Oct 21 2009
The Governor confesses, then blames the banks
The Governor’s speech was a curious mixture of the sensible, the insightful and the wrong.
He does seem to understand that regulation failed and helped cause the crisis. He stated ” unusually low real interest rates and large net capital flows from the emerging market economies to the developed world” “provided the fuel which an inadequately designed regulatory system ignited to produce the financial firestorm.” I agree. I would ask why the MPC of the Bank kept interest rates so low for so long, as surely that was part of the problem that helped ignite the fuel? Isn’t it time for an apology for those mistakes, made month after month in the days of excess credit? As he reminded his audience, the Bank ended up with inflation above 5% against a 2% target.I accept that the Chancellor too should accept his part in this, with the government’s change of inflation target in 2003 encouraging easier money.
I agree with his prognosis that there will now be some modest turnround in activity, and with his forecast that inflation will now rise into the new year as we see the results of the further devaluation, rising commodity prices and the increase in VAT.
I also agree with his criticism of the structure of the UK banking industry, with four mega banks that are too large to fail. I wonder why the Bank did not provide a stronger voice to back those of us who opposed the mega mergers which expanded RBS and Lloyds in the run up to the crisis? If we could see the dangers, why didn’t the authorities see them and act?
What I disagree with are his twin conclusions on regulation. He firstly argues that you cannot control banks properly by imposing capital requirements. We always used to, and did so well until the last five years. The relaxation of the capital controls under Basel was part of the problem. Under the Conservative plan the Bank will be asked to control banking cash and capital in a strong and counter cyclical way. We need a Governor who does think that is possible and will work.
He also thinks the way to cut the power of the banks and to stop them being too big to fail is to split risky investment banking away from utility banking. This is another misreading of the crisis. The first UK crisis in 2007 was a crisis of utility banking. It was mortgage banks who had lent too much to the wrong people in a tradtional way. It was the deposit base which lost confidence in Northern Rock and brought it down, following the Governor’s own foolish moral hazard lecture at a time when he should have made facilities available to the Rock to prevent the crash. The worst period of the US crash was when they allowed Lehmans, a pure investment bank, to go down instead of bailing it. The US authorities then bailed out or helped others bail out Investment banks in trouble.
The truth is you can control all types of bank by proper cash and capital rules, as we used to do before the big relaxation and easy money boom of 2003-7. I think the Governor is right to want more smaller banks in the UK. We do need more competition. Breaking up RBS and Lloyds is essential, but it does not have to be on strict utility versus investment bank lines. We need more utility banks to give customers choice, and to avoid more taxpayer bail outs.
27 Responses to “The Governor confesses, then blames the banks”
John Redwood has been the Member of Parliament for Wokingham since 1987. First attending Kent College, Canterbury, he graduated from Magdalen College...
We all have our own pet scapegoats on this one, but now is the time for the Conservative party to be specific in their proposals for the banks. I know JR has been showing us his plan, but he’s not the Shadow Chancellor. The proposals might be ridiculed by the Labour government, but they are part of the problem and the braying should be ignored. Any ideas they steal would be to the advantage of the country – point out their duplicity and be glad that your idea is implemented.
I still believe that if retail banking is to be given unlimited protection, investment and retail banking should be separated. It might not be necessary, but it certainly won’t do any harm, and serves as part of reducing the size of the banks. Having them linked seems to have contributed to the problem, so this possible trigger should be removed.
We also need limits on leverage; preferably none allowed, or just the amount that the BofE is prepared to extend cover for. Dependency on short-term money markets to support long-term borrowing is absurd. It also seems to allow the retail banks too much influence over the amount of money available in the economy as a whole, and this should be the domain of the Treasury and the BofE.
There is a long list of British institutions well past their sell-by date. The British banking system is near the top. Of course the banks should be broken up so that a mixture of providers emerges to cater properly for consumer needs.
The great majority of the public wants and needs a good choice of banking providers, some offering narrow banking only, and, in each case, good customer service. The first requirement is that retail banks should not go bust and take our money down with them.
Of course the requirements of the public count little to the political classes unless there is an election angle. At present, the plan to re-elect Gordon Brown in May 2010 trumps everything. Thus we have virtually no sensible public debate on the future of the banking system. Why not? It is one of our biggest earners of foreign income and occupies a large percentage of our commercial activity. It is the biggest and most important subsidiary of UK Plc and provides the Government with fistfuls of tax pounds to throw at the public services.
If the Conservatives were to campaign on the basis of the creation of a “peoples” sector in the banking system with no silly bonuses, no toxic investments, no casinos and no over-inflated remuneration at head office they would get plenty of votes on the back of it.
The good news is that entrepreneurs could probably make as much money out of well-run narrow banks as they can now out of no-frills airlines. To use Mr. Cable’s favourite phrase, the banking system has had a heart attack and is still in governmental intensive care. When it emerges from hospital it will not be in the same form as when it went in. The big banks need to watch it. They could end up like other dinosaurs which don’t look after the needs of the public – operating mainly to pay the directors telephone number salaries and keep afloat unsustainable pension schemes.
I do agree with most of what you have said however, I can’t agree with this statement
“This is another misreading of the crisis. The first UK crisis in 2007 was a crisis of utility banking. It was mortgage banks who had lent too much to the wrong people in a traditional way.”
The crisis and it’s on going legacy was caused by easy credit, this credit contracted when the investment banks realized that the merry-go-round of packaging up assets such as mortgage backed securities and re-selling them could not continue forever because they had lent to the most risky individuals. This meant that the MBS could not be valued and the whole house of cards came tumbling down.
This crisis could not have been prevented by capital controls because the numbers involved are too large and the investment banks that were producing the churn would have simply invented new ways to churn the money. There is too much funny money in the system and that has to be purged. This has not yet happened and it is why the crisis is far from over.
http://www.dailymail.co.uk/news/article-1221179/Michael-Heseltine-lined-shock-comeback-David-Cameron-government.html?
First Clarke now Heseltine!
And we are told Cameron is not a Europhile.
There is no chance that a Cameron led Tory party will get my vote.
What is needed is a mechanism by which the equity and bondholders of banks are clearly on the line for the whole of their investment. Northern Rock could and should have been restructured in this way. The Conservatives need to bring forward plans to show how retail depositors will be protected but other creditors will not. It may require a change in the law. If bondholders of banks cease to have a government guarantee there will be a very rapid adaptation to the new reality by managements of banks.
Mervyn King is a thoughtful man and does have some useful insights. But I hope its not unfair to recall that he was one of the 364 economists who wrote to the Times in 1981 slamming Sir G Howe’s budget, a letter which was to be so undermined by the outturn of events in subsequent years and from which academic economics in the UK has never really recovered.
John, I agree totally that you can control all types of banks with capital requirements within limits. However things go wrong; the periodic failures of investment banks before the current crisis – Barings, BCCI, for example – show that. If we are to have a depositor protection system for retail banking I for one wouldn’t want it to be activated by investment banking activities bringing down a mixed/retail bank.
Some sort of Glass-Steagall separation is necessary.
Yes, Northern Rock was a utility bank but its business model was 100% reliance on the inter-bank lending market, which dried up. Why did it dry up? Because the banks knew that the collapse of the US sub-prime mortgage market and the peaking of UK house prices was producing lots of toxic assets, but no bank knew the extent to which its competitors were affected. Hence the lack of trust.
By all means rely on intelligent cash and capital controls provided they will work. The Govenor stated that the taxpayer contribution to banks in grants and loans is nearly one trillion pounds. I want to here the words ‘never again’ from John Redwood and from the Conservative Party. That means that if another bank gets into trouble, it will be allowed to go bankrupt. This is the capitalist norm, and I see no reason whatsoever why banks should be treated any differently from any other company.
I have questioned King’s suitability to remain as Governor under a Conservative government but at least he is warning that it will take a generation to clear up this wretched government’s debt. As I wrote yesterday, this message needs to be drummed into people before Labour claim that everything is hunky-dory and its all thanks to them.
Given that the banks have been behaving pretty outrageously, the obvious reponse is Whats new? (See above comments about Barings and BCCI, one brought down by poor judgement and
the other by the housing market).
The Home Ownerist press and political parties (thats about all of them) have done a good job blackguarding the Bankers who are never going to be popular in a recession but the real culprit was the Home -ownerists in the USA ,seeking to enlarge their permanent constituency by signing up/ bribing a lot of people to take on mortgages they could n’t afford in hopes of tax free capital gains.
If the mortgage providers hadn’t loosened the criteria described by Brian E on JR’s blog on 19th October,2.5 times his income,no wife’s earnings,25% deposit ,(plus the income tax schedule on imputed rent which he did n’t mention) then the investments based on sub-prime mortgages would n’t have got into the circulation of the banks and caused the seizure .
Once again ,it is the record of the Conservative Party that got rid of Schedule A in 1963 and ended years of flat house prices(and Resale Price Maintenance in 1964 which ended small shops) that does n’t bear much examination and which modern Conservatives should set right ,instead of aping the Republicans.
John
There has to be a balance. Breaking up the mega banks might resolve some problems (i.e. too big to fail/dominance in a sector of the market such as mortgages) but might create others. Smaller banks might be vulnerable to foreign take-overs weakening the financial services sector and its supervision.
Anyway, I suspect that the new smaller banks will then start on a period of consolidation through takeovers/mergers and will emerge as mega banks again!
You can look at other industrial sectors in the UK where the takeover of a company has eventually led to its closure and the transfer of its intellectual assets overseas should its new parent encounter problems. I can almost see Pilkington following that path ………. (but that’s something for a future thread).
Regards
Andrew
We need more utility banks to encourage price competition. That is we need to de-cartelise the utility banking sector.
I agree with your analysis. It was the utility banks pumping up house prices that was the main underlying cause: the collapse in MBS values was merely the symptom. Moreover, it was financed from abroad (those “large net capital flows from the emerging market economies”). Such money used to be known as “hot money” because it can be very mobile, and withdrawn on a whim. There was even published analysis questioning whether China would trash the dollar by refusing to roll over debt that recognised this (while staying mute about the implications for the UK) – see Ambrose Evans-Pritchard. Of course, China is already starting to spend the money on neo colonialism in resource rich countries that it needs to supply its ongoing economic miracle: they have learned well from British history.
Anyone who has worked in areas that have contact with Wall Street bankers knows there is a pecking order: the collapse of Lehmans (and Bear Stearns et al.) merely reflects the elimination of competitors lower down that pecking order. If those higher up the order had been directing events entirely themselves, they would have happily encouraged the elimination of competitors.
Some of them now seem to have strong parallels with the Medici – dominating their industry while cosying up to the sources of power. You focus on the structure of retail banking, but a very real problem is the power of the Wall Street investment banking barons who decide where money flows. Hot money would not have been parked in the UK to feed the house bubble and finance Brown’s profligacy without their say-so. Remember Rothschild: “Give me the control of the credit of a nation, and I care not who makes the laws.”
The sad truth is that nobody really knows what to do about the Financial services sector in the UK. It has simply grown too large and wealthy for the country’s good (ask the Icelanders about that).
Naturally, government loves the huge tax revenues that the sector usually delivers, not to mention the large salaries and bonuses which work their way through to the wider economy. So is any future government likely to heed Mervyn King’s advice and split up the high-street and investment banking sectors? I doubt it very much, as the investment banks would soon decamp to cheaper, sunnier and less-regulated climes, leaving the government with a vast hole in its finances (much the same one that it is currently trying to plug via the QE insanity).
The only solution that I can see, assuming that we genuinely wish to avoid a repeat of the financial crisis (and I’m not so sure that the will is there amongst the great and the good to ensure that we do avoid another one) is for UK banking to be completely reformed root and branch (sic.), so that we will live with a much smaller financial services sector in the future, and also much less of the benefits that have come from the City’s irrational exuberance since 1986.
But which party or politician is brave enough to wield such a sword?
Mervyn King is perhaps the only star in the Bank of England. He voted against rate reductions several years ago because he thought it would make monetary policy too loose. Unlike bitter Blanchflower, Mervyn King is very careful to keep out of these petty disputes.
“It was the deposit base of Northern Rock which brought the bank down”
Dear me.
Questions about the financial model of Northern Rock – borrowing long to lend short – had been raised some time before its collapse, notably by that female former Conservative minister, who represented Norfolk, whose name I’ve forgotten for the moment.
The banks collapse was precipitated by the closure of the wholesale capital markets – its source of short-term funds. It couldn’t function.
The sight of customers queuing outside NR branches to withdraw their money was a symptom rather than the cause of its problems.
Correction: Should of course be “borrowing short to lend long”
We were due a deep recession from the dot.com crash. After 9/11 Alan Greenspan flooded the market with cheap money at low interest as an emergency measure.
Bin Laden’s decimation of the World Trade Center had to hit global markets in a big way at some point. OK – it’s taken nearly ten years (credit to the Americans for staving it off for so long) but here it is. The ship has been oversteered.
On the current banks, could someone please inform me what has happened to the toxic debt?
Secondly, I am with the Nationwide because it doesn’t gamble with my money unless I ask it to.
My health and my money are really important to me, so I go where I can trust the people who look after them for me. If banks are not doing that, then where are the people who will?
I am reading, at the moment, the moving story of John Kirby who, on unashamedly Christian lines started off “Christians Against Poverty” to help people in debt. It now has branches all over the world.
If I were starting a business, wouldn’t I go to a bank which actually worked helpfully with me and which was interested in my efforts? Isn’t that the nub of the problem?
If you need to take a punt, why not try Shanghai?
Only retail deposits should be covered by a guarantee and if a bank is too big to fail its too big. Even if it brings in billions in the good times, the bad times that follow wipe out that income and some more.
Note the investment bank part of the banks are also guaranteed by the Govt so their credit rating is far higher than it would be and so their access to funds costs much less. The taxpayer is subsidising the lifestyles of the rich bankers! Notice how rich bankers can borrow at 1.5% whereas the rest of us are lucky to get a mortgage at 6%…..
John
Rather than you ageeing with parts of the Governor of BOE.
May I suggest he is agreeing with most of what you have been blogging on this site since last year.
Perhaps if we wait a little longer, he will publically agree with more of your thoughts and solutions.
What a shame that this is only now only coming into the Public domain. Or is it perhaps he has only just realised (with some hindsight) that you were correct on so many issues.
This really so something Tory Party HQ should be shouting from the rooftops.
The Governor has come to the same conclusion as us. Assuming that Tory HQ of course agree with YOU.
Sort off topic but relevant.
Mrs Lola has banked with Lloyds forever. She also opened a current account and savings account with Halifax. So far so good. Always good to diversify suppliers, especially banks, because they in particular are totally untrustworthy.
As we now all know LloydsHBOS is one giant state owned company.
Today Mrs L received a letter and leaflets from Halifax setting out ‘importnat news about changes to your current account’. (In my view this is bank speak for ‘our prices are going up – just read on to see how much by).
Halifax are stopping paying interest on current account balances and charging it to overdrafts. They are replacing interest charges with a ‘fee’ of, wait for it, either £1 or £2 A DAY.
The full paragraph is:-
- If you use and arranged overdraft up to £2,500 we’ll charge you £1 a day
- If you use an arranged overdraft of over £2,500 we’ll charge you £2 a day.
- If you use an unarranged overdraft we’ll charge you £5 a day.
OK, what’s the cost of that?
Assuming you have an o/d of £2,500 for a year that’s an interest rate of about 14.5% But if say you dip into overdraft of lets say £500 for a year the cost is 73%!
And if you have £2,501 for a year the rate is £29.2%.
This is a giant rip off. It’s an out of control bank blatantly profiteering from its customers, because it can. It’s stuff like this that ensures that no-one, quite rightly, ever trusts a bank. Personally I consider it state sanctioned (overcharging-ed). They are cynically rebuilding their balance sheets at the expense of their customers. They are the only businesses on the planet that can do this…….. If their balance sheets are so screwed, and they are, they should go back to their shareholders for more capital or do debt for equity swaps or whatever. But being allowed to rip of their customers like this, with State approval is just not on.
For God’s sake, break them up and introduce real competition ASAP.
(And Mrs L does not have an overdraft).
I really don’t agree with you, for once, John.
The fact that Mr King was talking about moral hazard instead of supporting the government’s mad schemes to bail out all the banks with taxpayers’ money, is to his credit.
Northern Rock was NOT allowed to fail. It was nationalised. In my view, it should either have been allowed to fail (if it was insolvent) or lent to by the BoE as lender of last resort (if it was just lacking liquidity).
I don’t agree with “counter-cyclical regulation”. Who defines the cycle? It is a recipe for politicians to cheat , fudge and spin. Remember Brown’s golden rule and how he kept changing the definition of the cycle to “prove” that he was still following it?
Rerply: Mr King did support the government’s bail out schemes, which I opposed at the time, preferring lender of last resort short term measures. If you are going to regulate banks cash and capital – and I think you should – you do need to make a judgement about the cycle. We are at the bottom today – not a difficult call.
I see Brown has contradicted King, and as one would expect, is insisting that only global regulation will do. Never mind that this will be as impossible to achieve as control of global carbon emissions, he has never grasped the point that regulations are an incentive to avoidance and not a prophylactic.
Just as there were several reasons for the crash (too much money resulting from low interest rates here and in the US and from innovatively opaque securities, leading to too much reckless lending; the BoE’s refusal to support a reckless NR, and then Brown’s fright at the prospect of it spreading to HBOS and other high street banks), there are several elements to a response.
I have no doubt that King is right, that as regulation cannot be the entire answer there must instead be greater competition between banks, with depositors’ protection calling for special treatment. Since mutual protection schemes cannot function without penalising the most cautious banks there is a need for closer regulation of such areas. And if we want innovative banking, these have to have less regulation and so be small enough to fail with the losses borne by their creditors and shareholders.
So the conclusion must be for legal separation of bank functions, with the custody of depositors’ savings and their lending policies being closely regulated; and less regulated investment banks where rewards and risks are high but do not pose a threat to the wider economy.
From the inaction and antipathy of Labour towards breaking up the banks one can only assume somebody is keeping some seats warm at RBS, Lloyds etc. for the old soldiers of the Labour High Command post-June 2010…. after all, who wants to have to do some work in a small competitive bank, when you can strategise and pontificate amongst the Great and Good in a Mega Bank?
It was the deposit base which lost confidence in Northern Rock and brought it down,
Yes because they were only insured to £2,000 per customer. So the Insurance was pathetically outmoded showing a complete disdain for depositors in Financial Nirvana Britain.
As for Northern Crock it ran a unit called Granite in Jersey which posed an existential threat to NR if it did not keep up a steady flow of mortgages into this Securitisation Unit. So by creating CDOs Northern Rock had to manufacture mortages just as Goldman Sachs did to sustain trading activities.
I do not consider Northern Rock to be a mortgage bank, nor HBOS – they were securitising and HBOs was funding LBOS and Leveraged Recaps. How NR was permitted to set up SIVs to run a CDO operation and offload the core balance sheet in a contingent arrangement which held residual threat of insolvency to the mainline business should mortgage growth slow is perhaps a sign that financial regulation in Britain is staffed by the lower decile of the intelligence distribution.
Dim but a banker would seem to sum up the manner of this country
Reply: The securitisation part of NR was the only stable part in the collapse.
I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around [the banks] will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs.
Thomas Jefferson, (Attributed) 3rd president of US (1743 – 1826)
Often quoted but could it be entirely accurate?
Also – if you owe a bank thousands they are your master – if you owe it millions [billions these days] then you are their master]. Is that also trite? In this country’s case who is ‘you’?
And, without a lot of knowledge – many on this expert site will say ‘well, you’re right there’ – I think the Glass-Steagall’ rule had a lot going for it.
Why is Mervyn King still there and why does he think anyone should listen to him?
His answer to every problem has been to do nothing.
He could have avoided the run on Northern Rock. When the markets dried up the Fed and ECB provided extra liquidity, Northern Rock as a UK only bank was unable to access this liquidity. The bank of england answer was a lecture in moral hazard.
He left it to the last second before rescuing HBOS and RBS. All the banks complained that he just doesn’t get it.