LONDON: What a pity that JK Galbraith did not live to witness the nemesis of the new financial wisdom a nemesis that he had so confidently predicted! How he would have greeted with a wry smile and a sardonic ‘Surely not?’ those practitioners and commentators who are telling us that, after everything the financial markets have delivered with their so-called ‘products’, the last thing we need is an overreaction and a new round of regulation.

Every time one reads that the US does not need another Glass-Steagall Act, the more inclined one is to think it probably does require a modern version of that example of sensible regulation, on whose demise the likes of Alan Greenspan were so (successfully) keen.

As older readers will recall, the Glass-Steagall Act was passed in 1933 to separate the activities of retail and investment banking, as part of an effort to avoid a recurrence of the kind of wild speculative financial activities that contributed to the Great Crash of 1929 and the subsequent Depression. If there is anybody left who maintains that many (I don’t say ‘all’) of the activities of the financial sector in recent years have not been wild and speculative, I should be delighted to let them buy me a drink of my choice with their bonuses in a bar of my choice and listen to an explanation of their choice.

Now, I agree that we don’t need an ‘overreaction’. By definition, one does not need an overreaction. But when these people say ‘overreaction’ they mean ‘reaction’. And reaction there has to be, because in recent years the financial world went over the top. And, unfortunately, politicians and central bankers were not, to use a favourite central bankers’ word, sufficiently vigilant. They were vigilant about inflation in general, but not about the inflation of asset prices in general and house prices in particular. I say ‘they’, but I don’t necessarily include the Bundesbank and the European Central Bank.

I shall never forget the story told by the late Lord Alexander of Weedon who, as chairman of NatWest Bank, visited the Bundesbank when Karl Otto-Pohl was its president. Alexander was carrying a copy of an English newspaper that displayed a headline to the effect: ‘Good news another rise in house prices.’ Herr Pohl commented: ‘Over here, that would be bad news.’

In evidence to the British House of Commons Select Committee on the Treasury last week the Governor of the Bank of England came out in favour of more regulation, saying: ‘Financial institutions will have to hold more capital in the longer run’ and ‘their activities will have to be monitored much (my italics) more closely.’ Much more, indeed.

The US sub-prime market, which proved the trigger for the collapse of the new financial wisdom (‘buy a house - get one free’), was not a market that Alan Greenspan wanted to regulate at all. According to Greenspan, ‘the benefits of broadened home ownership are worth the risk’. The problem was that it wasn’t really ownership.

Now, regulation as such is all very well, and as someone who (sadly) almost despairs of the way the public sector treats the citizen these days, I am not too hopeful about the potential in this country for good governance. Nevertheless, it stands out a mile (or perhaps a kilometre and a half) that banks should concentrate on banking (learning more about their customers, their assets and their liabilities would not be a dangerous thing) and that building societies should be run with traditional prudence.

Some people may say that this is like closing the stable door after the horse has bolted; but you’ve got to think of the next horse - provided, after the credit crunch, you still have a stable.

Which brings me to a conversation I recently had with Lehman Brothers (and former OECD) economist John Llewellyn. While having every sympathy with the general desire to stave off a nasty recession or even a depression, we both wondered whether there is not a potentially disturbing confusion in the current debate. Thus for some years it has been obvious that the US economy has been living beyond its means. History suggested that at some stage it needed to adjust. An adjustment began several years ago with the decline in the dollar, but the US consumer carried on borrowing and spending the US being known in international economic circles as ‘importer of last resort’. The trigger for the retrenchment by US consumers turns out not to have been a planned adjustment of spending and borrowing habits but the credit crunch, which was in turn triggered by those familiar events in the sub-prime mortgage market.

A ‘globalised’ financial system has produced a globalised financial crisis. Heroic efforts are being made to limit the damage. But many US commentators give the impression, not only (and quite rightly) that depression should be avoided, but that somehow the status quo ante should be rapidly restored. In due course, perhaps. But the US economy has long needed to cut its coat according to its cloth, and that means economic adjustment although not unnecessary pain.

As for the ramifications, Michael Dicks, head of research at Barclays Wealth, suggests, on the basis of evidence so far, that ‘other major economies are influenced by developments in the US but not bound by them’. The traditional assumption is that, when the US economy sneezes, the rest of the world catches a cold. However, Dicks argues that when the US catches the flu, ‘Europe and Japan (only) catch a cold.’ Let us hope he’s right. — Dawn/The Guardian News Service