Fixing Wall Street: Reimagining - Not Just Repairing - Banking

by: Umair Haque

Here's a curious fact. If you think about it for a second, we're witnessing the simultaneous failure of three very different banking systems.

The first is, of course, America's. While financial determinists might argue that banks are on the road to "repair"--and that's arguably true, if what you're focused on is financial mechanics, like balance sheets--in no economic sense is the banking system any closer to functioning than it was half a decade ago (consider any number of recent slightly crazy horror stories you've heard about malinvestment, malfeasance, or both).

The second is Europe's. Here, the problems are by now familiar. Europe's banks funnelled funds into "peripheral" nations, underweighting real risks--and when a revaluation of credit finally occurred, a sudden stop brought the eurozone to the brink of disaster.

The third is China's. A state directed and controlled banking system, which is essentially a conduit that channels household savings to national champions--the flipside of the reserve accumulation that subdues a tightly controlled exchange rate. It's blown a massive asset bubble, and, by definition, held down living standards while doing so.

Here's what all three have struggled (mightily) to do--and I'd argue, haven't done. Transform savings into what might be called meaningful investment. Allocate capital to it's most socially productive use. Monitor and enforce corporate hubris and excess. Set incentives for dynamic efficiency. In the limit, create authentic value.

Though the superficial paths to failure differ--the failures are strikingly similar. The deeper roots of those failures lives in the institutional DNA of banks. In other words, it's not a crisis "in" banks, but a crisis of banks.

Here's what's glaringly clear. Beyond merely recapitalizing (taxing, etc) banks, we're going to have to reinvent banking--institutionally. The (purely mechanical) steps we've taken so far are tiny, halting, and fundamentally insufficient--concerned solely with technicality, instead of substance--to craft financial systems fit for the future.

So here are a handful of principles I think might help us think bigger.

  1. Purpose, not just profit. Banks should be social enterprises, tasked with delivering real benefits--not just shareholder value.

  2. Radical transparency. Banks shouldn't be opaque swamps of disinformation--but providers of real-time info about which funds are going where, when, and why.

  3. Punishment, not just reward. Bank execs should face real penalties for the consequences of their decisions.

  4. Flexible, not fixed. Banks should a dynamic capital structure that reflexively reconfigures in the event of a crisis. Think bail-ins as a starting point and you begin to get the picture.

  5. Failure, not success. The problem of too big to fail is, in actuality, a problem of too interconnected to fail: a problem of network centrality. Network centrality is often a telltale sign of market failure. Hence, a central network position should probably be dynamically de-subsidized (ie, guarantees removed). In the limit, radical decentralization might mean that a bank's "deposits" are distributed in the equivalent of escrow across members--allowing for micro-failure.

There are plenty more principles we might readily apply, but the real point is this. Banking as we know it is fast becoming a liability for nations. If it's a dynamic, resilient, vibrant economy capable of enduring, meaningful prosperity you wish to build--there's little worse way to go about it than to build a thriving financial sector. Hence, among the most urgent imperatives for national advantage today is reimagining banking--and though it might sound obvious, it's a journey few are even preparing for, let alone beginning.