Are some banks too big to fail?

I have always been careful to go along with the conventional wisdom and with the government spin that there are banks that are too large to be allowed to fail. I have done so knowing how powerful the spin against me would be if I ever suggested otherwise.

To concede that does not mean, however, that I have to support the huge sums of money the government has made available to bail out bad banks, and certainly does not mean I agree with buying shares in them which delays sorting them out. If the authorities are stupid enough to get themselves into the position where some banks are too big to fail, it is even more important they take prompt action to break them up so they cease to be too big to fail. The correct strategy with an unwieldy conglomerate like RBS is to break it up into its constituent parts and find answers for each of them. Some could be sold immediately. Some will need managing to health and some like the Investment bank can be closed down after the bits of value have been sold. You should also keep RBS short of capital and cash to force it to raise more of its own, and to prevent it from paying the absurdly high salaries and bonuses it is still paying when it is no longer making profits and raising private money to do so.

This is a good policy for the taxpayer, cutting the taxpayers risk and getting some cash back. It is a good policy for the banks’ customers, leading to more banks and therefore more choice in the marketplace. It is good policy for the regulators, making it easier to see what is going on with each business having its own balance sheet and its own more visible and accountable management team.

The Competition authorities were asleep on the watch in recent years. They should not have allowed the Lloyds/HBOS merger, nor some of the constituent mergers that created RBS. Allowing banks to come that big does damage the market, putting too much banking under common decision making and ownership.

I read yesterday that the FSA is now going to hire 280 extra staff and is going to make life frightening for banks. I don’t think that is the right response. The regulatory failure in the UK occurred thanks to the former Chancellor. He was the man who split responsibility for banks capital and solvency by making the Bank of England responsible for the banking system and making the FSA responsible for individual banks. He became the chief Regulator himself, as the Head of the tripartite system. He must take the ultimate responsibility for what went wrong.

What he failed to see was obvious. Banks were allowed to expand their balance sheets far too much. It does not take 280 people to work that out. Just one person who knew what they were doing could have seen that the top four banks were all expanding too quickly and had too little capital in relation to the amount of business they were writing. If I could see that from the sidelines, surely the Chancellor could see it aided by all the advisers he enjoys at the Treasury, Bank and FSA. They had the powers to make them have more capital for any given volume of business and should have used them.

When I wrote the Conservative Economic Policy review Foreword I read the banks balance sheets and described how the fast growth of the previous few years rested upon the weird and wonderful expansion of financial instruments in the banking and shadow banking system. I explained how this would now come to a stop and how times would get tougher. This has been selectively quoted by the Guardian website to suggest I thought the expansion was a good idea! They just refuse to quote the crucial following passages and the recommendation that the Bank of England needed to be given back its powers to control banks cash and capital.

For those who have read the quote about how the easy credit created good times, misinterpreted on the Guardian site, here is the following quote in the same Foreword about what could happen next, written in June 2007 well before the run on the Rock and the events which followed:

“As we write, there is considerable uncertainty about how far the Fed, the ECB and the Bank of England may go in raising rates to squeeze inflation out of the system. They must know there are huge pyramids of debt throughout the system, and inflation will not be killed unless the appetite for more debt is blunted. They also know (perhaps they didn’t!) that if they push interest rates too high for too long they could bring the debt structures crashing down, as we have seen with the sub prime mortgage collapse in the USA, leading to falling asset prices, rising unemployment and even recession. “

I rest my case.

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22 Comments

  1. Deborah
    Posted March 13, 2009 at 8:14 am | Permalink

    It is infuriating when that well-thought out arguments are deliberately misrepresented.
    Thank you for putting the record straight.

  2. Demetrius
    Posted March 13, 2009 at 8:37 am | Permalink

    When big financial organisations get very big, go international, and begin interchanging credit creation systems and facilities with a range of others, then the risk of systemic failure is far higher. Think of the juggler. Four jugglers each separate and with three items, if one fails and the other three keep going, things can go on, and the one that fails may or may not recover. But if the jugglers then begin to interchange rapidly, and each adds items out of over confidence, if one goes down they all go down. If one or other of them in the course of juggling shuts their eyes, or tries to go faster than the rest, up goes the risk. This is all too likely to happen if the Ringmasters leave them to themselves, go off elsewhere, or much worse, try to join in the juggling. So in all this who are the clowns?

    There are enough lessons in history to teach us what can happen, but we are under a government with little or no interest in history, especially if what it tell us says is not convenient.

  3. StevenL
    Posted March 13, 2009 at 9:15 am | Permalink

    I remember reading all this here what must be about 18 months ago now, before the Guardian was even talking about LIBOR, Subprime, CDO’s etc.

    I remember when the document was published too, and the BBC introduced it as ‘… the most right-wing document ever’ after showing footage from over a decade ago of you trying to sing the Welsh national anthem, without ever actually bothering to debate the contents of it.

  4. HJ
    Posted March 13, 2009 at 9:19 am | Permalink

    John,

    As far as the Guardian is concerned, you are a weirdo extremist Vulcan and, as such, it really doesn’t matter what you say or whether you are right or wrong about anything – it is their job to discredit you. The end justifies the means by which they do this.

    I am pleased to have been able to clarify this for you.

  5. rugfish
    Posted March 13, 2009 at 9:23 am | Permalink

    Anyone with commonsense knows that, “The bigger they are the harder they fall”

    I take a big exception to (the FSA ed) message that the industry should be “afraid”. Para left out re Mr Sants

    This situation must be resolved.
    It cannot be resolved by an army of bureaucrats I(acting in a high handed way -ed).

    Leaving aside what I’ve written above, people in the finance industry are not like others. Others have due process granted them along with access to courts. The FSA, in its role as Witch Finder General, is simply the judge and the jury in matters and this is completely undemocratic.

    Tales abound on this, so when you see that so and so has been “fined”, “banned”, had “remedial measures” taken against them, had their names and businesses blacked, and you discover their “crime” was to fail to cross a ‘T’, or dot an ‘I’, then you’ll likely understand why a continuing lack of business will exist, why many in the industry will have removed themselves from it or the country with their brains, and why our economy , will be sliding further down an unhealthy economic slope as a result of bureaucratic dictators trying to run it, and our country, and the many thousands of good people in the industry who are neither ‘fiddlers’, ‘rogues’, ‘fraudsters’, or kleptomaniacs, (despite their apparent good intentions no doubt), into the ground with “fear tactics”.

    I abhor such doctrine and treat it ….. with utter contempt.

    words left out

    I also rest my case.

  6. Waramess
    Posted March 13, 2009 at 9:25 am | Permalink

    At long last this wreck of an economy is slowly releasing its hidden cargo of common sense.

    No banks are too big to fail; it is just that most minds are too small to see the possibility of an orderly failure. But don’t try to save them on the way, that’s a job for the market, just let them fail.

    The amount of taxpayer’s money pumped into insolvent banks is truly excessive and they are still insolvent; and they will still need a lot more money before normality returns.

    These banks are too big to save and too big for the public purse. As importantly we are now saddled with massive real overseas liabilities that will reveal themselves as the bad debts are exposed.

    And yes, inadequate capitalisation. The major contributor to the banks’ failure and about which little seems to have been done other than a bit of tinkering.

    Your courage in highlighting these issues will, I hope, eventually result in a lot of people having to think very carefully about the wisdom of current policies.

    We can rest assured however the FSA themselves will instil no fear into the market until they have the courage to cause one of the big operators to close their doors for business

  7. Brian Tomkinson
    Posted March 13, 2009 at 9:52 am | Permalink

    Brown has been and continues to be an absolute disaster for this country. When are we to hear the Commons debate about reducing his salary for such incompetence? As you know, Labour and those journalists who support it will use every device, fair or foul, to discredit you and the Conservative party so the Guardian’s treatment will have come as no surprise. I sense, however, a lingering lack of confidence in your party to really take the battle to these people. Perhaps that is why you are an under-utilised asset in the Conservative party.

  8. Mike Wilson
    Posted March 13, 2009 at 11:52 am | Permalink

    Have you seen Jeff Randall’s article in the Daily Telegraph today?

    When are the opposition going to take Mr. Brown to task in like manner?

    We are way past the point of having to worry about what people might think – why you didn’t speak up sooner etc.

    The fact is that Brown is going to bankrupt this country – and in two generations time – they will still be paying for his mess. Time to hound him out of office before he can do any further damage.

    The excuse for not nailing him to the floor before must surely be that the opaque regulatory system he put in place failed – but it was not until, finally, the banks signalled the game was up by refusing to lend to each other, that it became clear what a mess we are in.

    We’re in a mess caused by debt. More personal debt is not the answer. Credit must be provided to viable businesses – but the housing market should be allowed to correct to sensible levels of affordability.

    Which is best? Someone who has £500 a month of disposable income left over to spend on meals out, clothes, holidays, weekends away, trips to the cinema …etc. etc. – all of which create jobs and keep money moving in the economy – or someone who has no disposable income because every penny they earn is spent servicing a mortgage just to put a roof over their heads.

    In the first scenario the whole economy benefits – in the second scenario, only bankers benefit.

    Time for a rethink, I think.

  9. Neil Craig
    Posted March 13, 2009 at 12:16 pm | Permalink

    I appreciate your problem & this is an instance where I am glad I no longer have party membership since I am not restrained from suggesting things.

    It is also a reason why I think the current FPTP electoral system acts as a straitjacket producing 2 parties both trying to stand on very similar grounds. Apart from the consideration of democracy the fact that small parties are suppressed prevents new ideas being aired.

  10. chris southern
    Posted March 13, 2009 at 12:59 pm | Permalink

    These 280 people may be part of the fast track for finaciers into teaching!
    i wouldn’t put anything past this goverment now.

  11. Peter
    Posted March 13, 2009 at 1:36 pm | Permalink

    “FSA is now going to hire 280 extra staff”
    Where is the FSA going to get the extra staff from?
    There are a fair number of ex-bankers out there these days.
    They have the experience of the industry, but will they make the FSA better?

  12. David
    Posted March 13, 2009 at 3:58 pm | Permalink

    “The correct strategy with an unwieldy conglomerate like RBS is to break it up into its constituent parts and find answers for each of them. Some could be sold immediately.”

    The answer is staring us in the face. Create 2 retail banks called National Westminster Bank and Lloyd’s Bank. Leave all the toxic assets where they belong; RBS and BOS based in Edinburgh. The problem was after all created by Scotsmen, some of whom worked in Scotland, the others in Downing St.

  13. Michael
    Posted March 13, 2009 at 4:45 pm | Permalink

    Is there anything to learn from what the Canadian banking regulator (or banks) did? The Canadian banks haven’t fallen into the trap that caught UK and US and so many other banks?

  14. AngloBear
    Posted March 13, 2009 at 5:36 pm | Permalink

    John, please get some exposure. Is everyone else sick of Cable?

  15. alan jutson
    Posted March 13, 2009 at 6:49 pm | Permalink

    Your solution seems reasonable to me, although I do not pretend to be an expert.

    Problem seems to me there are many who think they are experts and will not admit that they are not, think the name Brown & Co springs to mind.

    Oh by the way, many thanks for having a go at Wokingham Council who wanted to spend £3,000 on a Civic reception for themselves. Your intervention I understand made them change their mind.

    Good to see a Politician who takes action to support his ideals of stopping wasteful expenditure.

  16. Robert
    Posted March 13, 2009 at 10:01 pm | Permalink

    John, the first profit warnings from the likes of Paragon etc. in the UK happened in April of 2007 – the die was already cast !

  17. Ian Jones
    Posted March 13, 2009 at 11:51 pm | Permalink

    It would appear the banks think the good old days will be back soon and the politicians are still too scared of being accused of wrecking an industry.

    How long will it take before the banks are broken up and the deposit side wrenched from the hands of the gamblers?

    The whole banking profit system is based on growing the money supply or on zero sum games. The Govt should control money supply and the banks should earn profits on real investments.

    Until we stop pretending then salaries will remain high for doing nothing.

  18. rugfish
    Posted March 14, 2009 at 10:34 am | Permalink

    I’m surprised my comment on the FSA hasn’t been allowed Mr Redwood.
    Maybe I’m in the wrong place if all political truth is not permitted on your site.

    Reply: Not so, I will edit it in due course, but anyone who makes personal attacks on named individuals gets protected by editing. Yours need a bit of editing. Please make trenchant criticisms of institutions without personalising them, if you want fast posting

  19. Denis Cooper
    Posted March 14, 2009 at 11:52 am | Permalink

    Rather interesting and amusing:

    http://www.bloomberg.com/apps/news?pid=20601109&sid=aANXHOD12Q2A&refer=news

    “South Sea Bubble Survivor Says Dismantle RBS Along With Lloyds”

  20. Blank Xavier
    Posted March 14, 2009 at 7:26 pm | Permalink

    JR wrote:
    > I read yesterday that the FSA is now going to hire 280 extra
    > staff and is going to make life frightening for banks.

    As if they *could*.

    Regulatory capture is inexorable.

    Look at Freddie Mac and Fannie Mae. The Office of Housing Enterprise Oversight existed specifically and only to regulate those two (off-the-books) Government entities. The Office has an annual budget of about 66,000,000 dollars. I tried to find out how many staff, but failed; from their organisation chart and budget, I’m thinking some hundreds.

    Do any good? not a bit. Not to even mention the support in Congress and the House for increasing the scope and size of Frannies activities. In 2006, for example, there was a push to get Frannie to handle mortgages up to 735,000 dollars – e.g. to compete in the entire market, while being able to out-compete every private lender because of their implicit State guarantee – in others words, a State run mortgage market (which to a large extent is what the Americans had already at that point anyway).

    This entire CDO mess occurred because of Frannie, because the Americans back in about 1930 went for Big Government and started meddling in the mortgage market.

    When a problem takes 75 years to mature, when it finally pops, it’s big. But you know, you *get what you get*, and this is what you get for manipulating the market.

    Regulate? regulate when you’re *doing the wrong thing in the first place?* great! that’ll help!

    > I don’t think that is the right response.

    It’s more of the same, where “same” means Government following its natural course, to centralize and regulate.

    It’s not the case that regulation does not work; it’s the case that regulation *cannot* work.

  21. Harry
    Posted March 15, 2009 at 1:10 am | Permalink

    “Are some banks too big to fail?” is your question:

    No. And some government ministers, regulators and financiers should be strung up from the nearest lamp post.

  22. kiki
    Posted March 20, 2009 at 6:27 pm | Permalink

    even though you have given me a new perspective, it seems to me that your suggestions are much easier said than done.

One Trackback

  • By Bad boys, old boys, new thinking | AccMan on March 15, 2009 at 11:07 pm

    […] for me to agree with someone as extreme in his political thinking as John Redwood but in this piece I believe he is talking sense when he says of RBS: The correct strategy with an unwieldy conglomerate like RBS is to break it up […]

    Reply: There is n othing extreme in my thinking, as any reader of this site will know. Stop the myth making.

  • About John Redwood


    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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