Not much has been accomplished in reaching a consensus on a global regulatory approach. Basel III has been moving along, but with vociferous opposition. Now our British friends have stirred the waters by proposing to place clearly defined fences between banking and investment and trading activities.
The ideas in the report by the Independent Commission on Banking, led by Sir John Vickers, are a major departure from the collegial “comply or explain” British approach. The proposals are a significant move toward a more formal and regulated environment. They stress a clear separation between traditional banking, on the one hand, and investment banking and trading operations on the other. Fences around the banking sector would limit the use of deposits and shareholders’ equity to traditional lending strategies and procedures. Paul Volcker must find these ideas admirable.
The implosion of the global financial system created a “rush for the exits” from existing national regulatory systems. Convergence disappeared from the global meetings’ agendas. Sovereign nations reacted with suggested changes in regulations focusing on what’s best for their local interests. Convergence now rests on the Group of 20’s shelf alongside coordinated fiscal policies.
In the U.S., Congress passed the Dodd-Frank Act, which banks and trading organizations find onerous and oppressive. But a major victory for the industry lobbyists was the watering down of the Volcker Rule, which sought to re-erect part of the Glass-Steagall Act’s wall between banking and trading. The final legislation included only an abbreviated version of the rule, to be fleshed out by regulatory agencies.
Many of us non-bankers were very disappointed that Congress and the administration lacked the courage to face up to the realities of the causes of the present crises, take the necessary steps to return banking to its historical reason for being and put trading risks back in the hands of those with a significant personal stake. We also remain disappointed that some of the “gamblers,” who knowingly created the “packages” and passed them along to less well informed investors, are not in jail.
We hardliners believe that issuing huge amounts of debt to totally unqualified borrowers, bundling these ill-fated securities and selling them to anyone who took the rating agencies’ stamp of approval to be valid was, if not fraud in the legal sense, certainly a violation of the spirit of the law.
It is these legal and ethical grey areas that cloud law enforcement. For example, the SEC agreement to a $500 million fine for Goldman Sachs, in lieu of either a civil or criminal charge, in the Abacus CDO case clearly demonstrated the inadequacy of existing legislation in dealing with acts of “omission.”
The U.K. decision to move ahead on its own may be another stone thrown at the Dodd-Frank approach. Or it may reflect a realization that laws and regulations, no matter how complex and threatening, will never be able to stop greedy, speculative and unqualified persons from finding ways and means to “beat the system.”
I discuss with my MBA students whether a person, if basically motivated in ways that challenge cultural values, can be deterred by any set of regulations. I stress the importance of “internal governance” and controls by managers who act and live ethically.
I strongly recommend that the U.S. and the world follow the U.K. lead and “build a fence” around banking, so shareholder equity and depositors’ money can be used only to make loans to viable borrowers. Trading should be separated from banking and allowed only by firms organized as partnerships.
This is the governance theory of the “stick” as opposed to the “carrot” motivation for achieving ethical behaviour. Recent evidence that even the largest and best-organized trading firms cannot design or administer internal controls that motivate compliance with rules and with firm value systems calls for making the pain from bad deeds obvious and severe.
John Alan James is a professor of management and corporate governance at the Lubin School of Business at Pace University in New York.