American president Barack Obama has proposed structural measures that would keep his nation’s banks on a short leach. Under his plan, banks would no longer be allowed to invest on their own account, meaning they would no longer be allowed to gamble Las Vegas style, more or less under government guarantee, their sizes would be capped, and their ability to investment in hedge funds and private equity would be restricted.

Obama’s proposal comes just in time for the De Wit committee to consider it. This committee, chaired by the Dutch parliamentarian Jan de Wit, has been charged with an inquiry into the origins of the banking crisis and the lessons that need to be drawn from it, but the multitude of experts it has heard in its inquiry has had little to offer in suggestions for improvement, apart from suggesting better oversight of the banking industry, and increasing its capital reserves.

The financial sector however, is by its very nature unstable, unpredictable, and complex – making it extremely complicated to regulate and supervise.

A game-changing proposal

Obama’s move was immediately embraced by the Dutch finance minister Wouter Bos, and rightly so. For those who have yet to understand the relevance of what is going on– the Obama proposal would make for a whole new playing field. Structural reform was not on the agenda initially, but it is now. How it got there is anyone’s guess. The fact that greed-ridden international banking has so far proven unable to clean up its act on its own undoubtedly played a part. The stupidity of American banks, which ticked off authorities by paying out exorbitant bonuses and speculating on financial markets like never before, defies all understanding. Dutch banks have little to do with these most recent excesses, but the comments made by Dutch bankers questioned by the De Wit committee make one fear the worst. Bankers there implied that sooner or later, they too may be forced to jump on this bandwagon.

The fundamental problem: banking appears no longer to function as a lubricant for the economy at large, it has become an autonomous profit machine with no compass to guide it. Banking suffers from an image problem. Innovations created in banking have been getting a bad name. Paul Volcker, former chairman of the Federal Reserve and the intellectual progenitor of the Obama plan, went as far as saying the only useful innovation implemented by bankers in the last three decades was the ATM machine, which, by the way, bankers did not invent.

While this judgement is undoubtedly to harsh, something is surely wrong if the financial sector is more profitable than the rest of all industries combined. At the end of the day, the financial sector is the lubricant that keeps the economy rolling. It produces nothing itself, but allows the economic system to function more smoothly.

Diagnosis: sick of technology

A clear diagnosis of the problem is the key to its solution. I think information technology played a crucial part. It has caused financial institutions and markets to coalesce and made banks more volatile and unpredictable than ever before.

This process was led by financial innovations, like securitisation, which allowed banks to trade their assets directly on financial markets. But inter-bank lending, over-the-counter transactions and complex relations with other financial actors have also made for a system of total interdependency.

Today, a bank’s risk profile can change in the blink of an eye. Financial markets are key to this process. Worse, the impulsive behaviour enabled by this system has proven to be highly prone to herd behaviour. All involved are doing the same thing at the same time, inducing true systemic risk: everybody might be wrong at the same time.

Greed and gambling

I must conclude that the forces unleashed by information technology have left the financial sector beyond any control. We are left with no other options than to partially dismantle it. That is exactly what Obama is doing by forbidding banks to trade on their own account. His proposal resembles the 1933 Glass Steagall Act, which drew a line between commercial banking and financial market oriented investment that remained in place until 1999. The first type of banking encompasses conventional activities such as holding savings accounts, the payment system, and traditional loans. The second type of banking entails anything to do with the financial markets: Las Vegas style gambling, yes, but also things like public stock offerings, and bond trading.

Whether the distinction between the two types of banking should be re-introduced is doubtful. Providing a company with credit or letting the market do so by helping to sell its bonds are two activities that can easily be carried out by the same bank. Still, the destructive risk-seeking behaviour eminating from the financial markets need to be isolated from other interests. Banks do not necessarily need to be broken up to accomplish this. The Organisation for Economic Co-operation and Development has proposed structures that would untangle financial interests internally while leaving banks intact. A Bank’s ‘public’ segment, including deposits, payments and loans, could be effectively shielded from the risks that stem from their other activities.

The increased transparency this would create would make life easier for supervisors. The De Wit committee should take note of this in its questioning of those responsible at the Dutch central bank. It should not only ask whether or not the central banks has fallen short, but should ask what sort of restructuring of the financial sector could allow for effective oversight. The central bank will have to show some mental flexibility here. Until recently, it thought itself capable of handling any complexity, provided it was given some additional instruments. That, however, is an illusion.