tax havens. But that’s not all.

We’ve now been warned by the Financial Stability Board, the global financial watchdog, that the sudden vast growth of exchange traded funds (ETFs) into a $1.2 trillion business now poses a new risk to global financial stability uncannily similar to the derivatives market in sub-prime mortgages that heralded the worldwide crash in 2008. Pension funds and retail investors have been drawn heavily into these schemes with the promise of low costs and high returns, especially into the soaring commodity markets with huge returns from repidly rising oil, gold and silver prices. The fear is that ETFs will pursue the same route as mortgage-backed securities, being packaged and sold on in bundles across the world, yet as opaque as securitised derivatives, but with excessive leverage to increase returns. Yet the warnings are being ignored, and nothing is being done to prevent or head off the utterly predictable next crisis.

The real cause of the last crash was that the bankers didn’t know the risks they were taking. They still don’t appreciate the risks of the next round of the securitisation carousel, or else are ignoring them because the profits from playing the game until the next crash occurs are just too great to miss – exactly what happened last time round. No measures are being put in place to control investment banks’ in-house hedge funds. No finance minister seems to understand that eliminating all barriers between different types of banking has increased the fragility of the finance system by making it more homogeneous. Like the Bourbons, we seem to have learnt nothing.

2 Comments

  1. admin says:

    John Redwood MP has commented on this post. He says:

    Michael Meacher today claims there will be another financial crisis owing to the failure of John Vickers to recommend the splitting of investment and retail banks, and owing to the growth of exchange traded funds.

    I think he is looking in the wrong direction for future financial problems. Most informed commentators are concerned about the state of the public finances in a number of countries, and the impact on banks who own large quantities of government bonds if some of those countries default or move to substantially higher interest rates under market pressures.

    The failure to split investment from retail banking is not going to bring the system down. Large retail banks need careful regulating even without investment banking arms. Northern Rock and Lehmans were segregated. Most Exchange Traded Funds are owned by pension funds, charities and individuals who do not borrow to buy them, and most Exchange Traded Funds are ungeared portfolios of shares. Such ungeared investments did no damage to the system in 2007-9 and there is no reason why they should in the future.

  2. Graham Milne says:

    ‘The real cause of the last crash was that the bankers didn’t know the risks they were taking.’

    This is not correct. The bankers knew the risks and there were plenty of warning signs, it was just that there was no sanction (punishment) for not taking those risks or not reporting them (including by the auditors) – plus there were huge personal rewards for taking those risks. The key is therefore the lack of effective punishment. You can have as many rules as you like but if there is no punishment for breaking those rules then they are completely useless. And because no effective sanctions have been implemented in the wake of the last financial crisis, the conditions for the next financial crisis remain. Both Michael Meecher and John Redwood have missed this crucial point.

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