Terry Murden: Obama's reforms risk creating banks that like to say no

Published on Saturday 23 January 2010 13:17

PRESIDENT Barack Obama has picked a fight with the banking sector that is in danger of creating more problems than it solves.

For a start, the global nature of banking makes it particularly difficult to introduce change without co-operation from other nations.

The G20 may have pledged to work together, but co-ordinated action is rarely achieved. Just ask those who attended the Copenhagen summit on climate change.

The British government has imposed its own clampdown on the banks, but is resisting measures that simply copy the Obama blueprint, and Lord Myners, the treasury minister, has pointed out that the problems that struck down the British banks did not concern those activities that Obama's reforms would address.

The financial sector itself is clearly unhappy at what is proposed. Reaction has been particularly vicious among fund managers, brokers and economists, who have denounced the plans as potentially dangerous and a risk to economic recovery. One warned of the banks moving their operations to the Far East.

The threat of a "Glass-Steagall" type of separation of deposit-taking banks from casino-style investment banking activity, is now hanging over the sector. America's Glass-Steagall Act kept the two separate in the 1930s but it was repealed by President Bill Clinton, a move seen as a root of the crisis because it allowed normally sedate banks to venture into risk-taking activities that got out of hand.

Mervyn King, Governor of the Bank of England, is probably the most high-profile supporter of restoring this separation in the UK – putting himself at odds with the Treasury. He will be among those backing the US proposals.

But Obama goes further, proposing restrictions on the banks that have critics fearing for the impact on the wider economy. It is thought that investment banks may find limits placed on assets that would prevent them from growing "too big to fail", but they may also become too small to meet demand. A weakness in his plans is that he identifies size and function as the problems behind the financial crisis when the real issues were over-leveraging and the loss of confidence in the banks to repay their debts. Royal Bank of Scotland failed not simply because it ran up a high level of toxic loans, but because confidence evaporated and the wholesale markets shut down when the US refused to rescue Lehman Brothers.

Reform will be better achieved by making these levels of gearing unattractive or impossible in spite of size or function, and in the UK this has been addressed, in large part, through tougher capital adequacy requirements.

Limiting the scope of trading activities is not a convincing argument for encouraging a return to growth. If anything, it is a contradiction.

For banks to flourish they need the freedom to explore opportunities and the flexibility to serve their clients. Tying them up in the way proposed will restrict their potential. We don't want banks who like to say no. We want them to say, yes we can.

Haven't we heard that slogan somewhere before?

The saving graces of income-tax abolition

KEITH Skeoch has been contemplating something that a lot of us would welcome: abolishing income tax.

The chief executive of Standard Life Investments wants to replace it with a spending tax as a device to correct our attitudes towards saving and debt.

Skeoch tells me he has thought about this for some time but only made his thoughts public at a business breakfast in Edinburgh on Friday.

The idea is simple: an individual declares his income and savings on his tax return and the difference – the expenditure – is the portion subject to tax. Save more and you pay less tax.

A similar idea was mooted in the 1970s when its adherents included Mervyn King, but it never took hold.

Skeoch is apparently trying to circulate the idea at a higher level and has received some tentative support.

The beauty of the plan, apart from its simplicity, is that it creates a proper incentive to save.

Of course, any plan to encourage saving and discourage spending would have the demand-pull economists up in arms as it would remove a huge economic stimulus in what has become a consumer-led society.

For that reason it may struggle for acceptance, though Skeoch points out that the public would not convert to greater savings overnight.

It may, however, help curb our addiction to debt.