The deep recession of 2008-09 is almost over for the developed countries. The UK, the weakest of the lot, has just come in with a 0.1% GDP growth for the last quarter of 2009. But the other crisis?the financial meltdown?has yet to be dealt with. While we knew how to take care of the recession thanks to Keynesian lessons, the financial meltdown was not in any of the macroeconomic models. It is not part of Keynes?s General Theory either. Thus, there had to be a lot of innovation in the way the governments tackled the banking crisis.
They did innovate a lot. Thus, bank recapitalisation was invented on the spot. Banks were not nationalised (Northern Rock excepted), but their equity was bought in return for the money they received. This equity can be sold when the banks? shares recover and taxpayers can enjoy a profit on their timely intervention. Banks themselves have been eager to repay these loans since they wish to be free of constraints on their behaviour. This has been most successful in the US.
Yet the politics of the bank bailouts has not been played out. Voters are angry that while they always get a brush-off from governments when it comes to their modest demands for relief, banks have had the floodgates opened to them. Banks have not helped themselves by resuming their large bonuses. So, taxpayers want some drastic reforms of the banks to prevent a repeat of the crisis. The main emphasis is on seeing that banks are never again ?too big to fail?.
European governments would like the banks to agree to some sort of ?living will?, which will alert them to the possibility that when they are about to fail they can be dismembered in an orderly fashion and not rescued entirely. This means that banks agree that getting too large is their fault and if that leads to death, so be it. This does not require banks to change what they do but just to become more responsible for their failures.
Americans have taken a different route. Until 1999, they did not allow banks to indulge in activities such as investment banking, trading on account, hedge fund management but only deposit taking and loans on strictly commercial basis. This was because banks were regulated by the Glass-Steagall Act of the New Deal era. President Obama has been advised by Paul Volcker, the former Fed chairman, to revert to the pre-1999 days. This means that if banks want to enjoy the facilities of the Fed?s window then they must be small and focused.
This is a drastic reform since banks have enjoyed an enormous growth since 1999 when the Glass-Steagall restrictions were lifted. But Europeans do not mind their banks being universal multi-function banks. European banks operating in the US will also face the same rules and may have to dismantle themselves. Europeans are angry that the Americans are not coordinating their banking reform with them. But the Americans had until 1999 a different system with small banks and no branch banking allowed across state lines. They had hundreds of banks, mostly small. They also have a long-run distrust of banks embedded in their politics.
Obama will get what he wants with difficulty since Congress has its own plans for banking reform. But if the US can successfully reverse the clock and force specialisation on the banks this may mitigate the chance of future meltdown. Europeans are relying on new regulatory structures since they have to reconcile many more traditions of how banks are viewed in their politics.
What seems to be agreed is that there should be some payback by the banks. The UK has proposed a tax on bonuses and the French are happy to follow. There are proposals for some sort of transaction tax?Tobin tax for instance on forex transactions?across all countries, which may lessen the likelihood of excessive risk-taking behaviour. Tobin tax used to be treated as an NGO hang-up and rejected by practical policymakers. But the anger is such that it may be implemented. What is more, the counter-terrorism legislation against money laundering has provided the tools for implementing a Tobin tax.
Thus, the meltdown may yet have a positive outcome. But one needs to recall that meltdowns have happened before even when banks were small.
After all, that is how central banking got invented in the mid-19th century. Thus, all we may accomplish is to prevent the last crisis. The next one will surprise us again.
The author is a prominent economist and Labour peer