Banks: utilities or casinos?

by | Apr 3, 2009

I was at a very interesting little conference at the Liberal Club yesterday, on the ‘future of the financial industry’.

The first speaker was Vince Cable, who added his voice to those, like Martin Wolf of the FT and Mohammad El-Erian of Pimco, who say banks should become, or are on their way to becoming, more like utilities than glamorous investment vehicles.

Cable basically suggested a two-tier banking system: some retail banks would be considered crucial to the payment system and the economy, and thus ‘too big to fail’. They would be managed like electricity utilities, with very strict regulation, and owned, he suggested, through some form of public-private partnership, or as mutuals.

Any other financial players would be treated like hedge funds, and ‘would have no claim on tax-payers’ money should they fail’.

Bank of England governor Mervyn King weighed up the pros and cons of a similar model in a speech to a group of bankers on March 16:

“There are good arguments in favour – to separate the utility functions of a retail bank taking household deposits and running the payments system from the casino trading of an investment bank, and good arguments against – the difficulty of maintaining a credible boundary between those institutions that are eligible to receive government support and those that are not.”

Martin Wolf is in favour either of a complete utility model, or of mechanisms to let big banks fail :

The UK government has to make a decision. If it believes that costly bail-out must be piled upon ever more costly bail-out, then the banking system can never be treated as a commercial activity again: it is a regulated utility – end of story. If the government does want it to be a commercial activity, then defaults are necessary, as some now argue. Take your pick. But do not believe you can have both. The UK cannot afford it.

Adair Turner, formerly a senior advisor to Merrill Lynch (before it had to be rescued by the US Treasury) rejected this division of banks into those we let fail and those that don’t, in his recent report. He came out instead in favour of banks putting aside more capital in the good times, to act as a buffer in the bad.

I asked Cable if he thought the government was fudging the essential unfairness of the present system, whereby banks have repeatedly kept the profits and socialised their losses:

“Yes, the government and Turner are turning their face away from the problem. At the moment, the system is obviously unfair. But the government wants to muddle through with it anyway. Turner’s argument is that hedge funds can grow so big that they acquire systematic importance and have to be bailed out.”

This is true – look at the example of Long Term Capital Management, the enormous hedge fund which threatened the stability of Wall Street when it went bust in 1998, because of the emerging market crises, and had to be supported by the Fed.

At the same time, hedge funds were then (and are today) unregulated. They are now going to be much more actively regulated by the FSA and SEC.This could prevent the rapid unsupervised growth of funds like LTCM – the FSA could have the power to intervene, and rein in the organisation’s balance sheet.

It seems to me that banks and hedge funds have enjoyed the largesse of tax-payers for far, far too long. It’s not just 2008: in the last 30 years, they’ve been bailed out during the 1998 crises (via the IMF), during the Latin American debt crisis (via Brady Bonds), and during the Savings and Loans crisis. They chronically over-extend themselves, and then turn to their friends at the Treasury and IMF for a bail-out, while tax-payers – whether in emerging markets or at home – shoulder the cost and the suffering.

Who is the bigger fool – the banks, for repeatedly getting into serious debt problems, or us, for repeatedly giving them the tax-payers’ money to go off and do it again?


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    Jules Evans is a freelance journalist and writer, who covers two main areas: philosophy and psychology (for publications including The Times, Psychologies, New Statesman and his website, Philosophy for Life), and emerging markets (for publications including The Spectator, Economist, Times, Euromoney and Financial News).

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