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Two key votes to break up the megabanks

October 21, 2009 |  7:00 am

Former Federal Reserve Chairman Paul Volcker has been arguing for the breakup of the biggest banks to make sure history doesn’t repeat. Current Bank of England Gov. Mervyn King now is endorsing the same idea.

But the U.S. and British governments both seem unwilling to give up on the megabank concept that marries commercial banking with Wall Street banking.

In a speech in Scotland on Tuesday, King said there were only two ways for banking regulators to approach the mess left by last year’s financial meltdown:

"One is to accept that some institutions are 'too important to fail' and try to ensure that the probability of those institutions failing, and hence of the need for taxpayer support, is extremely low. The other is to find a way that institutions can fail without imposing unacceptable costs on the rest of society."

The first approach, King said, would entail forcing banks to raise their capital buffers to levels sufficient to protect against failure. But in reality, he said, it would be "almost impossible to calculate how much contingent capital would be appropriate" for each institution.

The second approach, he said, would amount to rejecting "the idea that some institutions should be allowed to become ‘too important to fail.’ " Rather, King said:

"Instead of asking who should perform what regulation, [the second approach] asks why we regulate banks. It draws a clear distinction between different activities that banks undertake. Mervynking The banking system provides two crucial services to the rest of the economy: providing companies and households a ready means by which they can make payments for goods and services and intermediating flows of savings to finance investment. Those are the utility aspects of banking where we all have a common interest in ensuring continuity of service. And for this reason they are quite different in nature from some of the riskier financial activities that banks undertake, such as proprietary trading.

"In other industries we separate those functions that are utility in nature -- and are regulated -- from those that can safely be left to the discipline of the market. The second approach adapts those insights to the regulation of banking."

King referenced Volcker’s idea to reimpose some version of the Glass-Steagall Act, restricting banks to traditional commercial banking and forbidding them from engaging in higher-risk Wall Street-related businesses.

But as the New York Times noted in a story Tuesday, the Obama administration so far is siding with the banking titans, which naturally want to keep their empires intact.

"People say I’m old-fashioned and banks can no longer be separated from nonbank activity," Volcker told the Times. "That argument brought us to where we are today."

The British government also wants to keep the megabanks intact, despite King’s view that the government bailouts that have propped up the institutions have created "possibly the biggest moral hazard in history."

From Bloomberg News:

U.K. Finance Minister Alistair Darling said yesterday focusing on capital rules may be enough to ward off future crises and is unswayed by arguments that banks should be broken up.

"You regulate according to risk," Darling said before King’s speech. "The greater the risk, the greater the capital requirement. I don’t think an arbitrary split would deal with the problem."

-- Tom Petruno

Photo: Bank of England Gov. Mervyn King. Credit: Chris Ratcliffe / Bloomberg News

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