The harsh reality is that commercial banks must wax while Wall Street wanes. Over the last fifty years security markets have grown enormously at the expense of plain vanilla banking. Wall Street's juggernaut has finally ended and the whole world is suffering from the hangover. The metaphor is apt: early British visitors of India coined the term, "juggernaut" to describe their highly colored description of Hindu processions. They maligned Hindus as drugged frenzied fanatics who in the processions for their Lord of the Universe would throw themselves under the cart wheels to be crushed in the insane state of their delirium. Does that sound like the buyers of many financially engineered securities?
John Kay with his usual perspicacity and disdain for cant, advises us to "Wind down the market in five-legged dogs."
What's that you say? Read on:
"Abraham Lincoln posed the question: “How many legs does a dog have if you call a tail a leg?” Honest Abe’s answer was four. A tail is still a tail even if you call it a leg.
"The world of finance is a bit more complicated, but not much. How can a package of loans be worth more than the sum of their individual values? The amount borrowers pay is just the same even if you call the loans an asset-backed security or a collateralised debt obligation."As usual his analysis is good economics and good sense. Do read it all.
One implication is that both the City of London and Wall Street will have to shrink, but that, in my opinion, is a good, necessary, but painful reality.
To quote John Kay's conclusion: "The objective should not be to revive the originate and distribute model of banking, which has demonstrably failed, but to secure its orderly winding down. Banks should retire to the traditional and profitable business of taking deposits to make loans: the business we want them to do and the business they really understand. The British government plans to provide insurance for new asset-backed securities. That is like helping a junkie to detox by guaranteeing drug supplies until the local dealer resumes normal service."