FT Proposes Financial Regulation For The Long-Term

Today and in the weeks ahead, market participants and policymakers will be consumed by Treasury’s plan to bring liquidity to the markets. But even Henry Paulson acknowledged in his proposal statement that financial regulation must be modernized. The Financial Times yesterday proposed some specific regulatory ideas:

First, the independent investment bank, as a business model, is over. Much more capital, of the kind boasted by big universal banks, is needed if you want to take the kind of risks the investment banks have been taking.

Second, the model that will emerge triumphant will look a lot like a traditional commercial bank, built around deposit-taking and strong balance sheets, with lending decisions taken by humans, not markets. Among the few winners from this crisis are Bank of America (which won Merrill Lynch), and Lloyds TSB, which gets HBOS for a knockdown price.

Third, the market for credit derivatives – swaps of debts between banks that created a myriad of financial relationships – is also dead in its current form. Any doubt about this was extinguished when the US swallowed hard and spent $85bn of US taxpayers’ money to rescue American International Group only two days after it had tried to draw a line in the sand by refusing to bail out Lehman.

Why? AIG was more central to the credit derivatives market. This proves beyond doubt that credit derivatives were too important to be left unregulated: if this market is to be reinvented, it will be based on some kind of exchange.

Fourth, the fate of New York as the unquestioned capital of global finance is sealed. And London’s pretensions to take over are dead. Not even two years ago, London was trumpeting the success of its “light-touch” financial regulation, and Wall Streeters complained of over-regulation. Such claims now seem both distasteful and foolish.

Finally, the regulation system that has overseen the globalisation of finance for the past decade has, beyond doubt, failed. It must be replaced, with something more intrusive. That means the profitability of the financial services industry, even if the US can bail out its worst excesses, will stay below the levels that it had been enjoying, probably for a generation. We now see, beyond doubt, that banks are a public utility and must be treated as such.