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(originally published by Booz & Company)


Is State Control Making a Comeback?

A huge list of possible changes is emerging from a series of reports by regulators and government working groups. (See Resources.) Whichever menu items are enacted, this new agenda will include more attention to systemic risk, revision of the Basel Accord to build in rising capital requirements as leverage increases, greater transparency, reform of rating agencies, a revision of mark-to-market accounting, and changes to the basis of remuneration.

The structure of banking will also change. In the U.S., this is unlikely to take the form of a statutory return to the Glass-Steagall Act (the 1930s law, repealed in 1999) that prohibited a bank holding company from owning other financial companies. But riskier forms of banking will require more capital to be posted, and the increased expense will constrain banks’ expansion. (It will be like Glass-Steagall without the Act.)

Trust and simplicity will become major selling points. Enterprises that offer closer connection with their customers will see major opportunities. There could be a global renaissance of financial-services institutions that have a mutual or cooperative tradition, of which there are many in Europe. The over-zealous promotion of debt-financed home ownership will be scaled back. Governments will give greater priority to ensuring that people provide for their ever-longer retirements.

The pace of global integration of financial-services institutions could also slow down, or perhaps even partially reverse. For a while, bankers will have to concentrate on getting things right at home. And political leaders will continue to question the economic purpose and social justice of income differentials that have widened dramatically in the last five or six years. The morality of paying the person at the top 500 or 1,000 times the pay of those on the shop floor or in the banking hall will come under challenge. The solution may be a combination of governance changes and heavier taxation of higher incomes.

Many people today think that finance has become too disconnected from the real-world activities it is meant to support. That point of view will become more common, and will influence both rules and practices. There will be calls for greater transparency and simplicity in business finance. Those who lend money will have to have a better sense of the value of underlying assets. Simplicity is not good news for the private equity world, which puts a lot of financial engineering and debt between the underlying production and the financial results.

If I am right that there will not be a massive expansion of public ownership, we may well see a resurgence of publicly supported bodies that provide financing to small and medium-sized enterprises and to the housing sector. They will need to be structured to avoid repeating the disasters of Fannie Mae and Freddie Mac. There could be a revival of the European Investment Bank and national equivalents. Interest in domestic sovereign wealth funds will grow.

Please note what all of these possibilities, even at their most draconian, do not include: a movement toward stricter regulation in the nonfinancial world. Nonfinancial businesses already had their moment earlier this decade when excesses came to light in companies such as Enron, WorldCom, Tyco, and Parmalat. Those scandals gave rise to the United States’ Sarbanes-Oxley legislation and the tightening of auditing and corporate governance worldwide. But since 2008, at least so far, there has been an absence of major scandals in the industrial sector, which sees itself as victim rather than villain. It would take a cause célèbre in the nonfinancial sphere to raise public pressure for greater regulation of business as a whole. In difficult trading conditions, governments will be reluctant to impose further regulatory burdens.

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  1. Group of 30, Financial Reform: A Framework for Financial Stability (PDF), January 2009: Recommendations from an international body of leading financiers and academics on how the financial system should be organized, once the present crisis has passed, to improve stability.
  2. Jacques de Larosière, Report of the High-Level Group on Financial Supervision in the EU (PDF), February 2009: The European Union’s road map for stronger coordinated supervision and effective crisis management procedures.
  3. Financial Services Authority, The Turner Review: A Regulatory Response to the Global Banking Crisis, March 2009: An in-depth review of the causes of the financial crisis and recommended steps for reform, commissioned by the U.K.’s Chancellor of the Exchequer.
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