In 2008, financial services firm Lehman Brothers filed for Chapter 11 bankruptcy in the United States. With over $600 billion in assets, Lehman Brothers remains the largest bankruptcy filing in US history. Under-capitalised and enormously leveraged with significant holdings of risky mortgage-backed and residential property-related assets, despite weeks of intense negotiations with regulators and prospective buyers no viable solution could be found and Lehman was allowed to fail.
In the ensuing market chaos, and following a G20 meeting in London in early 2009, the Financial Stability Board was established to monitor the global financial system and coordinate financial regulation among the G20 nations. One of the Financial Stability Board’s key objectives was to end “too big to fail”, the idea that these huge, inter-connected financial institutions with balance sheets comparable to the GDP of small nations were too complex and not capable of failing without having adverse effects upon the broader global economy. As part of a package of measures, the G20 proposed and adopted rules that would ensure that all globally and systemically important financial institutions were required to hold more capital, to segregate riskier investment banking and trading businesses from retail banking operations and, significantly, that upon the failure of the institution, the bank’s creditors have their holdings written down or “bailed-in” in order to avoid future tax-payer funded bail-outs.
As an objective policy, this makes sense. Clearly those who seek to invest in firms so that they might share in the profits should also be expected to bear any losses should that firm fail. The existence an implied state guarantee of financial institutions, funded by the tax payers, is surely in direct contradiction to the free-market principles on which the economy is based. It creates ‘moral hazard’, as banks, encouraged by shareholders, may feel free to take more and more risk, safe in the knowledge that they will be bailed out should things go wrong. That such a system should apply as broadly and in as coordinated a way as possible is also obvious. Otherwise we end up with bifurcation of rules, state protectionism and concentration of risk in smaller, more economically vulnerable countries.
Unfortunately this is precisely what we are starting to see. For example in Italy, where the increasingly unpopular Matteo Renzi government is challenged by extreme parties from the left and right, macro-economic problems, simmering beneath the surface for so long, have begun to manifest. Italian banks in particular have been teetering on the precipice since the European sovereign debt crisis began in 2009. The choice for Renzi therefore is: (i) breaching EU law by adopting a policy of targeted fiscal injections into the worst affected financial institutions and (ii) writing down the holdings of bank creditors, of which a considerable number are Italian retail investors. The consequences of either course of action would raise serious questions over Italy’s continuing membership of the euro and/or the EU.
As evidenced by the recent European Banking Authority Stress Tests, southern European financial firms remain perilously under-capitalised. As local economies continue to stagnate, we will inevitably see more calls for these types of exemptions, fundamentally undermining the system of global, coordinated financial regulation that has become the legacy of the 2008 financial crisis.
Does recent experience demonstrate the weakness of harmonized, global regulation? Will pragmatism and the short-termism of increasingly populist governments mean that, in times of existential difficulty, nationalist and protectionist realpolitik will always take precedence?
As an internationalist party, how should the Liberal Democrats respond to those nations who resile themselves from such international commitments? In this example, does the overall policy objective of ensuring a broadly safer financial system justify the imposition of, arguably, punitive measures upon retail creditors?
I would be interested to read your views in the comment section below.
* Ciaran McGonagle is a Liberal Democrat member originally from Derry, Northern Ireland and based in Colchester. He is a solicitor working in financial services in the City of London.