The Example of the European Banks

Posted in Blog at 2:52 pm

(In the Wall Street Journal’s Law Blog on Friday, 22 January 2010, there was this item, regarding the White House’s call for proprietary trading to be severed from commercial banking):

Are Obama’s Bank Reform Proposals Good News for Lawyers?

By Ashby Jones

The stock market sure didn’t respond well to President Obama’s calls on Thursday to regulate the size and activities of the nation’s largest banks. (The Dow Jones was down over 213 points).

But how did lawyers respond? From what we’ve seen so far, it was a mixed bag. Allen & Overy’s Doug Landy, the head of the firms’ U.S. bank regulatory practice, isn’t a fan.

In an email to the Law Blog, Landy wrote:

The Obama proposal on limiting bank size and principal activities is a troubling concept that is neither supported by the evidence of the causes of the credit crisis nor well designed to prevent future systemic risk issues. If either being a large bank, or engaging in agency and principal activities in the same entity, were so inherently risky as to require banishment, every European bank would be collapsing as we speak.

As European banking is something I know a little about, I could not resist responding to this argument, rooted as it is in most Americans’ relative ignorance of financial markets other than their own:

Good try on behalf of your clients, Mr. Landy, but the argument doesn’t hold up. The European universal banks are regulated and protected by their national treasuries to a degree that all Americans—both bankers and taxpayers—would find intolerable. The culture is different, and most traders and other capital markets types in these banks work (under conditions of much greater job security) to gain promotion, not to become instantly wealthy and contract themselves out to the highest bidder each season. The senior executives are often ex-civil servants themselves, and in any case, are far more responsive to a telephone call from their country’s finance ministries than are their American or British counterparts.

The Continental banks were traditionally stodgy, and much less prone to finance risky enterprises, which has helped make their economies less dynamic than our own. After two decades of expanding into riskier activities, most are still far more risk-averse and top-down managed than our hybrid investment/commercial banks. Even so, little Jérôme Kerviel was able to start a run on the Société Générale just by engaging in a little unauthorized trading in order to impress his boss and earn a slightly bigger bonus (laughable by New York or London standards). The Trésor had to come to SG’s rescue.

Then there is the wonderful example of UBS, which tried to follow the American model and managed to lose more money faster than any bank in history. It is now a ward of the Swiss state. The trading mentality is inimical to the prudence necessary to run a commercial bank, and the very necessary function of significant risk-taking should be taken on by separate organizations that are not also insured and protected by governments because they accept demand deposits, clear everyday financial transactions, and serve as the gatekeepers to most everyday economic activity. The marriage of risky investment banks with risk-averse commercial ones was made in Hell, and deserves to be undone at the first opportunity.

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