The library takes as its motto an aphorism of James Grant: “Progress is cumulative in science and engineering, but cyclical in finance.” So much of what has happened this month seems like history repeating itself: regulators creating a new crisis by trying to fight the last one; fearless free-market financiers suddenly discovering the virtues of state intervention; class warriors (who predicted 10 out of the last three banking collapses) claiming capitalism is unfair, dead or both.
And once again we must confront the reality that the rules of finance are going to change. For the history of financial regulation is basically a history of crisis management. The modern Federal Reserve was created after John Pierpont Morgan had to organize a last-ditch private-sector bailout of the economy in 1907, locking his fellow bankers into a room in his house at 219 Madison Avenue. The Glass-Steagall regulations separating investment and commercial banks were introduced by Franklin Roosevelt in 1933 after the Wall Street crash. They were then repealed by Bill Clinton in 1999 because banking restrictions were blamed for encouraging irresponsible innovation in other sections of the finance industry, only for the division to be partially reintroduced in the 2010 Dodd-Frank Act that itself followed the 2008 Lehman Brothers meltdown.
This time, the restructuring of finance looks less likely to be about a big new set of rules than about a deeper change in the political mindset: an acceptance of a mercantilist form of finance — something that Adam Smith would have abhorred but which chimes all too well with the statist policies of modern geopolitics. We could be slithering toward a new form of financial capitalism, one laden more with peril than with promise. That won’t happen overnight. Especially in the banks themselves, the accent for the moment is on survival rather than revolutionary ideas.
Indeed, for financiers rather than politicians, the new normal can be summed up in one phrase: back to basics.
If the 2008-’09 crisis was all about the quality of assets (all those dodgy subprime loans and vertiginous piles of derivatives resting on a tiny sliver of capital), the focus this time is on liquidity. In principle, both Silicon Valley Bank (SVB), which closed on March 10, and especially Credit Suisse Group AG, which collapsed into the arms of UBS Group AG last weekend, had relatively large amounts of equity capital to cover their possible bad debts. They just did not have enough ready cash to cover the long line of depositors suddenly wanting their money back. Everything may have taken place on computer screens, but these were bank runs just like the old-fashioned queues at tellers’ counters.
But blaming everything on a sudden liquidity crunch lets SVB and Credit Suisse off the hook. Depositors only want their money back in a hurry when they don’t trust their bankers. And when it comes to trust, SVB and Credit Suisse got some fairly basic things wrong.
When we began in journalism, Credit Suisse was a byword for boring financial probity. Swiss financiers were basically like German ones, but with the interesting bits removed. The one exotic part of the bank — an investment offshoot called Credit Suisse First Boston — required an American infusion to make it interesting. Whenever the chairman of the main Swiss bank spoke at a financial conference, he (invariably he) emptied the room as he spoke.
Somehow that focus on the great virtue of tedium was lost. This century has seen a series of embarrassing episodes that the bank’s senior management chose to treat as one-off mistakes rather than a systemic problem of risk culture. Credit Suisse’s name kept cropping up in scandal after scandal, from Mozambique to Russia, as its bankers, chasing higher returns, ignored the Duke of Wellington’s maxim that “High interest is another name for bad security.” Gradually the trickle of deposits being withdrawn became a flood.
In SVB’s case, the collapse was more sudden but the human error was even more basic. All the clever clogs at the Californian bank seem to have focused their energy on the sexy business of lending to venture capitalists, rather than the boring trade of deciding where you can safely park your depositors’ cash. Buying long-term fixed-rate government bonds when you have short-term floating-rate liabilities is a very basic mismatch — so basic that everyone in finance assumed it could not happen again. When interest rates rose, SVB’s “safe” government bond portfolio dived in value — and the bank stared into the jaws of destruction.
What will the politicians and regulators do? Several scapegoats have appeared. One, in SVB’s case, is wokery. Conservatives point out that the trendy San Francisco bank went without a chief risk officer for seven months, but nevertheless found the energy to boast about its record on green and LGBTQ issues, promising for instance to invest $5 billion in sustainability by 2027. That is pushing it. SVB looks ever more like a boys’ club with a sprinkling of wokery. Even if it had been a woke Elysium, its bankers could surely have found a few minutes to check out the bond market.
The bigger target for blame, embraced by people across the political spectrum, are the central banks, which are accused of keeping interest rates low for too long and then hiking them too quickly. There are elements of truth in this. Yes, it looks clear that they kept interest rates too low for too long. Cheap money helped create bubbles and encouraged banks to chase dodgy returns. And yes, if the Fed had not rushed to raise its rates so quickly, to make up for its earlier errors, the mugs at SVB would probably still be collecting banking awards and Credit Suisse might be considering yet another relaunch. But it is a big jump from that to saying that the central banks should give up raising rates now. The job of the Fed is to look after the economy as a whole, which primarily means tackling inflation, not keeping rates low in order to save a few badly run banks.
So the real debate will once again be whether there is a better way to govern those banks. An old argument has already restarted between those who think we should protect depositors even more fully (if you are going to end up bailing out depositors anyway, you might as well be honest up front) and those who want to stop the moral hazard that ensues from bankers getting away with mistakes. Chances are that the two sides will cancel each other out.
Our guess is that there will be some new rules, but not on anything like the same scale as after 2008, largely because banks have much more capital now. The most interesting change may be some redefinition of what banks are. Since 2008, American regulators have chosen to concentrate on monitoring the balance sheets of big banks that were “too big to fail.” Staggeringly they concentrated their stress tests on banks with more than $250 billion in assets. Mid-sized institutions like SVB (which had just over $200 billion) also did not need to meet the same liquidity ratio, thanks to a Trump administration rule change lobbied for by SVB’s CEO and others. Now we have discovered that SVB, too, was too important to fail.
The other much bigger class of entities that could be dragged into greater regulation (especially if one of them also goes bust) are all the non-banks that do versions of lending — including private equity firms, venture capital firms, hedge funds and the host of special purpose vehicles that finance has invented to get round banking rules.
The biggest regulatory change, however, will be to do with mindset. The regulators’ actions over the past few weeks may not have pleased Adam Smith, but they would have brought a smile to Jean-Baptiste Colbert, Louis XIV’s finance minister and the father of dirigisme. The idea that finance is an arm of the state is back — and global banking is likely to be reshaped by it.
This has been coming for some time. For all its claims to be frictionless and global, finance is corralled by national rules: Look at the dearth of cross-border takeovers. And is there anything new about national bailouts? Mervyn King, the governor of the Bank of England during the 2008 crisis, liked to point out that capitalist companies are global in life and national in death — always looking to their national governments to save them if things get difficult.
But the mood music of bailouts has significantly changed. In 2008, the three great economies of the world — the United States, the European Union and China — acted together. Taking control of banks was seen as a temporary detour from the true path of building a liberal global finance system. Now the global economy is breaking up into competitive regional blocks, and government rhetoric has shifted toward creating national champions and directing consumers toward local providers: Joe Biden seems incapable of signing a law without adding a Buy American provision. Mercantilism is back with a vengeance.
This month’s government-driven rescues fit into that pattern. Silicon Valley Bank was not “systemic” in terms of its threat to America’s financial system, but its collapse would have been a major blow for America’s tech industry, the center of the country’s competitiveness (especially against China). Lots of venture capitalists had unthinkingly stashed their investors’ money with SVB. If it had been based in Oklahoma, it might have attracted less attention. The decision to rescue was more about industrial policy than prudent finance.
Meanwhile, Switzerland’s decision to force UBS to take over Credit Suisse is an admission that banking is a strategic industry. In any normal reckoning about free-market competition and consumer protection, letting the country’s biggest bank buy its main competitor would make little sense. But if your main preoccupation is to keep Swiss finance Swiss, then handing over a third of the banking sector to one outfit works just fine. The foreigners, including the Qataris and the Saudis, who invested prodigiously in Credit Suisse, were barely mentioned. The Swiss even chose to demote one class of mainly international bondholders — Credit Suisse’s “Additional Tier 1” bonds — below equity investors. That helped Swiss pensioners, but it has sent shockwaves through the $275 billion AT1 market.
And this looks like just the beginning of the Colbertist turn in finance. Look at the European Union. For dirigistes across the continent, finance has long been a hideous provocation, partly because it’s a potential source of anarchy and partly because it is so US-dominated. The West’s five most powerful banks are all American — JPMorgan Chase & Co., Goldman Sachs Group Inc., Morgan Stanley, Bank of America Corp. and Citigroup Inc. This relatively novel arrangement (back in 1980, only two of the world’s top 10 biggest banks were based in the US) has always annoyed Colbert’s descendants in Paris, but now other politicians are looking at it afresh.
For instance, Germany may be Europe’s industrial engine but it lacks financial clout. The EU’s most successful bank currently is French (BNP Corp.), with its closest competitors being focused on the Americas (Spain’s Banco Santander SA) or trapped in Brexited London (HSBC Holdings Plc and Barclays Plc). The arrival of a new Swiss champion next door is a prompt for Berlin once again to consider merging Deutsche Bank AG (which has often vied with Credit Suisse in terms of scandals) with Commerzbank AG, which, for all its bureaucracy, would bring in a rich deposit base.
The alternative route — fraught with emotional difficulty for Berlin — is for Germany to combine with its neighbors and start building European champions. Why not merge Commerzbank with Italy’s UniCredit SpA? It is hard to make a currency union work without either fiscal union or banking union. Every bank CEO in the EU has a list of potential merger candidates in other EU countries if the rules change and cross-border alliances are allowed. After this week they are much more likely to do so.
American bankers will no doubt cheer on any European consolidation on the grounds of “better late than never.” But America’s banking market is even more misshapen in many ways than Europe’s — with consumers getting an even worse deal in terms of basic banking products like credit cards and current account charges. For all the focus on “too big to fail” banks, America has always had too many banks that are too small to function properly.
These minnows made the Great Depression significantly worse. While Canada had four national banks, each with branches across the land, widely spread shareholders and diversified customers, America had some 25,000 mostly undercapitalized banks, regulated by 52 different regulatory regimes and dependent on the vagaries of local economies. Things are a little better now, but there are still 4,000 American banks — most of them small local outfits, often protected by local political lobbies and over-dependent on local industries. In the new era of national financial capitalism, this looks more like a weakness than a strength. Expect to see another wave of FDR-style consolidation justified by SVB’s fate and cloaked in nationalistic rhetoric.
In America, bringing finance into the new mercantilist age is merely being consistent. If like the Biden administration you are already bribing semiconductor companies to set up shop in America, and cajoling your consumers to “buy American” regardless of quality, it also makes sense to regard finance as part of the commanding heights of your economy. If those computer chips are a vital national resource, then the bank that lends to those chipmakers is too. Especially as anything that comes under the heading of “containing China” can now count on provoking Republican cries of “more please.”
America’s protectionist turn has given other countries the chance to follow — especially as the Swiss, one of the great internationalists, are also looking after their own. European capitals are full of fury about the protectionism in Biden’s Inflation Reduction Act — and full of ideas about how to build fortresses of their own. Politicians are calling for state aid rules, the cornerstone of the EU’s Single Market, to be revised to allow more subsidies. China is doubling down on seeking self-sufficiency in key technologies. Everywhere nearshoring is happening as multinationals move from “just in time” manufacturing to “just in case.”
The New Financial Capitalism
Despite their reputation for being rootless cosmopolitans, the world’s banks will be only too happy to go with the mercantilist flow. As Adam Smith would be the first to point out, bankers were opportunists long before they were cosmopolitans. If the West’s politicians want national champions, then bankers will be happy to fund them. If the politicians want to replace free trade with mercantilism, then they will be there to offer shortcuts. And if somebody begs them to buy one of their rivals, that might be just fine.
From this perspective, UBS may quite possibly come to be seen as a first mover. It has just snapped up its main rival for under a 20th of its value a decade ago and secured a mass of state guarantees and a $100 billion financing backstop. In the US, it is notable that Warren Buffett, no stranger to a bargain, is once again offering his services to help the American government sort out finance. The chances are that his offer is not entirely based around altruism.
We are seeing the birth of a new form of financial capitalism — banks are becoming more intertwined with governments, and governments are picking winners and trying to back the industries of the future. Some people will do extremely well out of this. Politicians will no doubt welcome it because it increases their control over the economy. But peruse the tomes in the Library of Mistakes, and you will find that Colbertism also has its problems. Just look at the shortcomings of China’s state-directed banking system for starters.Perhaps we will look back on these few weeks as the time when the era of free market truisms ended — and Western governments decided that finance was their territory. Some bankers have once again been found to be fools, and many more have been hypocrites. Adam Smith often thought of them that way. But a large part of the free market’s power lies in its ingenuity and flexibility – and finance for all its faults has always been part of that. Alongside their occasional catastrophes that adorn the Library of Mistakes, Edinburgh’s financiers helped pay for trade, infrastructure and innovation around the world. Progress may be cyclical in finance, but it has still usually been progress.
More From Bloomberg Opinion:
• Paul J. Davies: Can Credit Suisse Stay Independent?
• Jonathan Levin: A Year In, the Federal Reserve’s Scramble Is Looking Costly
• The Editors: The Fed Needs to Keep Hiking Despite SVB Turmoil
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
John Micklethwait is editor-in-chief of Bloomberg News.
Adrian Wooldridge is the global business columnist for Bloomberg Opinion. A former writer at the Economist, he is author, most recently, of “The Aristocracy of Talent: How Meritocracy Made the Modern World.”
More stories like this are available on bloomberg.com/opinion
