The Big Bang Theory gets it wrong

It has become routine to blame the economic crisis engulfing the developed world on what could be called the Big Bang Theory. This is not a reference to the television geek comedy but to financial deregulation as exemplified by London’s Big Bang 25 years ago this week.

The basic idea behind the argument is simple. All was well with the City until deregulation came along in 1986. But the forces of greed where unleashed once financial institutions were allowed to engage in casino-like activity. This in turn led to a credit-fuelled binge of overconsumption. Although it may have taken over two decades for a global crisis to emerge it all started with the Big Bang.

Many influential commentators have put such arguments. For example, Larry Elliott, the economics editor of the Guardian, said earlier this year that: “there is a simple reason why output is still 4% below its peak and growing only slowly: the debt-driven model of economic growth deployed in the 25 years from the financial deregulation of the 1980s to the bank run at Northern Rock no longer delivers”. Similarly Will Hutton contended in his regular Observer column in 2009 that: “What has happened to finance and the financial system since London’s Big Bang in 1986 is an astounding story of ideology, greed and lack of restraint”.

I have argued many times in Fund Strategy that it is wrong to blame the banks or greed for the crisis. But it is also incorrect to claim that the Big Bang represented a move to an unregulated City. What happened in 1986 could better be described as reregulation rather than deregulation. It is true that some rules were scrapped but in many respects regulation has become more extensive since then.

Looking back 25 years the old City, pre-Big Bang, looks as dated as the bowler hat. Until 1986 it was forbidden for outsiders, including foreign firms, to become members of the London Stock Exchange. The deregulation opened the way for investment banking operations on the American model to start operating in London. It also replaced open outcry trading on the floor of the exchange with electronic trading.

But it is not true that regulation of investment business disappeared. Before the Big Bang such operations were largely regulated informally. The London stockmarket operated as a club where members could be blackballed if they behaved badly. Those who worked in the City often knew each other from the network of elite public schools, Oxbridge colleges and Sandhurst.

Since then the regulatory system has changed several times but the trajectory is towards more formal and extensive regulation. Today the City is overseen by the Financial Services Authority; a statutory body with strong powers and an extensive rulebook. When it is replaced by the new Prudential Regulatory Authority within the Bank of England it is likely to be more powerful still.

The idea that the Big Bang of 1986 ushered in a largely unregulated City is a myth.

This is my latest blog post for fundweb.co.uk