Time to take decisive action

Near death moments can be fortuitous. People can have life transforming realisations and make radical decisions because they suddenly realise how precious life is....

Near death moments can be fortuitous. People can have life transforming realisations and make radical decisions because they suddenly realise how precious life is.

Or they may not...

The global economy is the patient. And I fear that now the patient is ambling around again, he is starting to puff on the odd cigarette and enjoy his tipple again.

Are we just heading for another crisis?

Not imminently but the answer is if we don't change the system then we're headed for another bump within ten years.

It is just impossible to run an economy with massive banks taking huge risks using depository money knowing they are too big to fail. This means we are guaranteed to transfer, every so many years, massive private sector losses onto the national balance sheet. And there is no disincentive for it to stop. As long as banks can't fail they will continue to gamble.

What can we do?

Think about a bank along three dimensions or axes, X, Y and Z. X is the size of the bank. Y is the risk of the investment activity and Z is the proportion of the bank's capital exposed to the risk. The greater X, Y and Z are combined the higher the risk to the general economy.

I read recently in the FT that the use of capital ratio requirements is superior to regulators defining various "utility" and investment activities and preventing banks from undertaking both. The FT argued that regulators are ill equipped to draw the line so the separation of functions, as called for by Mervyn King, is impractical. How is the manipulation of capital ratios against measured risk any easier? Indeed, it is probably harder.

So regulators need to state clearly that if a bank as above a certain size of retail deposits then it cannot participate in easily definable high-risk investments. This can be kept quite broad. Then the investment banking side of the industry needs to be regulated whereby capital ratio requirements are set by celebrating bank size, investment risk and exposure (X, Y and Z) and stage of economic cycle.

But not doing so and allowing any banks to participate in utility banking and investment banking simultaneously, is the equivalent to allowing the biggest air polluters to continue to poison the atmosphere at no cost.

Indeed there is an economic parallel between the financial crisis and global warming. Where we organise the market economy in such a way that doesn't price a scarce commodity properly (capital for finance and air for global warming) the beneficiaries will be companies run by men of greed serving their own interests to the detriment of society.

If we do not take decisive, global action now it is the equivalent of being in a ship which is unable to drain away the water from the last wave before the next one hits.

If Western governments do not step up this challenge, there will be two consequences.

The first will involve either a crisis in government lending and the bankruptcy of states or massive taxes that kills productivity or very high inflation.

And second, a major further shift of power away from the first world to the emerging world, in particular China, India and Brazil.

As I heard someone say today "we have thrown a whole load of hope and a fast money at the problem but it was hope and fast money that caused 2008 in the first place."

The choice is ours. But I fear that political weakness, a lack of voter pressure and a paucity of vision will mean that the structural problems will not be addressed.

Shame.