Banking regulation? Malfunction!

The few regulatory measures introduced since the financial collapse in 2008 are being supervised by the same banking sector that caused it in the first place, writes Financial Times journalist Lucas Zeise. Governments’ delegation of regulatory responsibilities has deeply negative implications for democracy.

Two years have passed since the outbreak of the property and financial crisis, yet there has been no progress in the regulation of the banking and financial sectors. Worse still, a serious start has not even been made. This diagnosis doesn’t only go for Germany. It applies equally to the US, the European Union, and at the level of international regulation.

Not that there has been a lack of fine words. Alongside US president Barack Obama, who last summer announced the biggest “overhaul of the financial regulatory system since the reforms that followed the Great Depression”, the German chancellor is now proving to be a master of empty promises. Her new year’s address of 2010 contained the beautiful sentence: “We must and will continue to work resolutely to introduce new rules into the financial markets, which will in the future prevent in good time the concentration of excess and irresponsibility.” Angela Merkel made very similar sounds in New Year 2009, when she was still head of the grand SPD-CDU coalition.

Cynics as realists

Cynics will say that exactly this was foreseeable following the bank bail-outs in autumn 2008, when practically all capitalist countries ensured the survival of “their” domestic banks with hundreds of billions of euros, dollars, yen and pounds. The cynics have turned out to be realists. They knew that the political establishment is always and everywhere closely associated with the most senior figures in the financial sector – or “high finance”, as one used to say. They do not even need to mention in detail that the investment bank Goldman Sachs has the best possible connections in all the upper echelons of US government, or that Germany’s leading commercial bank (Deutsche Bank) and leading insurance company (Allianz) have exercised a very strong influence on the legislative and executive since the beginning of the FRG (and of course before then, too). It is hardly surprising, then, that the only SPD politician to have kept a top government post after the change from the grand coalition to the CDU-Liberal coalition is one Jörg Asmussen, who as secretary of state in the Federal Ministry of Finance organized the billions of euros to rescue IKB, HRE, Commerzbank, Allianz, and ultimately the entire German financial sector. He is still needed.

In terms of results, it all seems clear enough. Apart from a few mini-corrections and proposals for raising minimum levels of private capital for investment banks, which will be implemented in who knows how many years, nothing, absolutely nothing has happened in terms of serious regulation. In view of the economic disaster caused by financial speculation, that surely is surprising.

After all, an economic crisis, particularly one of this scale, is no fun for capitalists either. Not all managed to remain in the profit zone. More than a few had to file for bankruptcy. In fact, it ought to be in the interests of industrial and commercial capital – let’s call it that rather than pure money capital or finance capital – to avoid similar occurrences in the future. In other words, there needs to be stricter state control of the financial sector. Otherwise financial crises will simply be unavoidable. Indeed, this conclusion seemed to have been reached by many people in many different places. However when it comes to concrete matters, the financial market becomes the judge of how regulation is carried out (which is what the neoliberal business model intends).

Banks’ obligations on private capital

Since banks are able to offer practically unlimited amounts of credit, and can thereby create money, capitalist states have tried to control and limit this credit creation in order to avoid precisely the kind of crisis like the current one. The most important means to do this are regulations on the amount of private capital a bank must have in reserve in relation to the volume of credit on offer. The total credit offered is thereby limited. The first internationally binding regulation on the private capital ratio, the so-called Basel Accord (Basel I), came into effect in 1988. In general, it stipulated an 8 per cent rule. In other words, 8 per cent of every loan offered by a bank had to be backed up by private capital, or, to put it another way, the banks were only allowed to loan out 12.5 times their own capital.

From the outset however, this agreement had holes in it. Worse, the rules were soon relaxed, supposedly in the interests of greater efficiency. After more than ten years of negotiations, the Basel II Accord came into effect in 2008, the year of the crisis. It ruled that a bank has to put aside a high amount of private capital for high-risk investments and low amount of private capital for low risk investments. Basel II, in other words, meant that the banking supervisory body has to assess banks’ increasingly complex risk-measurement systems, a task for which it is unequipped.

In December 2009, the Basel Committee on Banking Supervision – the body that Basel I and II had created – proposed raising the private capital requirements of banks. It also recommended that the concept of private capital be more narrowly defined. However Basel II itself was not questioned. The Committee wants to implement this gentle tightening of private capital regulations extremely cautiously, or at any rate not immediately. This considerateness follows the bidding of governments, who at the G20 meeting in April 2009 spoke out in favour of stricter regulations, however wanted them implanted only “after the crisis”.

Early warning system out of order

Still, it is possible to observe at least small signs of ideological progress in banking control. Governments recognize that they need an institution that takes care of financial stability. They are clearly not doing this job themselves, nor apparently do they see themselves in a position to start. For that reason, the “Forum for Financial Stability” was tasked with acting as an early-warning system at the international level. It is supposed to sound the alarm, to draw attention to flaws in the financial system, and to circulate suggestions for improvements if anything goes wrong. The Forum was set up in back in 1999, following the Asian crisis, which indicates its greatest shortcoming. Its first president was Hanz Tietmeyer, who had recently retired as president of the German Bundesbank. Under his leadership, the Forum omitted to condemn the international speculation that had led to the hyper-boom in the Southeast Asian tiger states, and then to the flight of capital from the region in 1997, which left in its wake a serious economic crisis. Instead, the Forum moaned about the poor statistics of the Asian national economies. Today, the Forum is equally “competently” staffed as before – with eminent bankers, central bankers and bank supervisors.

Until now, a macro-economy did not exist in Europe. There has also been no pan-European economic policy. The crisis has at least caused something to change in conceptual terms. A body has been installed equivalent to that at the global level in order to forecast instability and even to offer suggestions to governments. It is headed by none other than the president of the European Central Bank, currently the Frenchman Jean-Claude Trichet. Like the institution he leads, Trichet for a long time denied the existence of a financial crisis, and when denial was no longer possible, deemed its effect upon the rest of the economy negligible. This new arrangement is sure to prove extremely useful for the citizens of the EU.

There are some remarkable parallels between the US and Europe here. In both the world’s two largest national economies, the intention is that the chaos and incompetence should be reduced somewhat; in both regions, the central banks will take control. Compared to the “diversity” of competence that currently dominates the field, that might be a marginal improvement. It is consistent, at any rate. As the creator of the dollar, the Fed can indeed rescue banks. It has recently been doing just this, with élan. However it is also consistent that control over private banks has been handed over to a state institution that nevertheless belongs to these banks.

In Europe, governments want to centralize the supervisory bodies that have until now been operating at the national level. A committee made up of representatives of the many national banking supervisory bodies will be formed to this end. Presiding over it will in turn be the president of the ECB. However what authority will the committee have when it comes to closing or bailing out a bank? Can it really order the national supervisory body of a country, against its own (government’s) will, to do such a thing? One is almost grateful to the governments in London and Berlin that, at the instigation of their domestic banks, they refused to give this new body such a far-reaching mandate.

In Germany, too, the Bundesbank is in the process of extending its supervisory role. However neither it nor the CDU-led government can argue with the economic crisis. In its analysis of the crisis, as well as in its bail-out measures, the Bundesbank has proved itself to be extraordinarily incompetent. That such an important area of state activity should be handed over to an institution that is beyond parliamentary control is a further step towards the de-democratization of the country.

The same procedure?

In derivatives trading, too, the finance lobby is in the process of asserting itself across a broad front. In order to avoid similar accusations that followed the Lehman collapse, so-called “central counterparties” have now been installed. They act as a general market central. If a bank collapses, they take over its contracts. The credit-worthiness of these institutions must be beyond all doubt. A state-protected institution is the only option. The result: the state acts as guarantor of the speculation business. In terms of the limitation of speculation itself, on the other hand, there is nothing to speak of.

While the ratings agencies were indeed given a sharp ticking off shortly after the outbreak of the crisis, there is still no sign of a reform. They are neither controlled, nor has their power been reduced. On the contrary: the ratings agencies bear some of the responsibility for the disastrous way Greece’s debt crisis has been handled. Not only banks, but also governments have referred to their judgements as if they were law. This scandal is continuing completely unchecked.

True, there could soon be a register for all hedge funds. However, control of this currently rather unsuccessful sector is non-existent.

Moreover, the free circulation of capital is not even seen as a problem. As decoration, one might also mention that the German Social Democrats as well as the Britain’s Labour prime minister Gordon Brown are currently backing the old call for a financial transactions tax – probably because they know that it will never happen. Governments appear not to be bothered by the fact that mass Carry-Trade (acquiring debt in currencies with low interest rates while investing in highly profitable currencies) not only distorts the market, but also runs contrary to the intended effect of the financial policies.

The Icelandic example

Symptomatic of the failure of state actors is the conflict over the repayment of the money that, using high interest rates as a lure, Icelandic banks amassed from British, Dutch and German savers prior to 2008. Back then, the guest countries, in accordance with EU law, decided not to impose their national investment security systems on the Icelandic banks. The deregulatory principle of freedom of establishment, disastrous in every relationship, ruled. In other words, the EU member states quite consciously opted not to protect their citizens from the unserious financial deals offered by these banks. In 2008, the three Icelandic banks finally collapsed, and the remains were nationalized.

The UK, Dutch and German governments have compensated their conned citizens and want the Icelandic state to foot this bill (3.8 billion euros) according to a contract drawn up with Iceland. However, after the Icelanders staged massive protests, the president Olafur Grimsson refused to ratify it. A popular referendum will now take place that is very likely to reject this law.

One can only applaud the Icelanders and their president. By refusing to take responsibility for the losses incurred by the banks and the speculators, the Icelandic people have probably found the sole effective lever for halting deregulation – and ultimately even reversing it.

Published 5 February 2010
Original in German
Translated by Simon Garnett
First published by Blätter für deutsche und internationale Politik 2/2010 (German version)

Contributed by Blätter für deutsche und internationale Politik © Lucas Zeise / Blätter für deutsche und internationale Politik / Eurozine



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