Tuesday, January 26, 2010

Alastair Darling Is Right- Sign Of The End Times?

He certainly seems more right than either the Obama administration or George Osborne:

“It is always difficult to say ex ante that you would never intervene to save a particular sort of bank,” he said. “In Lehman, for example, there wasn’t a single retail deposit, but the then American administration allowed it to go down and that brought the rest of the system down on the back of it.

“You could end up dividing institutions and making them separate legal entities but that isn’t the point. The point is the connectivity between them in relation to their financial transactions.

“Equally, the large-small thing doesn’t run. Northern Rock was very small in global terms but systemically it was quite important when it got into trouble.”

Breaking up banks into smaller entities isn't going to prevent one bank collapse destabilising the rest. If small banks were the solution to economic stability then the Great Depression with it's unit banking laws and a separation of commercial and investment banking ought to have been a golden age, which as the term "Great Depression" it really was not.

1 comment:

TDK said...

Breaking up banks into smaller entities isn't going to prevent one bank collapse destabilising the rest.

There is no infallible way to arrange things to avoid hubris.

There's a lot been written on why the policies of the Roosevelt era prolonged the Depression. That being so, it is surely difficult to disentangle the banks performance from background events. It may not have been "separation" that held the banks back.

The recent problem with the banks is that they all invested in each other. If one bank fell then the capital owned by a second bank would become worthless. That second bank would then become technically insolvent. It seems logical to suppose that if banks were smaller then the loss arising from one failure would be easier to absorb.

The problem resulted not from banks alone but from multiple factors. One being the housing bubble which was going to end at some point anyway. That was tied in with government pressure in the UK and US to loan money to marginal cases because it was thought to be a "good thing". A second factor was the Basel II rules which forced banks to continually revalue their assets. That meant that when sub prime loans were regarded as a good investment that had the effect of making the bank's position look better than it was in reality and when sub prime dropped in value made it appear much worse. Add in gearing and the losses became astronomical. It is said that under pre-Basel II rules Northern Rock would not have failed.

In other words the sub prime crisis was not a problem of a particular bank but a failure of the system. The immature people blame this on greed and the bonus culture and imagine that some benign elite can devise rules to prevent hubris. Presumably this will be the same people who devised the Basel II rules that saved us last time or who thought it a good idea to create or allow a housing bubble.