A bit more on banking

So Obama is going to reform the banking system. Ahead of the publication of more details it looks like the aim will be to limit the activities of the 'traditional', commercial banks. There will be restrictions on their capacity to trade securities and invest in hedge funds. Whether separating the activities of commercial and investment banks can reduce risk in the kind of complex integrated financial markets that have emerged in the last twenty five years will be interesting to see.

Curbing the banks in some way is certainly popular. Dishing out massive bonuses is not going to endear them to the rest of us. Of course, the bankers point out that the bonus payments simply reflect the marginal value of employees who have contributed to massive profits. As a fraction of the wealth the bankers are generating the bonus payments are small. While that's true, a moment's reflection tells us that these are hardly normal circumstances. The very existence of many of these institutions today is thanks to massive amounts of public money being pumped into them. Moreover, the on-going availability of cheap credit lines and the liquidity support for the financial markets may well have had the effect of making many markets a one way bet. The rise in liquidity (and the flight to safer assets) would have had the effect of driving up the prices of certain classes of assets. Add to that the impact on equity values of the market anticipating economic recovery in the real economy and you hardly need to be a rocket scientist to make money (if the banks don't start lending more, then will that recovery in the real economy kick in without a massive burst of state pump priming as has occurred in China?). When these considerations are combined with the frustration at the apparent reluctance of banks to actually lend money to companies and individuals, you'll not find a great deal of sympathy for the bankers.

Still, I caution against too great a sense of outrage at the banks. What did we expect them to do? Even in favourable market conditions it's not as easy as I might suggest above to make money. You've got to take the positions and make sure you make the right decisions. Furthermore, surely we want the banks to accumulate profits as rapidly as possible. With all that public money in them it must make sense to see the banks rebuild their balance sheets. As for the failure of banks to step up lending, this might be down to their reluctance to risk capital when it could be more safely deployed.

Saving the banks was not the same as reforming the free market conditions in which these beasts thrive. In providing the conditions in which they can fatten themselves we should only expect one outcome.