Finance, Money and Banking
Firms need capital as an input; they borrow and pay interest and dividends. Banks, which borrow, lend and create money, are, like other financial intermediaries, firms in their own right as well.
Firms and banks are both micro and macro faces. Each have been partly reshaped by agency theory, asymmetric information, contract theory and games, as well as by certain advances in econometric methods. It is no accident that the interrelated disciplines of IO and monetary economics should have attracted scholars interested in both their union and their intersection. In earlier generations, Edgeworth, Marshall, Hicks, Friedman, Baumol and Shubik are prominent examples.Vickers' first publication in the area of monetary economics appeared in Oxford Economic Papers in 1986. It was agency theory applied to a central banker, who might be “dry”, a determined inflation fighter, or he could be “wet”, that is, concerned to keep employment high. But would a closet wet masquerade as a dry, Vickers asked, and try to conceal his preferences to stop inflation expectations running away, and if he did, would he get away with it?
Like John Flemming, who went on to be the Bank of England's Chief Economist in 1980, Vickers saw another side of finance for two years as investment bursar of his then college, Nuffield. He also looked at the economics of profit sharing with Colin Mayer (Mayer and Vickers 1996). Then came six influential papers in the Bank of England Quarterly Bulletin, when Vickers was the Bank of England's Chief Economist. All of these articles (Vickers 1998, 1999a, b, c, 2000a, b) were highly topical. They covered inflation targeting in 1998, shortly after its introduction in the UK; the euro; monetary union and economic growth; and the relationships between monetary policy and asset prices, economic models, and the supply side. Shortly after the global financial crisis erupted in September 2008, we see a 2010 BIS paper on central banks and competition authorities (Vickers 2010a), the Report of the Independent Commission on Banking (Vickers Commission 2013) which he chaired, and then three papers, among them Vickers (2012, 2014), which were devoted to the subjects of banking reform, and taxing and regulating banks.
The Vickers Commission was a landmark, in the UK and well beyond. It surveyed the various possible causal factors that underlay the global financial crisis. There were many. New accounting rules about marking to market, and permission to book now anticipated profits for future years; record low interest rates, held too long after 2001; the invention and profusion of fiendishly clever financial derivatives that hid various horrors; the 1999 repeal of the Glass-Steagall Act 1933 that had kept US investment and retail banking well apart. These and others are entertainingly discussed in a “The Financial Crisis: Whodunnit?” lecture delivered by Howard Davies in New Zealand in 2009 (Davies 2009).
However, two conclusions stood out. The banks that had failed had inadequate capital to withstand a large fall in the value of their loan assets, and those which had been “too big to fail”, and been bailed out, or taken into state ownership, had survived because their indispensable retail banking activities had been jeopardised by huge losses in their investment banking wing. The Commission’s main recommendations were therefore that banks should be required to hold a great deal more capital, and that retail banking should be insulated by Chinese walls from any speculative investment banking activities.
The banking crisis of late 2008 and 2009 was a massive earthquake. It was comparable in scale and gravity only to the Great Depression of the early 1930s, which would have numerous aftershocks, spread over many years. So, the Vickers Commission worked fast. Its final report was issued in September 2011. The urgency of safeguarding the British economy from any future banking crisis led the five members of the Commission, supported by a small team of civil servants, to cover a great deal of ground. The government at first reacted speedily. It initiated legislation on the day of publication. But it is sad to note that subsequent progress has been much less rapid. Vickers’ disappointment is expressed in a 2016 paper in the Journal of Financial Regulation (Vickers 2016). This was followed by a VOX essay (Vickers 2017) on the disturbing recent decline, to ratios often far lower than in 2008, in many banks’ equity valuations relative to the book values of their capital. Banks’ capital requirements have been moving upwards, but, as Vickers notes, they are based on the perilously unhelpful accounting fiction of book value. This is a theme pursued in Vickers (2019).
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