bounce back wednesday..

Mervyn King’s Speech in Edinburgh to Scottish business organisations.:
“
The second approach rejects the idea that some institutions should be allowed to become
“too important to fail”. Instead of asking who should perform what regulation, it asks
why we regulate banks. It draws a clear distinction between different activities that
banks undertake. The banking system provides two crucial services to the rest of the
economy: providing companies and households a ready means by which they can make
payments for goods and services and intermediating flows of savings to finance
investment. Those are the utility aspects of banking where we all have a common interest
in ensuring continuity of service. And for this reason they are quite different in nature
from some of the riskier financial activities that banks undertake, such as proprietary
trading.
In other industries we separate those functions that are utility in nature – and are
regulated – from those that can safely be left to the discipline of the market. The second
approach adapts those insights to the regulation of banking. At one end of the spectrum
is the proposal for “narrow banks”, recently revived by John Kay, which would separate
totally the provision of payments services from the creation of risky assets. In that way
deposits are guaranteed. At the other is the proposal in the G30 report by Paul Volcker,
former Chairman of the Federal Reserve, to separate proprietary trading from retail
banking. The common element is the aim of restricting government guarantees to utility
banking.
There are those who claim that such proposals are impractical. It is hard to see why.
Existing prudential regulation makes distinctions between different types of banking
activities when determining capital requirements. What does seem impractical, however,
are the current arrangements. Anyone who proposed giving government guarantees to
retail depositors and other creditors, and then suggested that such funding could be used
to finance highly risky and speculative activities, would be thought rather unworldly. But
that is where we now are.
“
The whole of this “gem” is here:
http://www.bankofengland.co.uk/publications/speeches/2009/speech406.pdf
The elements that this speech neglects and brushes over are precisely the counterpoint that such regulation would be impractical. It doesn’t address the potential side effects. It seem truly “unworldly” to believe that a separation of deposit taking and financial intermediation from propriety trading is possible. The distinction between prop trading and intermediation is totally artificial, ultimately banks make a profit from taking a risk, whether that risk is whether a borrower defaults on a mortgage or GBP/USD realized vol is lower than implied is irrelevant.
Utility Banks would still have to take deposits and invest them, so the question remains in WHAT? They’d clearly still be able to invest them in risky assets, after all there is no such thing as a riskless asset that earns a return, even government bonds have some degree of risk. Let us for a moment assume that all deposits are to be held in government bonds, where would borrowers source their capital from? Neglect the fact savers would receive a far lower interest rate on their savings (which would in turn reduce the savings ratio that Mr. King wishes to increase, now??), it would simply mean that the government took the role of deciding who to extend credit to and this pundit finds it even more “unworldly” that the government would optimally allocate capital without a hugely partisan agenda.
Does anyone for a minute believe that the government in the UK wouldn’t have made enormous sub-prime loans in the UK to first time buyers when the property market was at its peak?
His speech fails to really address the reason that the state guarantees retail deposits at all, after all the people that were taking risk that got rewarded for their failure were retail depositors in institutions such as Northern Rock. They went after 1% more interest rate and got a government guarantee, perhaps the politicians should asking for a claw back of interest payments above the BoE benchmark rate?
Other economists (real economists, not wannabe but failed idiots sitting at the central bank) make the case clearly that depositors have to be bailed out otherwise there is a total breakdown in the velocity of money, that people essentially hoard their capital, refusing to spend or lend it, which clearly kills demand and creates a depression. So the question should really be, who benefits from not having a depression? Generally that’s going to be the taxpayer...