Now Osborne wants ban on banker cash bonuses

At the end of this week, UK bank chiefs will submit their plans for limiting year-end bonuses or risk having regulators impose new rules on them. Lord Turner, head of Britain's banking regulator, the FSA, has asked for a breakdown of how bonuses will be split between cash, shares and other forms of payment. If proposals are not forthcoming, Lord Turner may demand the cash is used to beef up reserves.

If the banks weren't feeling regulatory heat before, they are now.

Today, Britain's shadow chancellor George Osborne will urge the government to follow the US lead and ensure this year’s bank bonuses are awarded in shares.

"The cash that would have been paid out should be put on to banks' balance sheets explicitly to support new lending," Osborne will say. "Where banks do want to pay bonuses this year to those senior staff who have earned them, those bonuses should take the form of new equity capital - shares in the business."

In a further evocation of the Conservatives' winsome desire to forge a special relationship with the Obama administration, Osborne will offer: "America is acting. Britain at the moment is not." He is referring in particular to US pay tsar Ken Feinberg's strict imposition last week of strict pay curbs on American banks still receiving state support.

Over the weekend, George Soros took the offensive, pointing out that banks are effectively being given subsidies of "enormous amounts" because of their ability to borrow at effectively zero from government.

Soros told the FT that near-record bank profits are "not the achievement of risk-takers" but the winnings of a player dealt an easy hand.

However, there is a sense that banker pay is a sideshow, akin to discussing how to make sports fairer, and a distraction from the unpopular but more important issue of systematic reform.

Former Fed Chairman Paul Volcker and Bank of England Governor Mervyn King were both comprehensively shot down last week for suggesting retail and investment banking should be separated. It's an eminently sensible proposition - just one that politicians on both sides of the Atlantic detest.

But why? The prevailing theory is politicians are profoundly fearful of a drop in the tax take from the financial services sector.

Under the Volcker-King plan, retail banks would take deposits, make loans and even trade securities - but only for customers. Investment houses would buy and sell securities for their own accounts, be free to take on debt and leverage assets, but they would no longer enjoy "too-big-to-fail" government protection.

Given this reluctance to consider a break-up, regulators are being urged to invent new tools.

If it is impractical to separate the two sides of the business, says Soros, "there have to be internal compartments that separate proprietary trading from commercial banking and seal off trading in various markets to reduce contagion".

One idea tabled is for central banks to limit lending to sectors considered to be overheating. In Soros's reckoning, the crisis of September 2008 was the collapse of a super-bubble that had been growing as a series of mini-bubbles since 1980. As each mini-bubble burst, governments stepped in, rescued institutions, offered monetary stimulus, and inflated the super-bubble further.

So where are the bubbles now?

Last week, Qin Xiao, chairman of China Merchants Bank, the country's sixth-largest, warned that China needs an "urgent" tightening of monetary policy to prevent the huge stimulus measures from inflating stock and property bubbles.

Norwegian Bank Governor Svein Gjedrem is set to increase interest rates this week after warning that property prices are rising "probably excessively"; Reserve Bank of Australia Governor Glenn Stevens cited costlier real estate as a reason for raising rates three weeks ago.

A survey of 147 clients published last week by Goldman Sachs found 75 per cent think low rates are triggering "too strong" climbs in assets. South Korea and India are signaling they may boost rates next year.

Even if low interest rates are inflating new bubbles, central bankers at least are more vigilant. Morgan Stanley calls it a "new era". At root is a profound change in faith: markets aren't self-regulating after all.

Says Soros: "The efficient market hypothesis holds that financial markets tend towards equilibrium and accurately reflect all available information about the future. Deviations from equilibrium are caused by exogenous shocks and occur in a random manner. The crash of 2008 falsified this hypothesis."