9th October 2008
They Think It’s All Over……
We’ve just had one of the Government’s ninety minute topical debate on ‘Financial Stability’. The length of a football match is an absurdly short length of time to debate the global economic crisis. But absurdity sums this place up just about as well as greed and reckless risk-taking sums up the UK’s banking sector.
The best speeches, they say, are the ones never given……so here’s what I would have said if I would had “caught Madam Deputy Speaker’s eye” (as they say in Westminster-speak):
1. The first point that’s worth recognising is that the Government has now almost certainly averted the catastrophe of one of the major British banks becoming insolvent, thus triggering a full-scale meltdown of the financial system. The Government has gone from Lender of Last Resort (its traditional role through the Bank of England) to Lender of Only Resort (through the Special Liquidity Scheme) to Owner of Last Resort (through the Recapitalisation Fund). Plan B effectively is more of Plan A i.e. if things get really bad the Government will move from partial to full nationalisation (*the Swedish model”) though that is admittedly unlikely. That said events have had a habit of going from the impossible to the inevitable with no intervening mid point in recent months, so never say never.
2. By guaranteeing the solvency of leading financial institutions, we have effectively nationalised the risk within the financial system. In this context, I think it’s extra-ordinary that the Government haven’t insisted on representation on the Board of any bank that asks for a capital injection. The biggest investor, in other words, will have the least Board-room influence. This could have been done via an arms-length body like the FSA. At the very least we could have asked for some employee representation, which is standard, for example, in most of the major German banks and would guard against some of the destructive short-termism that has got us into the current crisis in the first place.
Without voting rights we will have to rely on ministerial powers of persuasion, negotiation and the threat of as yet unspecified regulatory sanctions to change the banks’ policies on remuneration, lending and risk. Disappointingly, the Government hasn’t even asked for convertible preference shares which means that any up-side gain to the tax-payer from the investment will be much more limited.
I also find it surprising that the Government have said they will not ask for any changes in the management teams at any of the banks given the fact that it is their negligence in many cases that is responsible for the problems we now face. The simple fact is that many of the senior executives did not understand the complexity of the assets (Collateralised Debt Obligations, Mortgage-Backed Securities etc) in which they were trading.
On remuneration the Government says there will be certain conditions laid down but the Chancellor says it’s “ridiculous” to suggest the Government should set actual pay rates or bonus levels. I think it’s the voters that it will find it ‘ridiculous’ at a time when the Government is asking for a 2% pay cap among public sector workers that we cannot agree as a minimum that no executive should earn more than a million. (I found it extraordinary in the debate that the Lib Dem official spokesperson should attack David Cameron for insisting on a no bonus rule for banks in receipt of public funds - yet another sign of a rightward shift on the Lib Dems’ part?). The FSA’s new code of conduct on remuneration will apply to everyone in the banking sector. But surely banks in receipt of large amounts of public money should be expected to exhibit even more restraint.
Another issue is to what extent the part-nationalised banks will be forced to treat their customers fairly. The Government has said it won’t be capping interest rates set by these banks. And yet surely we should be stopping aggressive policies e.g. Barclays now charging some of its business customers 15.8%, and most of the banks raising overdraft rates and changing overdrafts into secured loans in return for a hefty administration fee.
A final issue on banking policy and practice is how we minimise the risk associated with the banks’ trading activities. As we can see from the experience of Nick Leeson at Barings or, more recently, with Jerome Kerviel at Societe Generale these can be substantial. If we are effectively guaranteeing the solvency of a bank then we should be in a position to ensure they are run in the most prudent way possible. In principle this should mean limiting the activities of the bank as much as possible to commercial and retail lending, together with lending to other credit-worthy institutions ata level that is not deemed to cause concerns over liquidity.
All in all, the strings attached to the Government’s bail-out are so limited one is forced to assume the Government was worried that if the terms were too tough, the banks simply wouldn’t take the medicine. Either that or the plan was knocked together in hours over the Chancellor’s Chicken Tandoori not ‘the many months’ the Treasury now claims. Let’s hope the tandoori doesn’t come home to roost.
3. Restoring a bank’s balance sheet, of course, is no guarantee that a bank will start lending again. Indeed as we were happily debating in the Chamber three-month inter-bank lending rates were actually rising - despite the biggest bank bailout offer in history and yesterday’s 50 basis points cut in interest rates.
Psychology is critical here (though real world fears about the state of the Chinese economy also play a role) so I would suggest two additional actions need looking at urgently:
firstly, yesterday’s rate cut needs to be followed by a series of drastic cuts in the end taking interest rates to somewhere in the range of 2.0% to 2.5%.
secondly, we need to shore up confidence even further by guaranteeing all retail deposits. It may be appear obvious to some depositors that after bailing out Northern Rock, Bradford and Bingley and Icesave that the Government will bail out all others - but that realisation has not necessarily penetrated consumer consciousness.
4. Loosening monetary policy is a necessary but insufficient condition for recovery. Because of the liquidity trap problem it has to be accompanied by fiscal expansion. Nancy Pelosi has called for a £150 dollar economic stimulus package in the United States. The Japanese Government are considering $18 billion of tax cuts for small businesses as a pump-priming measure. Providing a fiscal stimulus against a backdrop of growing Government debt is, of course, painful. But the alternative is turning an inevitable recession into a prolonged Depression. In other words, as with FDR and the US in the 30s, we have no choice.
Three obvious candidates for fiscal stimulus would be:
Construction -a sector which has been particularly badly hit by the downturn and where there is unused capacity, where there is massive unmet social need for housing, and where landbank values are now relatively cheap. If it makes sense to nationalise banks in whole or in part, and buy their shares because the private sector is unwilling to do so, in the hope that in a more stable financial environment the tax payer might actually make a profit, it must surely make sense for the public purse to spend money on construction when the costs are likely to be low and where the expenditure will be an investment of benefit to future generations.
Green Jobs - the Centre for American Progress and Barack Obama have suggested a $150 billion ‘green recovery programme’ focusing on renewable energy. The Government here have talked about the need for a £100 billion investment in energy infrastructure (though admittedly that includes nuclear). This investment in carbon-saving technology (including home energy insulation benefiting those on low incomes) would pay social and environmental dividends as well as creating hundreds of thousands of jobs.
Tax cuts - the fastest way to get the economy is to put money back in people’s pockets, especially the least well-off. The Democratic Congress in the US has already done this once this year. The easy way for us to achieve this would be to raise the tax allowance by £2000, which would cost roughly £12 billion. A similar argument could be advanced in favour of cutting corporation taxes for small businesses.
4. Over the longer-term we need to examine the causes of the current crisis and restructure the financial system to ensure it never happens again. What we need - but are unlikely to get from either of the two main British parties both of whom are funded to the hilt by City bosses - is our own version of th Glass-Seagall Act set up in 1933 after the last major US banking crisis and repealed by the Republican Congress in 1999 that separated out the activities of investment banks and commercial banks.
Secondly, we need fewer, smaller banks. In this period of mega-mergers this sounds counter-intuitive. But one of the phrases which has been used constantly recently is ‘too big to fail’. What clearly cannot be allowed in the future is to have the activities of large financial institutions posing a risk not only to their shareholders but to the financial system and the wider economy as a whole. The large integrated banks will need to be broken up if we are to avoid that prospect in future.
The final point to stress is this: Banks are different from other commercial entities, providing as they do the oxygen of money to the economic system. In more recent years they have begun to think that they create the oxygen itself rather than providing the piping down which it is pumped. They have seen themselves as ‘conjurors’ rather than solid, dependable engineers. But actually it is not the banks that ‘create value’ but the people to whom they lend. In that sense banks cannot be regarded in the same way as other companies. In some ways they are comparable to the railways, indeed the country’s transport system in general - carrying money, rather than people, to wherever it is needed most. The need to be regulated like public utilities - which will mean lower profits and lower bonuses for them, but also fewer crises for the rest of us. Or as Jonathan Guthrie put it in the FT this morning, bring back Captain Mainwaring.
In the meantime, Don’t Panic…..
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