Boring is the New Sexy In Banking

It's back to the future in the banking world - that is, if our policymakers are serious about reforming our financial system. The myth that financial "innovation" cannot be stifled, lest the economy stagnate, has now been laid to rest. Financial "innovation" merely allowed bankers to take and spread risks they did not understand, perform regulatory arbitrage, and justify their exorbitant salaries. Paul Krugman and Simon Johnson both make the case that we should end the era of free-for-all casino capitalism, and move back to the type of more stable, boring banking system we had during the postwar period up till 1980. From Krugman:

Before 1930, banking was an exciting industry featuring a number of larger-than-life figures, who built giant financial empires (some of which later turned out to have been based on fraud). This highflying finance sector presided over a rapid increase in debt: Household debt as a percentage of G.D.P. almost doubled between World War I and 1929.

During this first era of high finance, bankers were, on average, paid much more than their counterparts in other industries. But finance lost its glamour when the banking system collapsed during the Great Depression.

The banking industry that emerged from that collapse was tightly regulated, far less colorful than it had been before the Depression, and far less lucrative for those who ran it. Banking became boring, partly because bankers were so conservative about lending: Household debt, which had fallen sharply as a percentage of G.D.P. during the Depression and World War II, stayed far below pre-1930s levels.

Strange to say, this era of boring banking was also an era of spectacular economic progress for most Americans.

After 1980, however, as the political winds shifted, many of the regulations on banks were lifted — and banking became exciting again. Debt began rising rapidly, eventually reaching just about the same level relative to G.D.P. as in 1929. And the financial industry exploded in size. By the middle of this decade, it accounted for a third of corporate profits.

As these changes took place, finance again became a high-paying career — spectacularly high-paying for those who built new financial empires. Indeed, soaring incomes in finance played a large role in creating America’s second Gilded Age....

But my sense is that policy makers are still thinking mainly about rearranging the boxes on the bank supervisory organization chart. They’re not at all ready to do what needs to be done — which is to make banking boring again.

Part of the problem is that boring banking would mean poorer bankers, and the financial industry still has a lot of friends in high places. But it’s also a matter of ideology: Despite everything that has happened, most people in positions of power still associate fancy finance with economic progress.

Can they be persuaded otherwise? Will we find the will to pursue serious financial reform? If not, the current crisis won’t be a one-time event; it will be the shape of things to come.

Simon Johnson strikes a similar note, calling on policymakers to

make banks smaller, less powerful, and much more boring.

Using antitrust laws to break up too-big-to-fail banks into smaller parts, and re-instituting Glass Steagall and the division between commercial banking, which exists as a public utility, and investment banking, which takes on riskier enterprises underwriting securities, would be a good start. Unfortunately, Geithner and Summers seem too enamored with Wall Street to enact these reforms. We can only hope that more politicians can muster the common sense and historical humility that Senator Byron Dorgan did a decade ago, in condemning the repeal of Glass Steagall and deregulatory mania in general as an inevitable step towards a new crash.