Two years ago the collapse of Lehman Brothers heralded a frightening period for the world economy. As one bank after another toppled or came close, regulators worried that ATM machines would fail to operate and that companies would be unable to meet their payrolls. A second Great Depression seemed to beckon.
Extraordinary efforts were made to bail out banks, including state guarantees, partial nationalizations, near-zero interest rates and massive fiscal deficits. The public seethed at banks' profligacy. Surely finance would be reformed, as it was in the 1930s when the United States created the Securities and Exchange Commission and separated casino-like investment banking from retail banking?
Two years on, the landscape of finance has altered somewhat. Take hedge funds: The crisis wiped out around a quarter of their assets and forced many mediocre ones out of business. Many private clients left in disgust when they found these self-proclaimed superstars could lose money; the client base is increasingly dominated by institutions, which should insist on more transparency and better risk management. In private equity, the poor performance of the 2006-07 vintage of deals is making it harder for firms to raise money.
It is the banks that matter most; and, in banking, it is remarkable how little changed. Many are still "too big to fail" and the casino side of their activities remains mixed up with the mundane business of deposit-taking. Bankers are once more earning huge bonuses. How could this be?
Breaking up banks might have satisfied taxpayers' desire for revenge, but it is unclear what problems it would have solved. Anglo Irish Bank and Northern Rock collapsed not because they were too big, nor because they were playing the markets: They were classic "narrow" banks that failed in the traditional way -- borrowing short to lend long against property that was overvalued. The problems of the Spanish cajas show that a financial system with lots of small banks is not necessarily safer.
Still, the crisis made it painfully clear the world's banking system needed new rules to impose lending discipline and guard against temptation to migrate to the weakest regulatory regime. A new set, known as Basel 3, has been proposed. They will probably do the job.
The purpose of the new rules is to ensure banks have more capital when they face the next crisis, and are better able to cope with bad debt. The core Tier 1 ratio will rise to 7 percent, slightly less than expected but still better than before the crisis (at the end of 2007, Royal Bank of Scotland's ratio was just 3.5 percent).
The timing is more questionable. The new rules are being phased in slowly, under pressure from those countries, such as Germany, which escaped the worst of the crisis. The final deadline is not till 2019. Regulators reckon the rules are fairly tough, but critics think this deadline is excessively generous. The fact that bank shares rose in response to the Basel announcement will add to cynics' suspicions the banks were given too much time.
