The global financial markets were caught off guard on Thursday 21st January when President Obama surprised the banking industry by announcing reforms to the US banking system reminiscent of the Glass-Steagall model. The Glass-Steagall Act, separating commercial and investment banking, was enacted following the stock market crash in 1929 and remained US law until 1999. Thursday’s proposals by Mr Obama, advocated by Paul Volcker, former Federal Reserve chairman, would have the effect of banning US banks from proprietary trading or from owning, investing or sponsoring hedge funds and private equity as well as restricting their overall size. City Minister Lord Myners was reported by the BBC as saying that the proposals were "very much in accordance with the direction we have been setting" although subsequently the Chancellor Alistair Darling stated that the Labour party would not be pursuing such proposals. By contrast the shadow chancellor has been quoted as stating that if the Conservatives won the next general election they would impose a similar regime on the UK banks.
Whether this is a serious proposal radically to reshape the global financial landscape remains to be seen and will only be clear when the details of the proposals of the Obama administration are laid out in full. However, the reaction of the stock markets to Thursday’s announcement reveals an industry still in the fragile stages of recovery with confidence in short supply. This mirrors the sentiments expressed by respondents in our fifth most recent survey, tracking market sentiment in relation to the global financial crisis and recovery. In the survey, a cautious sense of optimism amongst respondents is tempered by an appreciation that any recovery is likely to be long and shallow and that confidence remains at best shaky.
However desirable or otherwise, implementing rules which clearly isolate what constitutes proprietary trading from "customer related" market making activities will be challenging. It is not clear whether the so-called "Volcker Rule" will sufficiently either limit the size or alter the risk profile of "too big to fail" institutions or deal with the shadow banking system into which these proprietary activities will be pushed. This has allowed commentators to question whether reform of the industry of the sort proposed by the Obama administration last week is what is required to avert a similar crisis in the future. Both the workability and relevance of these new regulatory proposals, like those currently being tabled in the EU, are also perhaps called into question by the results of the fifth and previous surveys. A consistent point of consensus amongst respondents to the surveys has been that the financial crisis was caused less by a failure of regulation and more by a failure to implement existing regulation. This and a failure to implement appropriate internal risk management procedures are felt by respondents to have played the key roles in the crisis.
The announcement from Stateside has had an understandably mixed reception this week in Davos with opinions divided as to the proposed reforms. Whilst there seems to be acceptance that reform is needed, there is still little consensus on the specifics of any proposals. Mr George Soros has announced himself to be in the pro reform camp. Whether or not his fellow delegates agree with Mr Soros, there is likely to be consensus with his view that now is perhaps the time to “depoliticise” the debate and to draft in the “experts” on any proposed designs for a new “regulatory system”.
For Dominique Strauss-Kahn, head of the International Monetary Fund, regulatory reform is a global issue requiring a global solution. Quoted in the Financial Times Mr Strauss-Kahn told the Davos
Delegates that reform cannot be “driven by what each country sees that it needs for itself” and that “we cannot afford to have different solutions in different parts of the world”. The debate had a final twist though when Larry Summers, top economic advisor to Mr Obama, pointed out in a BBC interview that historically there has always been a wide range of institutional and regulatory arrangements for financial institutions and that what was felt to be the “best approach” from a US perspective did not mean that other countries needed to adopt the same approach. Post Davos, the jury is therefore out on whether the US proposed regulatory reform is in fact a global issue or a US backyard issue.
However, in the short term, the prospect of such a radical restructuring of the financial services landscape with far reaching consequences for the industry will be unsettling for the markets and the financial sector as a whole. Recent IPO activity is also likely to be effected. Financial institutions will find it difficult to plan ahead and, with confidence in short supply, liquidity flow is likely to remain low. There is now some urgency for the detail of the proposals to be made clear to allow certainty and confidence in the industry to be restored.