Reforming the financial system is the one battle Barack Obama really has to win

If the American President fails to reform the financial system, we will all be the losers, says Tracy Corrigan.
Unlike healthcare reform, Obama's financial sector reform has significant global consqeuences Photo: Reuters

Barack Obama is locked in very public combat over health care reform. Much more quietly, he has also been struggling to make progress with financial reform designed to prevent a rerun of last year's crisis.

Yesterday, a year after the bankruptcy of Lehman Brothers, he went to Wall Street to push for action. Although there is almost universal acknowledgement of the need for reform, and bank chiefs have learnt at least to pay lip-service to it, movement has been slow. There is resistance not only from the banks, but also from Congress and regulators locked in vicious turf wars.
Should we worry? After all, it is dangerous to rush through changes that may have unintended consequences: a draft EU directive on hedge funds and private equity, prepared without the normal impact assessments, has come under attack as a result, and is now likely to be amended substantially.

It is possible, though, that American politicians – and maybe even the rest of us – no longer have the stomach for change. It's all very well to talk about reform in the heat of the crisis. But a year later, when our economies seem to be emerging from recession, change seems less attractive.

Any action that would curb banks' profitability would hit tax revenues and make it harder for governments to sell the bank stocks they ended up holding after emergency rescues. The resulting weakness in government finances would be felt in the form of tax rises or public service cuts or, most likely, both.

That is not the only financial consideration for politicians. American banks – including those in receipt of taxpayers' funds – have been particularly generous in their campaign contributions, and – surprise, surprise – more money goes to those on influential finance committees.

The problem is that while some dangers in the financial system have been curbed – leverage is lower and banks are rebuilding capital – the concentration of risk within a small group of financial institutions has increased. The pattern of consolidation in Britain, where Lloyds has absorbed HBOS, is even more pronounced in the States, where small banks are still failing, but the big banks are bigger than ever: the biggest, Bank of America, which took over Merrill Lynch at the height of the crisis, now has $2.2 trillion in assets, as of the end of June, compared with $1.7 trillion the year before and $1.5 trillion the year before that.

Even if Obama's plans do go through, Paul Volcker, the former head of the Federal Reserve, Joseph Stiglitz, the Nobel prize-winning economist, and others believe that they do not go far enough, because they do not deal with the too-big-to-fail problem, leaving the taxpayer vulnerable to future cash calls.

Obama's health care reforms are an American problem. Financial reform is another matter. If Obama can't persuade Congress to toe the line, there are two potential outcomes for Britain. The first is that the impetus for change, without American leadership, fades and the world remains vulnerable to another systemic shock. The second is that the impetus for reform within Europe does not fade, and that could be even worse. There is a slew of legislation in train from the EU. The most obvious victim of a twin-speed approach to reform would be London, which would become a less attractive place for banks to do business. British banks and the British economy would also remain vulnerable to systemic shocks from a more lax American banking system.

The Group of 20 leaders, which meets in Pittsburgh in 10 days, is supposed to ensure global co-ordination of financial reform. Its most recent communications sound rather convincing, but the reality is that they are dealing with a reformist European parliament and a laggard Congress.

Posted in: Business-Economic,World News