US/UK Reading From the Same Financial Hymn Book on "Too Big to Fail"

by Karl Hindle - London, U.K.

My colleague, Lisa Valentine, reported on Friday the U.S. Treasury proposals containing a 5-point plan for protecting the taxpayer from losses and the cost of bailing out failing financial institutions. U.S. Treasury Secretary Tim Geithner made the announcement of proposed reforms earlier this week, but at the same time, across the Pond, Prime Minister Brown was making similar remarks after a two-day G20 meeting in Scotland stating taxpayers should be protected from the cost of bank failure through a new “social contract” with the financial sector.

You can read Lisa Velentine's report here

It is clear that the “Too Big To Fail” mentality is being challenged on both sides of the Atlantic, and in some respects represents a major step forward in US regulatory thinking. While Geithner's 5-point reform plan is not altogether relevant to the UK situation, the short and sweet reform number 5 asking for the power to restructure or downsize a bank's operations echoes very strongly the UK approach advocated so strongly and eloquently by Mervyn King, Governor of the Bank of England.

With the announcement of new UK High Street banks being launched from assets acquired during the financial crisis, the British government appears to be taking the view that by increasing competition and creating smaller institutions, this will stop the problem of banks being “too big to fail” - a case of “divide and regulate”.

The problem is we already have banks that have long considered themselves too big to fail such as Barclays, HSBC, Lloyds and RBS (the last two are now majority owned by the British taxpayer). By creating a second division of smaller banks, we are not addressing the issues of those behemoths already interwoven into the fabric of the economy.

The answer appears to be more regulation, more pertinently, more legislation – either banks must be broken up into smaller components or “firewalls” imposed between the deposit-taking and risk-taking functions of the banks.

Which is it going to be - “divide and regulate” or impose Glass-Steagall controls?

Are these two simply different ways of putting the same argument forward?

Smaller banks will not command the financial resources of larger banks, and in turn this will not support the operations of risk-taking activities including hedge funds. It is the same thing to break up banks so they cannot operate risk-taking activities as it is to impose firewalls in a large bank. It is simple separation of the activity of deposit taking from risk-taking ventures no matter what you call it.

How does this lead to greater regulation and legislation in future?

For over 20 years, London and New York have been running a deregulation race against each other as they vied for the title of global financial centre. The dismantling of the apparatus our financial forefathers put in place, to guard against the very financial crisis we have just come through, is set to make a comeback no matter what form it takes.

Prime Minister Brown's closing statement at the G20 Summit meeting this week is telling:

“Strengthened regulation and supervision must promote propriety, integrity and transparency; guard against risk across the financial system; dampen rather than amplify the financial and economic cycle; reduce reliance on inappropriately risky sources of financing; and discourage excessive risk-taking.”

Note the future tense of “strengthened regulation”, and coming on the heels of Geithner's 5-point reform plan, as the song goes, “You ain't seen nothing yet!”