Adair Turner is a very dangerous man

The head of the Financial Services Authority is certainly a brilliant man. His speeches on the causes of the financial crisis are models of intellectual clarity. His phrase-making is lethal (he came up with “socially useless” to describe much of the banks’ trading activities). And just like the Bank of England governor, Mervyn King, Turner sees directly through the spurious lobbying of the sector.

The trouble is that Adair Turner thinks he is brilliant enough to tame the financial sector on his own by utilising the power of his intellect. Worse, he might even be right.

Turner has long argued that the way to make the financial sector safe and to prevent a repeat of the 2008 banking meltdown is active regulation.

And he understands that the banks will be constantly trying to find ways of evading that regulation.

He told the Today programme this morning:

“Whatever the set of regulations we set, the financial industry will devote a lot of energy to finding ways round it…That’s what happened in the past. New risks developed that we didn’t spot.”

Turner’s solution is to be smarter than those arbitraging bankers.

“In the future we’ve got to continually look at the changing nature of the financial system and if we see things developing in what people call the shadow banking system then we’ve got to be able to extend the range of regulations to cover those risks as well. It will be a continual process.”

It is a battle of wits that the brilliant Turner might be able to win. Terrific.

But what happens when Turner retires? Will his successor be as sharp as him in recognising when bankers are hiding risk in a systemically dangerous fashion? Will his replacement be as immune as Turner to the powerful lobbying of the sector? I think the answer is highly unlikely to be yes. Remember that Turner’s predecessors at the FSA never said boo to a banker.

It’s not all bad news. Turner used to be opposed to breaking up the banks in order to tackle the problem of institutions being “too big to fail”. Now he’s coming around to the idea, as his speech this week shows. But he’s still resistant to the underlying principle of structural reform, namely to create a credible threat that a bank will fail if its managements take irresponsible risks.

Turner also told Today this morning:

“We have to make sure that the probability of the failure of a large bank is very, very small.”

But where is the market discipline if regulation has supposedly minimised the risk of failure to negligible levels? Think of the incentives in such a scenario. If bank managements are told by the regulator that they are so well regulated that they will not go bust, they have a green light to go nuts on the lending front, hiding risk all over the place. And when it all goes wrong, they can blame the regulator for lulling them into a false sense of security. The only way you are going to get bankers to behave is if they feel that there is no state backstop if they get into trouble.

I think Turner’s right that breaking up the banks is not a panacea. I’m not a John Kay-style purist on these matters. There would still need to be regulation of banks, even if they were made small enough to fail. But the priority should be to cut the big beasts down to size.

I think Turner has it the wrong way round on the reform front. Tougher regulation will help tame the banks, but the heavy lifting needs to be done by greater market discipline. Structural reform is not a panacea, but tighter regulation sure as hell isn’t either.

It is said that the American system of government is so good because it was designed by geniuses to be run by idiots.  Turner risks creating a system of regulation that can only be run by geniuses like him. Hence the danger.

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• Oscar Weird

  Yes, but the trouble with regulating authorities is that they are a fig leaf to make these creeps acceptable to public opinion. Once Thatcher sold off the family silver to the spivs, it was the job of the regulators to cast a pall of fog over their activities. Whenever a regulator actually gets effective,they tend to be warned – or pensioned off.

• Richard_SM

  Introduce more regulations and you need more people and more methods to police the big banks. Breaking-up banks to avoid “too big to fail,” isn’t the solution either. If they are all inter-trading in the same toxic deals, it simply means ten banks fall over instead of two or three big ones. A combination of regulation and size restriction presents further complexities; it just makes policing across a diversity of banks more difficult.

  A fourth option might be to cap or restrain big bonuses, but that doesn’t stop the organisational drive for more profit by risk-taking; it just means the traders earn less. Higher taxation on directors and traders, the fifth option, is similarly confounded: it doesn’t discourage the organisation.

  The sixth option might be for government to create a “risk fund” through a levy on profit or turnover, for example by reverting to 28% corporation tax and putting the 4% in a ‘bank-crash’ fund. This has some appeal, provided it wasn’t plundered by politicians, though it might encourage banks to take even greater risks.

  Perhaps if we can’t eliminate the risk, we could reduce some of the risk for the majority of the population. The vast majority of people simply want savings and lending facilities, and we used to have a thriving sector that fulfilled these needs: they were called building societies – of the mutual kind. Before they were de-mutualised, and because of their status, they were able to offer slightly higher savings rates than the high street bank – and lower interest rates on repayment mortgages. The public would largely be taken out of the equation if the banks failed again. I’ll call this option seven, as it follows option six.

  So it seems to me, the place to start would be the re-creation of the mutual building society sector. They could also be allowed to develop and manage “safe” pension funds. That would reduce the national risk, and banks would lose some funds, and it would also give them some indirect competition. Other options could be considered to build on this safer platform.

• Guest

  Size doesn’t matter. Many banking crises had small banks. John Kay is on the money.

• sunsetfriend

  We either need to start up ‘Not-For-Profit’ banking which would put the ‘for-excessive-profit’ banks out of business, or start insisting that banks do not need to pay outrageous sums to people and if they threaten to leave for greener pastures, good luck to them and goodbye. I don’t believe that people that work in banks are worth 10,000 times more than doctors, teachers, or even lawyers. They aren’t.

• cooperative5

  You mean like Adolph Hitler?

• http://pulse.yahoo.com/_PZCIZSSNFRIQOGPJS4S5A6EDD4 Kamal

  Regulate their pay and make it part of their contract that if they risk other peoples money in doggy deals they pay for it. Anyone or any bank that chooses to go elsewhere, all the better in my opinion, as I would rather have no bank, than a bank we will likely have to bail out to the tune of billions, negating any benefit from the taxes they pay, if they pay any at all, like those jokers at Barclay’s.

  This banking crisis has cost us all the taxes these horrible people are supposed to have paid for many many many years previously.

• Oscar Weird

  Godwin’s Law here we come!