Sep 13 2007
Chancellor blames the banks: he has to take responsibility
Some weeks late, the Chancellor has at last had something to say about the credit crunch.
Let’s look at the crucial statements from the interview:
"One of the things that happens with low interest rates is that banks look around for better returns"
Yes - exactly. The low interest rates generated by this government’s changing the inflation target to the unrepresentative and low figures of the CPI, allied to the international interest rate background, did encourage banks to look around for new and possibly more profitable ways to lend money. That’s what low interest rates always do, and any sensible government would have realised that before changing the target. If they had wanted to avoid a further burst of extra credit they would have stuck with the RPI, the index that is still used for indexed government bonds and in most pay negotiations.
"Institutions have in some cases been prepared to lend to people without checking if they were ever going to repay it"
No, No, No. This is prejudice by someone seeking to avoid the blame. I know of no bank that ever lends without having an agreement on when the money will be repaid and an understanding of how that will be financed. The problems in the money markets are arising because the money in question has to be repaid after 3 months, at a time when the government and Central Bank is now sending a totally different signal out, that it wants banks to lend less. Nor did banks stop assessing risk. It is,as Darling himself admitted above, a case that when interest rates were very low risks looked lower. Now Central Banks have put interest rates up a lot from the low, risks look different. Some of the funds that went wrong were often thought to be low risk funds, because they thought they were dealing in high quality paper as assessed by rating agencies. Higher interest rates and the wild gyrations of the markets have changed that. The government did not warn banks in the good times to lend less. It is perverse that now banks cannot lend as much they are warned to lend less!
"Institutions themselves need to open their own eyes and be more honest"
I doubt if there are many senior bankers with their eyes shut at the moment. As one who has said we need more information to help the markets, I would not endorse the emerging view that we need more regulation of international banking. I had in mind a quick word from the Bank of England and the FSA to the leading banks, advising them to make a statement of how big an adjustment to profit they felt they might need to make in their next figures to write off any exceptional losses from the market turmoil. Imposing yet more cost and obfuscation on them will simply intensify the lending squeeze, not help resolve the position. The market is trying to form a judgement of how much each big bank has lost on poor quality mortgages, and on lending to support investment in various types of mortgage and short term paper.
We learn Mr Darling is going to discuss these matters with the US Treasury Secretary and with European Finance Ministers. I just hope when he does so he is better informed than he appeared to be yesterday for this strange outburst about a return to "good old fashioned banking." What he should be doing is:
1. Asking himself if he should in the longer term carry on using the CPI for the inflation target at the Bank of England.
2. Asking many whether now the world’s Central Banks should be turning their attention to fighting falling activity and slowing growth. Japan’s economy is now experiencing falling output, and most forecatsers expect the US and the main EU economies to slow from here.
3. Talking to the Bank of England about how far they propose to allow mortgage and other lending rates to go above the base rate they solemnly set each month, before they too like the Fed and ECB recognise the need to intervene in the money markets to get actual rates more in line with the rates they are setting.
At the moment the system of monthly interest rate meetings at the Bank which this government confirmed as their principal macro economic policy is marginalised when it comes to the rates people pay for their borrowings and the availability of credit. A policy of lecturing banks on how to lend is not going to work. The Chancellor is the elected politician responsible for this problem. He has at last taken a step to acknowledge his responsbility by his statements yesterday. Now he needs to think again, realise his statements were unhelpful, and try behind the scenes to sort out the mess in the money markets which arises from the boom and bust approach to lending which has characterised the last few years.
If he wants a "more honest" approach he should start by publishing proper figures on how much the public sector has borrowed in recent years, including full accounting for Network Rail and other guaranteed borrowing, and full figures on potential liabilities under Public Private Partnerships and Private Finance Initiatives. He will find the private sector reveals more about its finances than the government does on its own balance sheet.
John Redwood has been the Member of Parliament for Wokingham since 1987. First attending Kent College, Canterbury, he graduated from Magdalen College...
Another thoughtful and well argued piece. Why aren’t you the Shadow Chancellor?
Can you please tell me why it has been legally possible for Brown to effectively keep two sets of accounts by not showing all the public sector borrowing, to which you refer, on his balance sheet? Wouldn’t a company finance director be jailed for so doing?
Reply: Thanks for the kind words about my piece.
Gordon Brown has been able to keep borrowings off his balance sheet by making the rules himself, or by persuading the governemnt’s own statistical service to endorse these treatments. Of course no Board of Directors could treat guaranteed borrowing and contingent liabilities as outside their annual accounts. They do not make up their own accounting rules: Parliament sets the legal framework and the FRC/ASB issues the accounting standards they have to conform to.
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Mr Redwood thank you for your analyses. One odd thought is, that though I was in short trousers at the time of the 1992 General Election, I have since heard older Conservatives mutter that if Neil Kinnock *had* won in ‘92, Black Wednesday would have happened on his watch and the Conservatives may therefore have won in ‘97 and afterwards.
Obviously this is completely unverifiable and pretty pointless to speculate about. Except that, given the possibility of the economy suffering over the next couple of years from the events you describe, do you think that, if a November G.E. were to be called, it would probably be best if the Conservatives actually lost, rather than walking straight into a fiscal thunderstorm?
Or, more practically, what would you propose to avoid this situation? From your blog you seem to have some ideas - can the party not be more vocal about the dangers to the economy and how we, rather than Messrs Brown and Darling, have the right ideas to ameliorate it?
Reply: yes, Labour would have inherited the ERM experiment in 1992 and have suffered from the financial difficulties which followed. There would have been poetic justice in that, as Labour in opposition supported membership of the European system which caused the problems.
No, I don’t recommend losing an early election for the Conservatives. This credit crunch can be sorted out in the traditional way by cutting interest rates and making more money available. If the Conservatives won an early election I would want to see that process accelerated.
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I would think regulation may have to be an issue here. If the consequence of a potential unstable banking system is unbearable then action needs to be taken.
What strikes me most about the current crisis is how often you hear commentator saying nobody knows who is holding the bad debt. That position needs to improve in the future and we need to be assured that it has.
The underlying problem here is that those who made great bonuses and business for the last few years will not be the ones paying for the downside.
Reply: I suspect some of the large bonus makers will be paying for the mistakes. Some will lose their jobs in the shake out, others will not be earning the mega bonuses they were used to in the good times.
There are two different elements to to the current difficulties in the markets. There is an element of not knowing how big the losses are and where they lie. This will be solved as banks and other financial institutions release their half yearly figures, when they will have to make provision for bad debts and for losses on holdings. I would like this to happen more quickly, but it does not require new regulations.
There is then a simple shortage of cash. The takers for 3 month paper are much reduced, so banks are having to make loans on their own books instead, limiting their capacity to write new loans for others. The authorities can decide how long they want this to continue, by their policy towards interest rates and supply of cash to the markets.
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Couldn’t agree with you more, John. The whole situation stinks of trying to pass responsibility onto the banks, when it is the government who have set the tone all the way.
http://lettersfromatory.wordpress.com/2007/09/13/nervous-times/
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Great article exposing the incompetence of Gordon Brown and his patent lack of economic credentials. For too long now Gordon Brown has peddled the myth that he is some sort of economics expert and has created a miracle economy where everyone works and everyone can own a home. Recent events have exposed Brown badly and he has been keeping his head down. Then when Brown finally raises his head he comes up with naive and damaging statements about financial institutions. I fully agree that Gordon Brown needs to be fully transparent over public sector borrowing. The Labour government is keeping two sets of books and needs to come clean. Keep up the good work John, its great that we have a senior politician like yourself keeping us informed with such razor sharp analysis. We need it!
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Thanks for your reply regarding how Brown has been able to keep borrowings off his balance sheet. Is it not time that Parliamentarians made laws which applied to government ministers as well as the hoi polloi?
Reply: I quite agree - if putting all the borrowings on the balance sheet - and the pension deficits - is necessary for the private sector, why not for the public sector.
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Good article, John. Darling is either playing to the gallery or has revealed himself as someone who knows very little about how banking works.
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I agree that the Bank of England should never have switched from CPI to RPI, but surely switching back now may actually suit the chancellor and allow cheap money to continue. If there is a housing market crash isn’t there a good chance that RPI will fall below CPI and so by switching to RPI the BoE will be able to set lower base rates?
Reply: I wouldn’t rush to switch back, as we need the markets to calm down first. No, I don’t think the RPI would allow looser money than the CPI, assuming we continued to set a target with just a 0.5% difference from the CPI target.
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The point about renumeration for some of the key stars etc is that it is worth them taking the risk with other peoples money as long as the good times last for a few years.
This is a classic conflict of interest that for example delivered the Nimrod AEW fiasco. Key people knew the project was doomed, but it was never in their personal interest to point that out.
I’ve seen this in my own professional life with software projects that head to the wall - but its never in the interests of the developers to point this out to management as they just get their P45 a bit earlier.
Traders Nick Leason and John Merriwether also spring to mind as examples of individuals. But sometimes it can be whole groups or classes of people.
The facts that no one knows what the real situation is, or least they didn’t a few weeks ago, reflects the fact that no one cared enough to find out. Things were just going too well to be bothered to find out. Short term gains out weighed any long term risk for the individuals whose interests are not aligned with the people they serve.
I am always haunted by the impact of the bank collapses of the great depression in the US. I hope I’m not the only one.
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John, as you know the Bank of England was one of the few, perhaps the only, central bank to apply the penalty emergency lending rate a month ago thus jacking up LIBOR. I have heard folk say “bravo, they’re right to be strict with the banks, Bagehot would have been proud” and folk say “disaster, they’re risking a liquidity crisis”. Do you think the BoE did the right thing?
Reply: I think the UK authorities have gone from being too lax to being too tough
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