Memories are short. It was only nine months ago that two of Britain's banks were hours away from collapse, with a domino effect that would have carried away the rest of the British banking system. If negotiations to inject up to £50bn of capital over that fateful second weekend in October had not stabilised matters, there were emergency plans to declare a bank holiday in which transactions would have been suspended – the first such step since August 1914. An economic depression would have been the almost certain result.
Yesterday the government announced its plans to prevent such a crisis happening again. For all the drama last autumn they have a distinct St Augustine feel about them: O Lord help me be tough on the City – but not yet. The core proposals that would require banks to operate with substantially more capital and introduce tougher policing of borrowing in the interbank market, so-called macro-prudential regulation, are not wrong. With sufficient determination they could substantially reduce the casino proclivities of British finance.
The issue that has been dodged is how much capital. Britain could have prescribed minimum capital requirements for banks; instead that will be left to international negotiations. In any case, besides the scale of the debacle and the desperate need to have a financial system that operates differently, it would only address part of the problem. We needed structural reform as well as regulatory change. The opportunity has been flunked.
The proportional scale of taxpayer support and loan guarantees for our banking system, exposing Britain to losses that yet may exceed 10% of GDP, is so far proportionally the largest of any G8 state. Equally, the dynastic personal fortunes that were made in the City in the 20 years up to the summer of 2007 match some of the most egregious periods of self-enrichment in history. The returns from British banking were five times higher than the previous century for two decades – before collapsing and triggering the deepest recession since the 1930s.
British citizens have every reason to ask the toughest questions of the City of London, its regulators and successive governments that allowed this to happen. More urgent still is economic recovery – the chance of an asset price bubble and credit boom in the foreseeable future is close to nil. Britain is a medium-sized economic power whose priority is mobilising long-term equity and loan finance to build a balanced economy along with creating safe financial products for the saving and investing public. The design of our financial system should be focused on that.
Any serious changes on macro-prudential regulation, the most telling part of the paper, will have to wait. The government has said what it "believes" but not what it will do. Banks, investment banks and building societies – along with private equity houses and hedge funds – made those astonishing returns from borrowing ever higher amounts of cash against ever diminishing capital and taking hair-raising risks in financial products and loan advances whose risks they did not understand.
While asset prices rose the lunacy was disguised; as soon as they cracked the whole house of cards collapsed. The government says it agrees with Adair Turner's review of the global banking crisis, which identified indulgence of this growing lack of capital, along with a general regulatory laxness informed by the intellectual delusion that financial markets were efficient, as the core of the problem. They are right. In 2007, absurdly and madly, only 2% of British bank lending was underwritten by share capital. The Swiss now think banks should operate with 16%; the Americans float 15%. We are still in the dark as to what the British think. Any significant hike will be fought to the last because minimal capital is the key to making dynastic personal fortunes.
The issue is not how power is divided between the Treasury, Bank of England and Financial Services Authority, with the Tories saying the Bank should be top dog, and the government defending the apparatus it created; it is more their capacity to analyse what is going on and respond fast with the right interventions. Strengthening the hand of the governor of the Bank of England, who until June 2007 had not made a single public speech warning of the systemic dangers but was rather a cheerleader for efficient markets, is hardly a solution.
Should the government have gone further? Radicalism, argue both Vincent Cable and George Osborne, would have meant breaking up huge banks that are too big too fail, banning bog standard commercial banks from indulging in any kind of investment banking (as Roosevelt did in the 1933 Glass Steagall Act ) and promoting much more competition. The difficulty with singling out big banks or even going for a British Glass Steagall is that the problem was systemic. Overleveraged hedge funds began the crisis, but the first casualty was a narrow bank – Northern Rock. Certainly big banks like RBS and Citigroup got into trouble. Others like HSBC, JP Morgan Chase and Deutsche did not. Here the government is right to say that unless the Germans, French and Americans do a Glass Steagall with us, there is no point in Britain going alone.
A smarter way is to insist on more capital, rising according to the size and complexity of the bank and the generosity of its bonuses. If top banks had to show how they could be painlessly wound up if they got into trouble, were policed on how much they could borrow from the interbank market and had to deal in any derivatives in a licensed exchange which itself was toughly policed, the whole casino character of contemporary finance would be reduced. If the government had more chutzpah it would have said so, and promised action. Instead it wants to canvass City and international reaction.
Even the measures on pay suffer from the same St Augustine effect. There should be limits to bank bonuses and how quickly they are paid, as some on the FSA board argue. Equally it is good to argue for more competition in banking – but where is it coming from? Unless the government splits NatWest from RBS, and HBOS and Halifax from Lloyds it is hard to see how competition will quickly emerge. Reforming finance will take courage and vision. There were signs yesterday that the government knows part of what needs to be done. The jury is out on whether it, or a successor, will ever do it.
Copyright Speakers Corner 2016