'Big Bang' Pioneers Rethink Banking Overhaul

London launched a radical set of market reforms known as Big Bang, turning the city into ground zero of a revolution that begat today's buckling global financial system. Now, as leaders of the world's 20 largest economies gather here to fix that system, some Big Bang architects are questioning the ideal of unfettered capitalism on which it was built.

In retrospect, they say, the movement unleashed unanticipated forces such as global banks whose influence extends beyond the reach of any one regulator. Those forces may be difficult for the G-20 -- or anyone -- to rein in.

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London Prepares for the G-20

London is bracing for angry protests before and during Thursday's Group of 20 summit, which will see fortresslike security for world leaders.

Few events embody the free-market thinking that shaped modern finance better than Big Bang. Under former Prime Minister Margaret Thatcher, a small group of officials, including Treasury chief Nigel Lawson and Secretary of State for Trade and Industry Cecil Parkinson, scrapped decades-old rules at the stock exchange and other institutions that they feared could leave London trailing behind rapidly globalizing markets.

The reforms helped trigger an economic boom and boosted the status of London's banking district, known as the City, as one of the world's financial hubs -- and as a testing ground for some innovations that wound up at the center of the current crisis.

Looking back two decades later, Messrs. Lawson and Parkinson say at least one thing went wrong: Banks were allowed to grow too big for anyone, including their own managers, to oversee.

"The notion that banks would get as big and as bloated as they did get -- that was totally unexpected," says Mr. Lawson, who like Mr. Parkinson is now a member of the House of Lords, the upper house of the U.K. Parliament.

As a result, they take a dim view of G-20 leaders' efforts to expand the global regulatory system to match the size and complexity of the financial system.

Over the past few decades, banking conglomerates have delved into a range of businesses, including buying and selling complex derivatives contracts as well as putting their own money on the line in bets on financial markets. In the process, they have become so large -- U.K. bank assets amount to £7.9 trillion ($11.31 trillion) -- that governments have little choice but to bail them out when they get into trouble.

The solution, Messrs. Lawson and Parkinson say, is to break banks into the separate businesses they used to be. Mr. Lawson recommends introducing a version of the U.S. Depression-era Glass-Steagall Act. The legislation created a wall between commercial banks, which take deposits and make loans, and securities firms, which take bigger risks with their money. By making sure commercial banks don't get too entangled with securities firms, the logic goes, regulators could keep troubles at the latter from infecting the former.

To be sure, restoring a separation among different businesses would be a daunting task, given the deep and complex connections among types of financial institutions.

Big Bang began with a seemingly small move: abolishing fixed commissions at the London Stock Exchange, which at the time was an exclusive association of small financial houses that dominated the U.K. trade in stocks and bonds. The competition unleashed by the move, which went into force in 1986, broke down a barrier that had helped keep the system stable: The separation of brokerage firms, which executed clients' trades, from so-called jobbers, or securities firms that risked their own money by taking positions in stocks and bonds.

In addition to ensuring that brokers weren't betting against their clients, the separation prevented firms from getting big enough to be a systemic threat.

Once the fixed commissions were gone, falling profit margins pushed the brokers and jobbers into mergers with big global banks. That opened the way for U.S. banks such as Citicorp (now Citigroup Inc.) and U.K. banks such as Barclays Bank PLC (now Barclays PLC) to get into the risky business of securities dealing -- something that was still banned in the U.S. under Glass-Steagall, repealed only in 1999.

Attracted by the freedom and later by the U.K.'s famously light-touch regulation, global banks turned the City into a laboratory for new financial products.

Now, as U.K. regulators seek to crack down by expanding supervision to cover the entire universe of banking, including hedge funds and structured investment vehicles, the Big Bang veterans are skeptical.

Amid preparations for the G-20 summit, authorities in England made five arrests Monday, according to the Associated Press. Police arrested five people in Plymouth, 240 milesfrom London under terrorism laws, the AP reported, and recovered a haul of replica weapons, fireworks and activist propaganda. Law-enforcement officials said officers are investigating whether the group planned to target the summit.