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Brexit and the City
07 August 2012

Paul N Goldschmidt: State and bank relations - An explosive cocktail!


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The time for half-baked compromises is over. One must either move forward with determination to build a "Federal European Union" or, failing agreement, initiate an orderly retreat to the pre-existing status of independent Nation States.


In a recent important article, Robert Fisk, the well known correspondent of the Independent, flags the steady drift of the Syrian conflict into the abyss and stigmatises the attitude of the world’s great powers. Hereunder, I paraphrase the introduction to his paper which can be applied, mutatis mutandis, to the financial crisis (original text in italics, substituted words in bold):

“Has there ever been a conflict displaying such hypocrisy in the financial sector? A conflict reaching such a degree of cowardice and of low morality, of such fallacious rhetoric and public humiliation?” 
 
He specifies that he is not writing in the name of “the physical victims of the financial tragedy”, but is referring to “the outright lies and the dishonesty of our leaders and of our own public opinion… in answer to this scandal”.
This description describes accurately the progressive drifting off course of the banking sector and the inadequate responses provided by the authorities. One should therefore fear that, in fine, the European citizen might have to face equally dramatic consequences, if not equally as violent as in Syria. The lack of confidence in the banking system coupled with the lack of political courage of Governments and the powerlessness of the European Union forms an explosive cocktail capable of transforming the financial crisis into an irreversible political and social catastrophe.
 
Revelations concerning fraudulent manipulations by some of the world’s largest banks of key market reference rates (LIBOR, EURIBOR, and TIBOR which set interest rates for trillions of dollars worth of financial contracts), are liable to deliver a final blow to the severely damaged reputation of bankers. Simultaneously, other financial institutions own up to blatant violations of regulations on money laundering, embargo transgressions or assistance in structuring tax evasion schemes.
 
It is already widely recognised that regulators and supervisors had failed in executing their mandate. They attempt to justify these weaknesses by hiding behind the limitation of their powers within their respective national boundaries while, at the same time, they are furiously defending the exclusivity of their own prerogatives. 
 
Recent developments point, however, to a long-standing unhealthy connivance between the public and banking sectors which, by becoming progressively dependent on one another, has reduced the ability of the former to control the latter. Indeed, States are dependent, for the distribution of their “sovereign debt”, on banks, while the latter rely on the State to ensure the trust of bank counterparties (depositors and other creditors); thus States and banks rely on each other to ensure their solvency.
 
Well aware of the strength of their position (too big to fail), banks are in a position to blackmail governments and exert pressure to weaken any legislative proposal that they consider too constraining (Volker rule, etc.). On the other hand, in light of the need to strengthen the capital base of banks (Basel III) and to avoid any new bailout by the taxpayer, Governments have encouraged the accumulation of profits by deliberately closing their eyes on practices such as the manipulation of key interest rates, to which their attention had been brought. Thus, after the Lehman failure, banks were able to restore rapidly their apparent profitability at the expense of consumers whose contractual interest rates on trillions worth of contracts (floating rate mortgages, credit card overdrafts, swaps and other derivative contracts) were indexed on the reference rates mentioned heretofore. 
 
The testimony of bankers and regulators alike in front of the American and British Parliamentary Committees has demonstrated the extent of the incestuous relations between the protagonists. The professional expertise being largely confined to the financial sector, it is not surprising that politicians are being lead “down the garden path” in many particularly complex matters, and are being kept in the dark about some of the consequences stemming from the often uncoordinated measures they are approving. The opposite is also the case when, weary of the experts, the body politic adopts measures without appropriate consultation (example: the preferred creditor status of the EFSF, ESM or ECB).
 
A first short-term consequence of these developments is the considerable damage inflicted on the reputation of the City and its status as the world’s leading financial centre. The American legislator and European authorities have already initiated measures to repatriate under their direct control high-risk operations carried out in London by subsidiaries of their domestic institutions; they were seeking to benefit from a favourable regulatory environment but whose “light touch” proved, in the end, to be disastrous (AIG, Morgan Chase, UBS, etc.). At EU level, the City will find it hard to find support for exonerating it from the reinforced community discipline applicable to the financial sector within the single market.
 
But beyond the short term consequences, it the whole project of European integration that is in jeopardy if the body politic fails to earn 'the citizen’s trust' that is the only justification conferring legitimacy on its authority. It is also the precondition to restoring trust in a financial system, considered rotten to the core, and which is the other necessary condition for resolving the financial crisis. 
 
The time for half-baked compromises is over. One must either move forward with determination to build a “Federal European Union” or, failing agreement, initiate an orderly retreat to the pre-existing status of independent Nation States. While the former alternative can provide hope for a better future, the latter carries significant risks of social unrest and conflicts.
 
To paraphrase François Hollande: “The choice is now!” 
 
Paul N Goldschmidt, Director, European Commission (ret.); Member of the Advisory Board of the Thomas More Institute
 
Tel: +32 (02) 6475310 / +33 (04) 94732015
Mob: +32 (0497) 549259


© Paul Goldschmidt


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