What Vickers got right
Having criticised the Vickers report, I’m now going to praise it.
The commission absolutely demolishes the argument of the mega banks that they receive no de facto Government subsidy.
Vickers reviews all the relevant literature – including this now seminal paper by the Bank of England’s Andy Haldane – and concludes, firmly, that the government guarantee enjoyed by banks drives down their funding costs by “considerably in excess of £10bn per year” (p286).
I was also struck by this chart in Vickers, based on work by a paper by Viral Acharya, Itamar Drechsler and Philipp Schnabl of NYU-Stern, which shows the movement over time of credit default swaps (CDS) in the Irish and British banking sectors, and also the movement over time of the CDS of Irish and British government bonds.
So what are we looking at? In the circled areas, the autumn of 2008, the price of insuring the bonds of Irish banks and also of UK banks fell sharply. At around that the same time, the price of insuring the price of Irish government bonds and UK government bonds rose sharply.
What that means is that, in the minds of the markets, as Vickers puts it, “credit risk was transferred from banks to the government in the UK and Ireland”. The banks were bust, so investors assumed the governments would have to bail them out. They anticipated that this would make a mess of the sovereigns’ public finances, so they pushed up the price of insuring sovereign debt.
And guess what? The markets were right. The bank bondholders were rescued and the public finances in both countries have taken a hammering. In Ireland, the banks’ liabilities were literally loaded onto the public balance sheet.
That’s the taxpayer subsidy for banks in action. That’s too big to fail in action. And that’s what Vickers says ring-fencing will largely eliminate.Tagged in: john vickers
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