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Op-ed

United Kingdom's version of the Glass-Steagall Act

Jeysundhar D, September 18, 2011

Last week saw the world's second-largest private wealth investor bow down and admit that it had fallen prey to unauthorized trading, commonly known as "rogue trading," allegedly by Kweku Adoboli, a 31-year old trader in the Delta One desk of the firm's investment bank. Initial reports estimate UBS's losses to be the tune of $2 billion. If found guilty, Adoboli will have generated the third-largest loss by a rogue trader in history.

While the UBS has been rescued by the Swiss taxpayer, the biggest beneficiaries of the fallout of this scandal appear to be Sir John Vickers, the Chairman of United Kingdom's newly created Independent Commission on Banking (ICB) and Britain's Treasury Chief George Osborne. In fact, the scandal could not have been exposed at a better time, as it was uncovered less than a week after the ICB made its recommendations to the British government on Sept. 12. Osborne had this to say after the scandal was uncovered: "If you ever wanted a better example of why the kinds of ideas that John Vickers was putting forward were right for Britain, look at what happened at UBS just a few days later." 

 
The ICB's headline recommendation was that British banks should separate their retail banking operations from their investment banking arms to safeguard against riskier banking activities, or as they liked to call it, "ring fencing." Inadvertently, the UBS and Adiboli have become the unlikely poster boys for the recommendations of the ICB. Supporters of these recommendations have been quick to capitalize on the opportunity to claim that UBS and the rest of the banking behemoths have not learned their lessons even after the greatest economic crisis of our times.
 
The general view of the ICB has been that the "casino" actions of the investment banks shouldn't be able to harm depositors as they did in the financial crisis. The recommendations have presented a picture of bankers as gamblers at a casino sitting around roulette tables betting on red or black with investors' money. John Vickers in his 363-page report has explicitly mentioned that "the risks inevitably associated with banking have to sit somewhere, and it should not be with taxpayers."
The recommendations have been hailed as modern and revolutionary but are merely a throwback to the Glass-Steagall Act of the United States, enacted after the collapse of the American commercial banking system in 1933. Glass-Steagall's benchmark move was to separate investment and commercial banks and to prohibit a bank holding company from owning other financial companies, as it would entail conflict of interests and monopoly in the sector. Glass-Steagall was repealed by the controversial Gramm-Leach-Bliley (GLB) Act of 1999, allowing Traveler's Group to merge with Citicorp to form Citigroup, which would have been declared illegal had it not been for the Act. Senator Phil Gramm has been termed as "the father of the financial crisis" by several critics including Nobel Prize winning economists Paul Krugman and Joseph Stiglitz. They also argue that GLB has created institutions that could escape under the guise of the "too big to fail" rationalization.
What is surprising to note here is that the omniscient and omnipotent banking lobby has allowed the United Kingdom to get so far and attempt to bite into their lavish, if blood-soaked, pie. U.K. banking chiefs are set to meet Osborne in the coming weeks to argue about if, when and how the reforms are to be implemented. The events of the past week certainly haven't helped them one bit. On the contrary, it has helped vindicate and strengthen Osborne's views. The mixed reaction received soon after the recommendations of the ICB were made public, has quickly changed over to support for their quick implementation. Citigroup analyst Ronit Ghose said after the scandal was exposed, "This will confirm any existing prejudices about 'casino' banking and provide increased support for retail ring fencing or even tougher solutions."
The unequivocal support to the recommendations has been manifested in the U.K. government's decision to introduce legislation in the Parliament the same day to implement them. Given Europe's unwanted affair with an angry, unemployed population tired of losing livelihoods to austerity measures, it is merely a matter of time before Europe follows suit with similar steps of its own. The United Kingdom could lead the way with early and efficient implementation of the reforms on its own turf.
While cautioning against the effects of the present crisis by saying, "Failure to tackle the imbalances during the seven years of plenty before 2007 threatens seven lean years thereafter," Osborne also had a word of hope: "We have to pass through turbulent waters, but we have set the right course." Though Osborne might have been talking only about the United Kingdom, the statement could very well be an indication of a roadmap for the European Union and the United States as well.
 
The United States needs to stand up and take cognizance of the fact that if the GLB Act is allowed to continue its free rein, it will lead to future crises and a grave sense of déjà vu, from which the United States might not be able to bail its way out. The United States also needs to do away with the toothless Dodd-Frank Act and frame a new legislation that, in principle and practice, matches up to the stringent nature of the Glass-Steagall Act.
 
The other recommendation of the ICB that banks keep 17 percent to 20 percent of certain assets as "loss absorbers" would also serve as an important buffer and put an end to the "bailout culture" with which the West has been obsessed. While critics of the reforms might argue that it would curb financial innovation and growth of the banking industry, the United Kingdom, Europe and the United States need to remember that though a dynamic banking and financial industry might be in the economic interests of the nation's banks, they cannot afford to let it pose a very real risk to the stability and prosperity of the global economy.
 
 
Jeysundhar D is a blogger and freelance political analyst from India. He blogs at jeys-abode.blogspot.com and jeysmallworld.blogspot.com.

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