The JPM London-Whale case has already rewritten pages in the U.S. regulatory playbook, all for what was initially a $2 billion surprise at an otherwise-robust bank. With the $350 trillion LIBOR scandal, the big-bank book is out the window. Sure, it’s just resting on the sill now as the House of Commons considered the comments Wednesday by a remarkably unrecalcitrant CEO. But, as Barclays unfolds, at least four other banks face wide-ranging and even criminal charges. For all the complaining U.S. banks do about U.S. regulators, the FRB and Treasury have stood by the big-bank, diversified holding company model throughout the crisis. Now, even they aren’t so sure, while the most senior U.K. officials have openly expressed outrage and privately reconsidered the fundamental premises of financial regulation. And, with Barclays alleging that U.K. regulators encouraged the bank to fiddle with LIBOR, the Bank of England and FSA have their own institutional backs against the wall. In so awkward a position, they may well lash out and, if they do, U.S. regulators will side with their kin. As a result, the industry now faces a real threat of direct assault, not the take-a-hill-here-or-there campaign regulators have waged to date.
I know banks don’t think they’ve been allowed to keep their lofty redoubts in the course of the regulatory rewrite over the past four years. And, indeed, many new rules rewrite the pilings of the industry’s strategic edifice. But, none to date has taken it down, forcibly broking up big banks, reinstating Glass-Steagall, imposing mandatory size limits or actually enacting any of the still more ambitious proposals.
How did the industry save the house? The press attributes this to formidable lobbying, and this of course played a vital role. However, we think lobbying was enhanced by two external forces. First, regulators disagreed among themselves and within the Obama administration on key provisions of Dodd-Frank, presenting a confused front line to the usually unanimous big-bank assault that made it easier for the lobbyists to pick off outliers. Second, many of the industry’s most vociferous opponents were, at best, ineffective counter-forces. Think, for example of the Financial Crisis Inquiry Commission, established by Congress to guide the nation to a next round of financial-services reform on grounds that Dodd-Frank didn’t do nearly enough. What of the FCIC? It fought viciously within its own ranks and finally came up with a partisan, huge report that went on for hundreds of pages to no clear conclusions or lasting effect.
Now, the industry is facing a far more formidable foe: a united front of deeply appalled regulators. The head of the Bank of England, Sir Mervyn King, has said that the LIBOR case ends whatever trust he had left in the ability of banks to abide by the premise on which market trust is based: “my word is my life.” That may sound quaint, and much of late in the City, as well as Wall Street, makes it seem downright doddering. But, it is in fact the basic rationale of banking around the world – customers must trust the bank enough to give it their money. If all that stands between depositors and ruin is regulation, then regulation must be omnipresent, deposit insurance has to be all-encompassing and, with this, banks have to be transformed into utilities.
Sir Mervyn has now argued forcefully for this along with Lord Turner, building on an array of prior suggestions from very senior U.S. and global regulators that big banks must serve social, not profit purposes. With LIBOR and the revelations to come, the calls for a total transformation of banking back to the basic business of financial intermediation will, we think, gain far more power than ever before. The reason big banks are as huge as they are and, for all the talk of shadow banking, why banks around the world still dominate global finance is that they are the only institutions governments, businesses and citizens really trust. This trust is buttressed by regulation, but not based on it. If policy-makers – especially those once inclined to credit banks with the ability to govern themselves – now think banks are too bad to be big, a major restructuring of the industry could well ensue.