GOVERNOR of the Bank of England Mervyn King and US Treasury Secretary Hank Paulson both in their different ways said last week that once this credit crisis is dealt with, there will be no going back to the old ways. There may be tighter regulation across the board, capital adequacy rules imposed on investment banks and even a move once again to separate commercial and investment banking activities as they were in the US under the Glass-Steagall Act from the 1930s right up to the 1990s.
What precisely will be different was not spelled out by these pillars of the financial community, and need not be at this stage. But all the above ideas are being talked about, and others will no doubt surface in the next few months.
The interesting thing is that so many senior figures in the investment banking business still don't seem to get it.
They still seem to be in denial, unaware that things will never be the same again. Business as usual was the message of the Pounds 21 million collected by Bob Diamond of Barclays Capital, making it look as if BarCap is in a different world and bears no responsibility for the financial crisis threatening to engulf the Western world.
It was also the message from JPMorgan Chase's Jamie Dimon as he promised to dish loads of cash to the best of his new Bear Stearns employees to persuade them to stay loyal. Neither seems to realise that the investment banking model where trading revenues are the major driver of profitability is broken, perhaps beyond repair.
There are two strands to this. The first is that is has become clear why Glass-Steagall was needed. Commercial banks came into existence to collect retail deposits and lend the money out over a longer time horizon. Their core skill is the assessment of risk, and that expertise is (or was) vested in the credit officer and the credit committee which assesses the likelihood of the bank getting its money back.
Trouble is this is difficult work and low-margin. If a bank is making only 1% on its loans, then after interest on deposits and costs are taken into account, one loan in 100 going sour wipes out the profit on the other 99. As a business, it is a million miles from gambling which is the trading investment bankers do stripped of the euphemism. Trading is quite different from investment because it is a zero sum game in which every gain for one party has to be matched by a loss for someone else. But it is undeniably exciting and, in bull markets particularly, it can appear that everyone is a winner. …