Such colossal sums of global taxpayers’ money have been spent and immense government guarantees continue to underpin the financial system that it is remarkable how little agreement exists to what constitutes the point at which the banking industry can be said to be fixed. Less still is there any emerging consensus as to the ideal future landscape of the financial services world.
This is no mere academic issue. The imperative to start repaying borrowing at the earliest opportunity cannot be overstated. Yet commercial lending is unlikely to return to anything like normal until the second half of 2011 as toxic assets are gradually removed from bank balance streets. The credit crunch will be with small and medium sized businesses for some time to come.
Meanwhile this year UK taxpayers are consuming over £4 in government spending for every £3 raised in taxation. This unprecedented burden of borrowing will have to be repaid by future generations in the form of reduced living standards; the UK situation being especially acute as our public finances were already in a dire state as we went into the credit crisis.
To extend beyond £200 billion of Quantitative Easing puts at great risk our medium-term economic prospects: so when can the Bank of England and the Treasury call time on their short-term fixes? Amidst the euphoria of a narrative suggesting recovery is within sight and a FTSE back above 5000 I fear that we are in truth some way from being out of the woods. I have written before that the root causes of the global imbalances brought about by the West’s financial calamity were the credit/debt bubble along with the East’s aggressive desire to build market share in global trade. China’s policy of suppressing its currency to soak up the West’s debt in the bond markets further helped hold down interest rates. Yet the resultant overinvestment, excess capacity and vast structural debt in the West remains in place. The underlying causes of the crisis have not gone away.
Notwithstanding the ruinously expensive bailouts and capital raising, the losses incurred by banks are probably still not even halfway recovered. Indeed the government’s insurance of toxic assets has provided a dangerously false dawn. There is no incentive – or currently requirement – for banks to crystallise non-performing loans because they could not then ignore the losses on their balance sheet. Lloyds Banking Group, for example, with a huge property portfolio courtesy of its disastrous HBOS merger, sits on an enormous pile of assets worth a fraction of their book value at their boom time purchase.
The collapse in public confidence in financial institutions and their more esoteric products has met with a strong-armed, opportunistic political response. Put simply, we need to ensure that management in banks are able to summarise in simple terms the financial products they wish to sell. If a derivatives product cannot be explained on two sides of A4 then frankly it should not be marketed. Naturally an unworkably complicated regulatory framework risks seriously hitting the future viability and profitability of the entire industry.
Instead, the wellbeing of the institutions in this sector – not to mention its customers – depends upon the development of a workable regulatory system based on commercial principles which pass muster over the decades to come. How else can we persuade those in their twenties to commence a lifetime of prudent saving as a prelude to a financially comfortable retirement? It all comes down to trust. This is an ingredient that no amount of regulation of ‘consumer protection’ will rapidly restore.
Alongside the promotion of open competition (an end to the heresy that a bank might be ‘too big or interconnected to fail’) the best government can do is to advance a culture of mutuality. In short, inculcate a sense of accountability between individual policyholders and a diverse range of financial institutions. For this reason, Conservatives should welcome the potential of Northern Rock returning to building society status once it has been stabilised financially. Promotion of as diverse as possible a financial services ecosystem ought to be a goal of future Conservative policy in this area. In future we need ethical values to come from individuals rather than resulting from a hostility which, inevitably, will be mounted against an all-powerful regulator. We should not expect too much from regulation. The buck must stop with all of us as consumers.
Regulation creates barriers to entry and promotes the large and bureaucratic over the small and innovative. A competitive free market can only be promoted by the reestablishment of less concentration amongst all institutions in the financial sphere and ultimately means allowing companies – even huge players like Lehman Brothers – to fail. The interests of depositors and retail investors should rightly be protected from such an eventuality.
A healthy, competitive and innovative capitalist system requires risk-taking, which is why shareholders and bondholders should not naturally expect such blanket protection. The trouble is that too much of the current debate on banking regulation has focused on how we should have stopped the last crash. This has not been helped by a government whose recent economic policy pronouncements are governed less by the national interest and more by a ‘scorched-earth’ approach designed to limit the room for manoeuvre for years to come of any incoming Conservative administration.
We would be better turning our attention to how best to create a future global financial system that will be trusted by today’s children investing in the decades ahead in anticipation of a long, secure retirement income.