George Osborne welcomes Sir James Sassoon's recommendations for a radical overhaul of financial regulation

George Osborne has this morning taken delivery of Sir James Sassoon's interim report into the tripartite structure of financial regulation in this country - which the shadow chancellor commissioned last autumn.

Sir James was formerly Alistair Darling's envoy to the City and was appointed to David Cameron's Economic Recovery Committee last month.

He says that it is clear that "fundamental reform" is needed and hopes that his report will kick-start a debate on what those reforms should be. He notes that such debates are already taking place in other countries by that "the UK the authorities have not yet engaged with many of the crucial questions."

You can download the full 80-page report as a pdf or access it from the Review website but the following are among the forty recommendations he makes:

• There should be new responsibilities and powers for the Bank of England so it can call time on debt;
• The Financial Services Authority should be fundamentally reformed to minimize the risk of individual institutions being able to again endanger the stability of the financial system;
• A full analysis should be conducted on the separation of ‘utility’ and ‘investment’ banks;
• There should be Increased capabilities for safeguarding financial stability in all the authorities, plus a closer relationship between the authorities to ensure better crisis handling.

George Osborne welcomed the "powerfully argued report" and promised to carefully consider it over the coming weeks and months. He added:

"The current tripartite structure failed to protect Britain's economy from over indebtedness, a banking crisis, and ultimately recession. The regime needs a radical overhaul, and this report sets out the options that we need to consider.

Jonathan Isaby

Comments

[Denis Cooper]

Jolly good.

How about Osborne now giving some attention to more immediate issues:

1. "Quantitative easing" by the Bank of England is being used by the government as a pretext to give itself indirect access to potentially unlimited sums of newly created money, as explained earlier in this posting on why there is no longer any pressing need to cut waste:

http://conservativehome.blogs.com/platform/2009/03/mark-field-mp-w.html

2. Darling's "Asset Protection Scheme" is a fraud against the taxpayer, as explained in this posting:

http://conservativehome.blogs.com/centreright/2009/03/the-most-expens.html

It would make sense for the Bank to use newly created money to capitalise a state-owned Resolution Bank, which would take over "toxic assets" from the commercial banks, getting those assets off the balance sheets of its client banks and replacing them with cash.

So removing the poison from the mainstream financial system into a safe place, for gradual disposal - and under tight contracts which ensured that eventually the Resolution Bank would recover all shortfalls and costs from its client banks, and could pay back everything it owed to the Bank of England when it was finally wound up.

But the Bank of England using newly created money to buy up top quality assets, gilts?

That only makes sense if this is understood:

AT THE SAME TIME AS THE BANK OF ENGLAND WILL BUY UP EXISTING GILTS, THE TREASURY'S DEBT MANAGEMENT OFFICE WILL SELL NEW GILTS TO FUND THE GOVERNMENT'S BUDGET DEFICIT.

It would have been more transparent if Alistair Darling had simply sent a written instruction to Mervyn King:

"Please credit £100 billion of new money to the Consolidated Fund account".

Because that must be the end effect of the Bank of England buying existing gilts, while the Treasury is selling new gilts.

I repeat what I said earlier, I await Osborne's resounding denunciation of these frauds; and what do I see?

Osborne issuing a statement welcoming a report proposing a reversal of stupid mistakes made eleven years ago, but which some of us actually noticed at the time, but which were barely mentioned by the Tories at the time or since, until very recently.

[Susan]

If Sir James was Darling's "envoy to the City" why were his recommendations (I'm assuming he made some not dissimilar to those in his Report) not accepted by Darling? If the answer is that they were not compatible with socialist ideology then I'm all for it.

However, until I have a clearer picture of Conservative policy, I can only feel uneasy at taking on previous advisers to a failed ideology.

I'm afraid I don't like the principle of an elected MP taking advice from an unelected quangocrat. And, in particular, I don't like unelected quangocrats flitting between parties.

[johnC]

Wouldn't the simplest thing just be to return to the system which worked perfectly well before it was replaced by this tripartite mess in 1997 ?

[RichardJ]

The only regulation necessary to bring these boom bust cycles to an end is to introduce a 100% reserve gold standard. However, as such a suggestion is seen as radical or even mad, the best we can hope for is that the BoE controls the supply of money into the economy more thoroughly.

[JoeF]

The recommendations are clearly better than the current mess but still not tight enough- 1 regulator is all that is needed.

As an aside, when I was in the City doing many Emerging Markets (saw many crashes, many arguments about regulation), my one rule on regulation was to see how many people had been sent to prison for breaking rules. There are crooks in every country, some never manage to send one person to jail, some send lots. Now just think about the UK...

[Denis Cooper]

Yes, but that's more for the future.

The immediate issues are the colossal frauds which are being proposed by this government in a desperate attempt to keep itself in office, and the feeble responses from the Official Opposition.

Here is a suggested alternative scheme, which would not involve the government

a) funding its deficit by telling the Bank of England to print more money, and

b) putting the taxpayer on the hook for future liabilities running to potentially hundreds of billions of pounds.

A not-for-profit, state-owned, Resolution Bank, established by Act of Parliament, which would:

1. Be owned by the Treasury.

2. Have an account with the Bank of England.

3. Be capitalised by a one trillion pound over-draft from the Bank of England - a PROPER use of "Quantitative Easing".

4. Have senior managers appointed by the Treasury, in consultation with the Bank and the FSA.

5. Have other staff seconded from and paid by its clients, the commercial banks, in each case to clear up the mess the client has created.

6. Have very closely worded contracts with each of its clients, the commercial banks that have got themselves into trouble through their own stupidity.

7. Have the remit of buying the "toxic assets" from each of its clients, at the minimum price compatible with the survival of the client as a fully functioning commercial bank, and in each case then allowing the seconded staff to gradually sort through their employer's mess, in some cases no doubt their own personal mess, and dispose of the "toxic assets" for the best prices they can obtain.

8. Return to each client any surplus over the price the Resolution Bank paid for its toxic assets, less costs.

9. And/or, claim back from that client any shortfall, plus costs, to be paid over a period of some years if necessary, with interest.

10. Be wound up when its job had been completed, and it had cleared its overdraft from the Bank of England, down to the last pound.

[David Belchamber]

Denis Cooper at 13.21:

"It would make sense for the Bank to use newly created money to capitalise a state-owned Resolution Bank, which would take over "toxic assets" from the commercial banks, getting those assets off the balance sheets of its client banks and replacing them with cash.

So removing the poison from the mainstream financial system into a safe place, for gradual disposal - and under tight contracts which ensured that eventually the Resolution Bank would recover all shortfalls and costs from its client banks, and could pay back everything it owed to the Bank of England when it was finally wound up".

This is a solution that should have been fully debated months ago (I suggested something along these lines back in November last but not nearly so cogently). This is roughly what Sweden did, is it not, with success at no huge cost back in about 1992?

The only thing I would add is the condition that the client bank be forced to use the receipts for the toxic assets as working capital to be passed on as lending to its customers and not stashed away on its balance sheet.

[rugfish]

Very good start, but it's interesting to note that a report released in March 2001 by the Bank of International Settlements, 'BIS', in Switzerland, which highlighted the risks of many of the events we are now experiencing, was completely ignored by Brown.

It must certainly qualify as gross incompetence on Brown's part when you consider the action Gordon Brown took was to 'remove' The Bank of England from having oversight and authority for regulatory controls of financial markets and banking in the UK, some four years previously.

But despite the BIS pointing out the systemic risks which existed, he took no action to remedy this obvious error, which is now unfolding as a homegrown UK and "Global Depression".

The BIS was set up by the Hague agreements in 1930, specifically to help coordinate regulation of financial transactions between central banks and banking in general, and it hosted an annual meeting of central bank economists on 9-10 October 2000 on the topic "Marrying the macro and micro prudential dimensions of financial stability", which outlined its intention "to stimulate debate on and study this important topic", which it gave broadly in its policy questions: -

1. How do central banks monitor the risk of financial instability?
2. What mechanisms amplify or dampen financial cycles?
3. How should policymakers respond to developments that pose a threat to the stability of the financial system?
4. Coupled with the statement:

The BIS continues

Quote: "Recent years have seen central banks pay increased attention to monitoring the risk of financial instability. As the papers in this volume illustrate, the approaches adopted by various central banks have much in common, although there are certain important differences. Some central banks rely mainly on aggregate macroeconomic and prudential data, while others make extensive use of supervisory data on individual financial institutions. Moreover, some central banks rely heavily on models of the financial sector, while others use a more eclectic approach. Overall, the work on indicators of financial stability has led to a more focussed analysis and a greater understanding of the aggregate risks to the financial system, even if it has not led to the development of a simple indicator of financial stability.

A theme that pervades a number of the papers in the volume is the recurrence of financial cycles. These cycles are often characterised by rapid increases in credit and asset prices, and often end with some form of financial system stress. The papers discuss the factors driving these cycles, including the tendency for assessments of and attitudes to risk to be pro-cyclical, incentive structures that encourage short-termism, and the nature of regulatory arrangements. One important issue addressed in some of the papers is the tendency for bank provisioning to be backward looking. This tendency reflects both accounting rules and the methodologies that are used by banks to assess risk. Another important issue is the role of contagion in amplifying the downswing of the financial cycle.

The papers identify a number of policy options for dealing with the build up of systemic risk. The first is public discussion by the official sector of the nature of risks facing the financial system. The second is to use regulatory and supervisory policies in a counter cyclical fashion or, less ambitiously, to make the financial system more robust to financial shocks. The third is to use monetary policy in an effort to constrain the development of financial imbalances that have the potential to cause financial and macroeconomic instability. The various papers discuss the advantages and disadvantages of each of these types of policies. One common consideration is the ability of policymakers to identify changes in risk sufficiently well to be able to respond. Another is the possible creation of moral hazard if the authorities systematically respond to changes in risk over time. A third important issue is the need to coordinate policy responses amongst authorities with different responsibilities". End of quote.

[Richard Calhoun]

Doesn't anyone accept that we ( the West ) will now have to unravel our hugely wasteful Welfare & benefit systems to bring our public spending back in line.

The Governments with cash are those in the East and they are not handicapped but pensions, benefits and welfare systems that are unsustainable.

If we want to have any chance of competing with these Eastern economies we are going to have to address this enormous problem

[Ross warren]

"The Governments with cash are those in the East and they are not handicapped but pensions, benefits and welfare systems that are unsustainable"

It really depends on what you call the east. The Saudi's have a very large royal family that in itself consumes massive amounts of wealth. Add to that their generous welfare provision,and they are another nation that could be turned into a basket case by the downturn. Of course some eastern nations do fit your bill, but in many cases they are backward nations. Britain far from having the worse and largest welfare state, pays some of the worst rates in Europe. That's not to say the welfare state isn't a problem, it is, but the amount of benefits paid is woefully low in comparison with Nations like French and Germany. Reducing the overall numbers in receipt of benefits whilst giving good benefits to those in real need should be our aim, I believe.

[Stuart]

So we have a tripartite system of regulation do we? The EU is one, what are the other two?

[IRJMilne]

johnC - we can't put things back to how they were because of EU diktat. Otherwise I agree!

I sympathise with RichardJ's comments on 100% reserves, but a mere improvement in that direction would be more realistic and still welcome.

[rugfish]

I'm surprised that no questions have been raised over the warning Brown was given by the Bank of International Settlements in 2001.

http://tinyurl.com/andz3f

I don't see Sir James has drawn any attention to the warnings given by the BIS several years earlier, that basically followed Brown's decision to remove the Bank of England from oversight of financial markets. Furthermore, this crisis is said to have stemmed from over leverage in the housing markets, yet Brown removed compliance in that field from the MCCB and gave it instead to the FSA, a body incorporate with an aim to follow European Directives not our own. Did this make any sense when knowing of the warnings given? I think not. Not only did it not make sense, it actually flew in the face of a warning from the biggest team of world economists one could muster.

The mortgage industry was upturned by the FSA, which placed guideline after guideline, and regulation after regulation, into an industry which had been working perfectly well for donkey's years before the FSA was created. Yet, despite there being added costs to the industry (and to customers), despite there having been a warning not to over leverage, despite we were rattling along nicely without the bureaucracy or interference from a Chancellor who knows nothing about the industry, he carried on to wreck it.

We HAD a situation where the entire economy rested on the ability of housing markets to steadily increase equity in accordance with natural inflation, and one which was offering sound risk. Since Brown created the bureaucratic overlord, the industry has gone bust and families have lost their homes.

The LAST thing we need, is more of the same by government interfering in the industry or a bureaucratic overlord which hasn't a clue either. What the industry needs (and what people need), is basic management controls and clear guidelines which actually make it work. What we need is the FSA to be disbanded and a return of specialists who know what they're doing. What we need is the MCCB and not the FSA.