The US is fighting recession, the UK is dithering

The Fed duly cut interest rates by another 50 basis points, taking them down to just 3%. We see recession fighting in full cry in the USA, where the Central Bank and the administration are uniting to pull the US economy out of its sharp slowdown.

Lower interest rates will ease some of the tensions in the housing market, allowing some people to carry on servicing mortgages which might have been too dear for them at higher rates. It makes it easier for all those businesses operating on borrowed money. It will also encourage a lower dollar, pricing US exporters back into world markets, and curbing the US appetite for imported products.

Meanwhile, on this side of the Atlantic, the authorities remain hesitant and divided over whether to carry on fighting inflation, or to see the Credit Crunch as the new enemy. UK rates are too high for comfort. Inflation will remain unpleasant this winter but will start to correct later in the year.

Yesterday the government published its review of the regulatory arrangements for banks in the wake of the Northern Rock crisis. They made suggestions and proposals in five areas:

1.” Strengthening the financial system” by introducing better risk management of banks and better supervision and rating of securitisation of loans.
2. “Reducing the likelihood of banks failing” by asking for more information and changing the arrangements for providing liquidity to banks.
3. “Reducing the impact of failing banks” by introducing a “Special resolution regime” by allowing the authorities to take action with a failing bank to achieve a rescue or orderly run off
4.”Effective compensation arrangements” including faster and bigger payments.
5. “Strengthening the Bank of England and improving coordination between authorities”.

The proposals combine the sensible with the foolish, mixing some important lessons learned with the sound of stable doors banging shut after the horse has gone.

I would suggest the government listens carefully to informed opinion before implementing these changes.

1. It is important to take action to improve the deposit protection regime, without requiring a large up front cash payment from existing banks at a time when they are struggling to re-establish strong balance sheets after the losses made on securitised loans.
2. The government should make the Bank more independent and stronger to deal with failing banks in the future. This requires transferring day by day banking supervision to the Bank of England, and transferring the necessary staff or recruiting the necessary staff with banking expertise to be able to do the job.
3. The “Special resolution regime” could give near nationalisation powers to the authorities without the need to compensate existing shareholders. These powers were not needed in previous rescues, as the Bank of England has a powerful position as only lender to a bank in trouble. It is difficult to see why they need all these extra powers. The one thing that does need clearing up is the legal power of the UK authorities to arrange rescues quickly and in private under current EU market regulation.
4. It is a moot point whether the Bank of England needs new legislation to clarify its powers and role, when it always used to be able to undertake these matters before many of its powers were taken away in the 1997-8 reorganisation. The availability of skilled and experienced staff in a banking and bank rescue is a more relevant consideration, given the removal of banking supervision from the Bank ten years ago.

As always, there is a danger of the authorities fighting the last war. There is no immediate prospect of another run on a bank. The current difficulties are those of a range of banks strapped for enough capital and cash, and a new aversion to risk as banks reveal losses on some of the paper they hold in the securitised and syndicated loans area. A sensible supervisor would be asking how can the regulatory burden be eased prudently at a time when banks have to recapitalise themselves. There is a danger that further capital adequacy and regulatory tightening, coupled with demands for up front levies for a compensation fund, will make it even more difficult to get the banks and the markets bank to balanced conditions, allowing a reasonable amount of credit to be advanced at sensible prices.

I will respond in more detail to the many individual consultation questions in the government document when I have had more time to consider all the detailed queries.

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3 Comments

  1. Tony Makara
    Posted January 31, 2008 at 12:05 pm | Permalink

    I can’t see the BOE doing anything other than shadowing the ECB driven by the fear of too great a differential between Sterling and the Euro. The more Sterling falls against the Euro the more high streets prices, particularly foodstuffs, are going to rocket. These are the prices that Joe Public will notice as he gets his weekly shopping in at the local supermarket. With inflation in the Eurozone up yet again the ECB will not cut rates and the MPC will be under political pressure not to follow.

  2. mikestallard
    Posted January 31, 2008 at 4:52 pm | Permalink

    Thank you for this succinct summary. You are leaving Europe out of the equation, though, aren’t you? (FSA/ anti monopoly laws under a strict commissioner).

    Mr Brown has so arranged things that he can have his own way in everything. This, actually, means that he is totally out of touch and also that he cannot take sensible advice from anyone either.
    All dictatorships have this problem: things are not discussed properly and decisions are therefore wrong. Or the dictator dithers.

    May I remind you that taxation is running at well over 40%, the national debt is rising fast and (Telegraph today) 1 million people face eviction when their mortgages fall through.

    It’s serious all right!

    On the BBC the other night, the economics editor let it slip that “taxation last year wasn’t as much as the government thought it would be.” Does this mean that the system is now so chaotic and the Treasury so shambolic that taxes are not being collected and that a lot of people are evading them?

  3. David Hathering
    Posted February 17, 2008 at 8:16 pm | Permalink

    What an absolute shambles – the Banks control our economy which we are told is on the verge of recession.
    If we do enter recession in england, it will be because the banks did not want to eat into their extortionate profits – no other reason at all.

    The banks should be abolished as feudalism can no longer be tolerated especially when it is thinly disguised as capitalism.

    The government is a complete kakistocracy, and what is worse; there are no real alternatives!
    The real issues are swathed in complicated explanations expertly delivered by politicians who apart apart from convulsive rhetoric have no place in our society – a true definition for the word vestigial.

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    John Redwood won a free place at Kent College, Canterbury, and graduated from Magdalen College Oxford. He is a Distinguished fellow of All Souls, Oxford. A businessman by background, he has set up an investment management business, was both executive and non executive chairman of a quoted industrial PLC, and chaired a manufacturing company with factories in Birmingham, Chicago, India and China. He is the MP for Wokingham, first elected in 1987.

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