Bank of England governor Mark Carney is kidding himself if he thinks Britain can become banker to the world without paying high costs and taking even higher risks.
Carney, the newly minted BoE head, gave a remarkably pro-finance speech last week in London, introducing some sensible reforms while sounding an extremely relaxed tone about the prospect of Britain’s finance sector more than doubling relative to the economy. (You may at this point need reassuring that yes, we are still in 2013, and yes, we did just undergo a damaging crisis in which the risks of an overdeveloped banking sector were terrifyingly demonstrated.)
“Five simple words describe our approach: we are open for business,” Carney said, describing the central bank’s willingness to provide cash to banks more easily, less expensively and by pledging a wider array of securities while making a case that institutions other than banks should be allowed access to BoE financing.
While stressing that it isn’t his job to dictate how big the financial sector is, Carney laid out a future in which, if current trends hold, banking assets grow by 2050 from four times the size of annual output to nine times. By comparison, U.S. banking assets are just a bit bigger than annual GDP.
Allowing that would be a grave mistake. Not only would it make the political and economic might of the banks so great that effective regulation might become impossible, it would almost certainly starve the non-financial parts of the British economy of focus, talent and even capital.
Carney places great emphasis on creating a more resilient financial sector, but his approach seems both naive and blind to recent history.
Financial intermediation in Britain has grown over the past 100 years, especially the last 20, even as its manufacturing sector has shrunk in relative output. Carney appears to view this as simply a function of the happy marriage of globalization and comparative advantage, in which countries develop those parts of their economy at which they excel and we all grow richer.
However, if it all goes wrong with the auto industry or semiconductor fabrication the damage that is wreaked on the home economy is not as bad as seeing your global titan banking industry fall to pieces. That’s because bank liabilities, under the current set-up, are ultimately backstopped by the host nation.
While you can argue, and Carney does, that this is all susceptible to mitigation by international reform, there is no credible international failed bank resolution regime. Even if such a thing came into being, it would, in the event of a crisis, be a bit like a mutual defense pact, sometimes honored but sometimes, disastrously, not.
There is also no guarantee that globalization continues at its accustomed pace. Global trade growth has slowed markedly since the crisis. And even if emerging market countries start to consume more financial services, what Carney calls a financial deepening, there are good reasons to fear that their commitment to the international regulation and the backstopping of British banks might end abruptly at the next crisis.
If you look at the development of the British economy over the past quarter century, the argument for supporting the further development of finance is pretty thin. Finance has created wealth, but it has been wealth which proves remarkably difficult to tax, and ultimately to control. That’s especially unfair as the largest British banks, like their American and European counterparts, only exist and profit because they enjoy a government guarantee. That hasn’t changed, and in the absence of hugely higher capital being held by banks, won’t.
The ascendency of finance has also shaped the country and its attitudes towards capital and its deployment, and towards labor and even the application of intelligence. What’s done well in Britain? Banking, insurance and real estate. Those have also been the sectors which have attracted the most talent, and found it easiest to attract capital. The result: a country in which the average worker can’t really afford the average dwelling and the state turns to borrowing subsidies to keep the circus in the air.
If Britain encourages finance to grow, then, there will be a huge opportunity cost in medicines and 3-D manufacturing processes which never get invented or commercialized in Britain because the sharpest minds are busy perfecting securitization techniques.
None of this is to say that the regulatory reforms Carney suggests aren’t worth pursuing, within a context of limiting growth in order to limit risk and allow other sectors room to develop.
If Britain does become banker to the world, a few will benefit and many will very likely pay.
— James Saft. Published with permission of Reuters.