This summer, US politicians revisited a hotly debated topic when exploring possibly implementing the “Volcker rule”: Should financial institutions be allowed to have multiple lines of business? In other words, is it time to reinstate Glass-Steagall?
Monday, UK Finance Minister George Osborne’s declaration, “the days of banks being ‘too big to fail’ are over in Britain,” revives the basic question across the pond. Responding to recent illegal activity tied to rate-rigging by some of Britain’s largest banks (for those not following the scandal, click here for a useful infographic), Osborne asserted his and the British Treasury’s power to break up errant banks. What’s more, they propose not just ring-fencing rule-breaking banks, but electric-fencing them via the (rather colorfully named) “sword of Damocles” rule.
Osborne’s scorn of illegal activity certainly is merited, but we question whether the threat of break up is the appropriate response. It’s true UK banks were bailed out during the 2008 financial crisis, some with multiple lines of business (commercial banking, investment banking, insurance) and some with only one. And one large multi-line financial is currently under scrutiny for fixing the key interest rate (about four years after being bailed out and still about 65% owned by the UK government from said bailout).
And there’s the rub. It seems to us, the UK’s new movement to break up rule-breaking banks is primarily a response to illegal interest-rate fixing. We agree skullduggerish behavior warrants consequences. But separating investment banking from traditional banking (or insurance or mortgages or or or) wouldn’t have prevented banks from engaging in rate-rigging and won’t in the future.
A debate about what makes a bank “too big to fail” and whether that should be prevented is fine and well and good. But there’s no evidence multi-line firms cause greater systemic risk. For example, none of the major US failed institutions (like purely investment banking Lehman or insurance-only AIG) were multi-line businesses. Pure-play investment banking only survived thanks to a government-arranged, would-have-been-illegal-under-Glass-Steagall marriage of Bear Sterns with JP Morgan, creating a multi-line behemoth. Bank of America and Merrill Lynch were similarly joined. That’s America’s business, not the UK’s, but we might note a similar merger occurred in the UK with Lloyds TBS and HBOS.
The problem clearly didn’t stem from having multiple business lines. Rather, one could argue having multiple lines of business—and therefore multiple, diversified streams of revenue—actually helped those financial institutions survive 2008. And, on the flip side, one could argue the economy did just fine for decades under Glass-Steagall. But, ultimately, legally required, sudden separation of lines of businesses likely brings about unintended consequences—which can surprise economies and markets to the downside (we’re looking at you, FAS 157)—for what appears to be an unrelated reason. In our view, politicians would be better off seeking solutions to problems they want to address, not the other way around.