What will the new rules for the banks achieve?

Lord Turner is an intelligent and hard working man. He is untainted by the failures of the bankers and their regulators over the last giddy decade of excess credit. Let us hope he shows some wisdom in responding to the present crisis, and let us hope he understands that Regulators have to look ahead. The issue today is not how we stop the last crisis, but how we stop the next one. It is likely to be different from the last one.

Leaks imply the authorities now think banks should be made to hold more in cash and government securities. They should ask themselves why they want to feed the bad habits of the last heavyweight debt junky left on the bloc – the UK government.

Shouldn’t the Regulators be warning that the next problem could be a government debt problem? Shouldn’t they say to banks that lending to the UK government at very low interest rates has in the past been a very unrewarding pastime. It is true the government may print enough money to buy enough of its own bonds to drive the prices higher in the short term. But won’t there be a day of reckoning? Doesn’t the turbo buying have to stop at some point? What happens then? Couldn’t the banks all lose money if they hold too much government stock bought at high prices? How does that strengthen them?

Leaks also suggest they want to impose a limit on lending to people buying homes of three times income. They are right to think that interest rates are going to have to go up again. It would be wrong to calculate how much mortgage people can afford based on current low rates of interest.
A three times limit is well below the limits banks and Building Societies have been applying in recent years. It implies the authorities want to see a further substantial fall in house prices.

There is a case for driving prices lower again. Some of my correspondents have made it, saying it is high time homes became more affordable. A young person or couple starting out today still faces a house price mountain to climb to get their first owner occupied home.

Such a policy also means further distress for the banks, as lower house prices will leave many more mortgage loans they have made higher than the value of the property which is their security. It means weaker banks for longer, as the adjustments take place. That in turn means fewer mortgages, driving the price of homes down further. It means fewer jobs – fewer jobs building homes, and fewer jobs elsewhere, as lower house prices means lower consumer confidence.

One thing we can do without is yet another regulator, the Euro regulator, coming in to the game on top of everything else. We need simplicity and clarity, not more expense and more complexity. One of the worst features of the banking world in recent years in the UK has been the lack of choice and competition on the High Street for our banking business. More levels of regulation will mean more barriers to entry, and even less banking choice.

Would counter cyclical regulation of banking cash and capital be a good idea? Asking banks to have more capital in the good times, to protect them in the bad times? Yes it would. Will the Regulator be able to judge the cycle? Time will tell. The Regulator will be more likely to get that right if he is not trying to do too many other things as well. The problem with counter cyclical regulation is you need to be able to read the cycle. That was clearly beyond both the banks and their regulators in recent years.

By definition the regulators will not stop the next crisis. By seeking so many ways to stop the last one happening again, they will doubtless be looking the wrong way for the next one.

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28 Comments

  1. Simon D
    Posted March 18, 2009 at 8:59 am | Permalink

    If you asked a man or woman from Mars to design a new high street bank from scratch what would they produce? I suggest two banks.

    Bank One would be for personal customers whose requirements would be modest – payments in and out from current and deposit accounts and the odd overdraft. Leave all the other specialist stuff to building societies and insurance companies who can provide services such as mortgages and insurance much more efficiently than banks. It all sounds very much like the 1950s with a few whistles and bells on it.

    Bank Two would provide a similar service specialising only in business customers.

    Both banks would need a low cost base but would have to supply a much higher level of customer service than that currently being offered to high street customers. One of the features of banking over the last ten years is that while salaries and costs at director level roared into the stratosphere customer contact staff were de-skilled and service levels in the local branches went into steep decline.

    I don’t know what the people from Mars would do with the casino function in banking. Any ideas?

    • StevenL
      Posted March 18, 2009 at 10:52 am | Permalink

      They’d probably think “Wow! This doesn’t half look fun, imagine all the money we could make if we got lucky in here!”

      • Freddy
        Posted March 19, 2009 at 10:12 am | Permalink

        ” … imagine all the money we could make if we got lucky in here … ”

        I bet you will never find a successful trader who thinks his success was down to good luck … they all think it is because they were smarter than everyone else.
        So the Martians will probably all be thinking “Wow, look at all these idiots in the markets, bet I’m smarter than them …”

    • Robert
      Posted March 18, 2009 at 2:07 pm | Permalink

      A person from Mars would have no better chance of creating a “good” or “bad” banking system than would a politican or a regulator. The point is not to fantasise about an idealised banking system but to allow free markets to create the best structures. The reason the banks over-extended themselves was because they mis-priced risk and the reason they did that was because of loose control of the money supply. It’s the finance ministries, central banks and regulators that should take the principal blame for the collapse and they should be the last people given the job of cleaning it up.

      • Jonathan
        Posted March 19, 2009 at 2:20 pm | Permalink

        Robert:

        You say it’s not the job of the regulator to create the best structure but that it is the job of the free market. I know where you are coming from but I don’t think you should get confused between free market capitalism and anarchy.

        Some form of regulatory system is needed to ensure cartels, monopolies and other market abuses do not occur. Capitalism is a game with certain rules and these need to be followed so that the best outcome occurs and to ensure that all the players start out with the same level of power and ability to participate.

        Adam Smiths comment is quite applicable here: “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices. It is impossible indeed to prevent such meetings, by any law which either could be executed, or would be consistent with liberty and justice. But though the law cannot hinder people of the same trade from sometimes assembling together, it ought to do nothing to facilitate such assemblies; much less to render them necessary.”

        The regulatory system needs to focus on ensuring that risk, reward and ownership are properly aligned and that competition between participants is maximised.

        I think that Labour are trying to regulate a game that they don’t believe in with the wrong set of rules and this has led to much of the current problem.

        Regards

        Jon

  2. Waramess
    Posted March 18, 2009 at 9:34 am | Permalink

    You are again spot on. Governments and in particular this one, have been keen to use the banking sector as a tool for their own expansionist dreams but less keen on the consequences of their own excesses.

    When the capital adequacy rules were first introduced by the Bank of England they looked carefully at the different classes of assets in a bank’s balance sheet in order to prudently assess the inherent risk that would be covered by capital.

    Now more than ever the banks should be required to hold capital relative to the risk of their portfolio and that means any loan granted in excess of a predetermined percentage of the security held should be backed to that extent by even more capital, with few explicit exceptions.

    In this way the banks will leverage themselves not against reserves held at the Bank of England but against capital held conservatively against their various classes of assets. This is the way most companies operate.

    The problem with Lord Turner’s remit is that as he is operating in the vacuum of political influence his initiatives are bound to be formulated with this in mind.

    Nice simple transparency is all that is required with the FSA providing a detailed capital requirement to be held against different classes of asset, including the high risk fixed rate gilt.

    Most important will be the need not to devise rules to accommodate this period of great excess but to accommodate a banking sector in more normal times.

    Now, what we will get I suspect will be entirely a different matter

  3. Letters From A Tory
    Posted March 18, 2009 at 9:42 am | Permalink

    Attacking perfectly sensible mortgages around 4x salary is an absurd response to this crisis.

    I completely agree that the very notion of getting banks to put money aside ‘in the good times’ is flawed from the very start. No-one on the planet is able to predict economic cycles – they just happen. For any regulator to act on what is essentially nothing more than a wild guess will cause chaos.

  4. Jonathan
    Posted March 18, 2009 at 9:53 am | Permalink

    Simon D:

    Your two banks idea is I assume a variation of reintroducing the Glass-Steagall Act.

    I don’t quite understand why there is such enthusiasm for this idea as it doesn’t seem to be something that would have stopped this current problem. The first bank to go bust was Northern Rock a nice ‘traditional’ bank, later followed by Bradford and Bingley. In America it was the investment only banks, Bear Sterns, Lehmans, that failed. All these banks already ‘complied’ with Glass Steagall in that they were one or the other, yet they still failed.

    I think the problem has been too many large/mega banks. We need more, smaller banks that can fail without the whole system falling apart. Ideally when the government reprivatises RBS and Lloyds they will break them up into smaller components. The Competition Commission should also be stricter and no longer allow bank mergers or takeovers that result in only a few dominant banks.

    John Redwood:

    I would agree that houseprices are too high and need to fall to make them more affordable for those starting out. I cannot understand how people think rising house prices is a benefit when if it was any other commodity, an increase in price would be seen as a negative. You mention that higher houseprices increase jobs, however if people aren’t spending their money on unproductive houses they will hopefully instead be buying more productive items and if banks aren’t lending on unproductive property they will hopefully be investing in more productive enterprises.

    The only advantage of rising houseprices seems to be that it allows a large amount of money in the form of debt to be injected into the system on the assumption that its low risk lending. In effect we have had a huge fiscal stimulus or printing of money over the last few years. For a while this benefited the economy but when it came time to pay it back it seems to have ended in disaster.

    My worry is that the government may be able to borrow enough to keep things ticking over but that the economy will be so weak that in a few years time we will be in an even worse situation.
    Regards,

    Jon

  5. Neil Craig
    Posted March 18, 2009 at 10:16 am | Permalink

    You are right about the problem of having the tactics ready to fight the last war.

    These regulations look to me to rather clunking limitations which will make our financial services sector significantly less competitive. I doubt if, taken together, they will be as good a counter to moral hazard as letting some of the banks go bankrupt would have been.

  6. Mark M
    Posted March 18, 2009 at 10:39 am | Permalink

    I can’t tell you exactly what they will achieve, but I can tell you what they won’t achieve.

    They won’t achieve their specified goal. How do I know? When has anything this government has put through actually achieved its specified aim?

    I’m all for limiting mortgages to 3x salary, but I would rather see interest rates used to regulate this – not some arbitrary lord, as qualified as he may be. The reason people were able to borrow 5x their salary just before the bubble burst was because interest rates were too low and had been for too long. The regulator did not need to step in to ban excessive lending – the Bank of England should have raised interest rates and this would have prevented 5x salary 125% mortgages from ever being affordable.

    King can blame brown and the FSA all he likes, but the fact is that the BoE allowed too much personal debt into the system by keeping interest rates too low. All three corners of the tripartite system are to blame. At least one of them should have said ‘enough is enough, we need to slow down the growth of debt’.

  7. oldrightie
    Posted March 18, 2009 at 10:59 am | Permalink

    Many banks will convert out of sterling as soon as possible. US dollar at $1.30 is good value compared to where it will be next year. Following that, individuals and companies will want to trade in other than sterling. Ring any bells?

    • Robert
      Posted March 18, 2009 at 2:10 pm | Permalink

      By the time Obama’s finished, I wouldn’t be so confident about the dollar

  8. Denis Cooper
    Posted March 18, 2009 at 11:18 am | Permalink

    None of the mutual building societies has gone bust.

    A couple of the smaller societies got themselves into enough difficulty for it to be seen as desirable, maybe essential, that they should merge with a larger society sooner rather than later:

    http://business.timesonline.co.uk/tol/business/columnists/article4710760.ece

    and I know that Chelsea has recorded a loss this year, on the basis of writing off money lodged with Icelandic banks even though it may eventually be recovered.

    I also know that another society has complained about having to contribute to compensation for depositors with much less prudent institutions.

    On the other hand, none of the building societies which demutualised have survived as independent banks, and most of them have needed government intervention at taxpayers’ expense and risk.

    Could there be some kind of useful lesson here?

  9. John Coles
    Posted March 18, 2009 at 3:05 pm | Permalink

    I’m glad you spotted the perceived requirement for a “”EURO Super Regulator””.
    Was there ever any doubt that Lord Turner would call for this? He is enough of a careerist to know which way the political wind blows and instinctively does his master’s bidding.
    A EURO Super Regulator would interfere with our financial system and debilitate it (even further!), to the great satisfaction of our government in Brussels.

    • SJB
      Posted March 18, 2009 at 5:38 pm | Permalink

      Perhaps if a Euro Regulator had been in place several years ago the UK’s financial system would not be in the mess it is now. In addition, a single regulator for the whole of the EU might mean that the domestic variety could be pensioned off.

  10. savonarola
    Posted March 18, 2009 at 4:53 pm | Permalink

    In my view FSA and others are rong tree. They are looking through the wrong end of the periscope.

    Banks were given ‘low cost’ money for which they always find a home. Greenspan started fuelling the fire when he bailed out LTCP(Merriweather). Moral hazard compromised. The focus after 9/11 was to further reduce the cost of funds. Wrong policy and wrong message.

    Here we followed the fashion with our own twist. We set inflation targets which were designed by Brown to make him look good. CPI kept artificially low by imported deflation from China. No reference at all to asset price inflation. The ‘allright on the night’ philosophy suited Brown(and Con Party had to keep silent not to be seen as Cassandras).

    Brown should think long and hard(and so should Cameron) about the policy issues that were the original cause of banks being given free rein to expand balance sheets in the most reckless fashion.

    This micro regulation is fatuous and counter productive. By all means review bank balance sheets to see spread of assets by country but don’t start nitpicking.

  11. mikestallard
    Posted March 18, 2009 at 5:56 pm | Permalink

    The trouble is that there are three regulators and decisions will not be made because too many chiefs/egos are involved. It doesn’t matter how brilliant Lord Turner is, he is just one decision maker among many others.
    Add in a European Regulator, of course, and you get nationalism entering into the equation. Spanish and German bankers will be really, really happy!
    The Labour myth factory has insisted that Black Thursday was proof that the Tories had lost the economic plot. In fact, it brought a lot of sense into the economy and, with the Chancellorship of Ken Clarke, things looked very good. By 1997, the Bank of England and the Chancellor got on very well and planned together in friendship.
    Now the FSA is getting in the way of financial advisors, people who want to get mortgages, and so on; the Bank of England seems completely emasculated; and the chancellor does not seem to have a clue even about how much he is in going to go into debt.
    I know this is beginning to sound like a loop, but banking should be left to the bankers. It is, at the end of the day, their career and their money that is at stake. They deal in trillions. They take the risks.
    The government, and indeed the FSA, are not personally involved. They take no risks. They very often have no banking experience either. The front bench of the Labour administration has absolutely no experience of any kind of business risk. They are not in the arena and never have been. They are after votes as their website so clearly admits. And they are beginning to interfere politically in Northern Rock too (Spectator this week, Fraser Nelson).
    They are like the poker player with no experience of the game and very few chips.

    • Freddy
      Posted March 19, 2009 at 10:55 am | Permalink

      “The government, and indeed the FSA, … are like the poker player with no experience of the game and very few chips.”

      No, they have lots of chips. All of which belong to the taxpayer.

      • Freddy
        Posted March 19, 2009 at 10:57 am | Permalink

        Bah, sorry, please replace my quoted “The government, and indeed the FSA…” with “The front bench of the Labour administration…”

        The point remains, though.

  12. rugfish
    Posted March 18, 2009 at 6:14 pm | Permalink

    Recession is a natural occurrence. So when financial markets are connected globally and a recession occurs, then you’ll have a global recession. This is why global regulation, whilst appearing to provide a political solution, is really deficient when looking to avoid another global recession. Resolving an economic problem which could devastate the entire human race, which is both a mathematical and an economic certainty, would instead mean tackling how you limit that damage from becoming global.

    Essentially, continuing with financial markets in a global environment will inevitably result in another global economic crisis unless we realise that exponential growth will ultimately lead to global disaster. Not just financial but also for the human race itself as it has the real likelihood to cause effects upon the entire planet, to our food supplies, our political systems and even to population size which will at some point reach an unsustainable level otherwise.

    To limit the global impact of the next recession, we need to restrict global finance by placing an automatic limiter to exponential growth and to what we call globalisation, and that decision can only be taken at global level for it has to involve limitation of the money supply with one possible consequence such as a global tax on money exchange perhaps. e.g. Such as the late economist James Tobin had suggested with his Tobin Tax which he’d advised the European Commission should adopt in order to avoid this very crisis occurring. If there’s been a Tobin Tax in place then money would not have moved around so freely, but if it did and it led to crisis, then governments would have had the resources to bail the system out without resorting to borrowing. The simple fact is, that because the EU Commission refused to apply a Tobin Tax, it is now the people who’ll be picking up the cost of the crisis in terms of jobs and pensions and higher taxes, rather than those who created it.

  13. Adam Collyer
    Posted March 18, 2009 at 6:22 pm | Permalink

    Counter cyclical regulation sounds to me like an opportunity for the government of the day to manipulate the definition of the “cycle” and therefore interfere in the rules to its own benefit. A bit like Mr Brown and his redefinition of the cycle to suit himself over the last decade. We do have to remember that the FSA is actually part of the government, even if they wish to pretend it is independant!

    As far as Lord Turner is concerned, I’m not completely clear that he is “untainted by the failures of the bankers and their regulators over the last giddy decade of excess credit” – after all, he was Vice Chairman of Merrill Lynch Europe from 2000-2006. But maybe you were being sarcastic?

  14. snoekie
    Posted March 18, 2009 at 7:58 pm | Permalink

    1.An EU superregulator would be an absolute disaster. He/she would immediately try and impose EU desires to flatten the market between the various countries and to bring the UK into line with the EU’s wishes about banking being centred in London. Unacceptable. Furthermore, the rules would be inflexible to cater for the wide disparity between the various countries and would be unable to cater for local circumstance.

    2. It is a nice idea to have more cash available for the banks to have to meet the bad times. However, on a change of government, particularly to a Socialist government, there would be an irresistible urge on the part of that government to tap into those funds, one-off windfall (has been mentioned a number of times in recent years) windfall tax. Remember the one off windfall tax on the utility companies, and again, making it not one-off, but whenever they get into government , one-off. Look at what happened with the pension pots, a huge reservoir of money which they had to get their hands on to. The sale of gold, irresistible. Like slash and burn, it would be impossible for them to resist to tax and spend (waste).

    The problem that we had was not that there was insufficient regulation, there was, but the FSA, the lapdog, was following orders that it should not have been given, allegedly independent. It was not. To whom does Turner owe his appointment or reappointment? The government of the day. Accordingly he is going to kowtow.

    Turner should admit his failing in resisting the demand, and when he pointed out the overheating, to lay off. His duty to the public, in which he singularly failed, was not to ask the Chancellor, but was to trumpet the problem and also trumpet his solution, rein in lending, and raise interest rates to cool the overheated sector. He could not deal with interest rates because it was not within his remit.

    The current position is that interest rates are so low because of a “conspiracy” between government and banks. There were some fairly strident calls recently for banks to lower lending rates, but that has become a barely audible whisper of late. Why? I think it is because that somebody told him that be that by allowing the huge disparity (penalising savers) there will be vast sums available for the bank to be able to repair its balance sheet, and those sounds will be “profit” and available to be taxed by the Exchequer, and not having to pay savers, who have allowances, the whole amount is available for taxation.

    I ask, what about the lenders of the lender? By this I mean the savers who are in effect lending the money to the bank. If this government had any scruples whatsoever, it would insist on a fairer sharing, by raising the interest rates, but requiring the banks not to raise interest rates for borrowers until they got to within two or so points of their lending rate to encourage saving by paying the “lenders” a fair share. Admittedly this would result in a longer period before the banks balance sheets were in the type of shape that is now “desired”. Nevertheless, in the interim, the government would still be getting tax and of course 12% on the money that it has lent. Problem, not enough tax because of the downturn.

    The only way to ensure fairness, would be to get any future government to commit to this. They might promise, but then we were promised a referendum on the EU treaty, the referendum that never was.

    Regrettably, the cycle is the same, as soon as a Socialist government comes in its slashes and burns the economy and then claims it was not its fault. So, where do we go?

  15. TomTom
    Posted March 18, 2009 at 9:28 pm | Permalink

    We used to have special Deposits and Supplementary Special Deposits to control the asset-base of the banks, had we retained this system we might have had much less of a problem and Brown might not have lowered prudent reserve requirements in his 1998 Banking Act.

    I had not thought mortgages were such a problem per se. Wasn’t it Self-Certifying Mortgages issued by General Motors Acceptance Corporation (GMAC) that they sold on to Bradford & Bingley t hat finished it off ?

    Surely borrowers should not have voting shareholder accounts at Building Societies – they had a perverse incentive to vote for de-mutualisation and it is de-mutualised building societies that have been most aggressively suicidal just as in the US S&L Crisis in the 1980s.

    Use of offsheet SIVs was encouraged by the Treasury since that is how PFI is funded through tax havens – indeed where BSF schools and PFI hospitals and public buildings are held. Dublin was where German public sector banks such as Sachsen Landesbank hid their holdings of US subprime assets even though politicians controlled the institution directly.

    (Adverse comment on a NED on RBS left out) Non-Execs are Christmas-tree Decorations as Tiny Rowland said and in future all major lenders should have one Non-Executive appointed by the Regulator and the Compliance Executive should be accountable to that Non-Executive.

    Mortgage Brokers should not be used to subcontract credit-scoring of applicants

  16. Dan Tubb
    Posted March 19, 2009 at 3:39 pm | Permalink

    John, what we should be tackling is the baseless money supply we have. Trying to add another layer of government intervention to solve a problem with a previous layer is not the solution. Now certainly house prices are far too high, and the free market is slowly readjusting them. Although of course the free market interest rate would be significantly higher than it is now, and so government intervention is propping up prices.

    If we had a stable money supply we would not have boom and bust. Locate a long term graph of retail prices and your see stable prices for centuries. Then after 1914 and the UK ditched the gold standard and suddenly inflation appears. Then post 1971 and the abolition of Bretton Woods and the very tenuous ties to gold is cut inflation takes off. Since then the money supply has increased massively, coupled with the fractional reserve banking system that only requires 4% reserves is it any wonder we got into an asset price bubble. Deposit just £100 in your bank, and they can legally create and loan out £2500. Any bank pursuing a marginal increment in profitability has to loan out ever higher amounts. They simply followed a profit maximizing strategy in the conditions they found themselves in. But all that extra money that was created bidded up the factors of production. A larger and larger amount of money chased the same number of houses. During the boom, otherwise sane people really thought nothing amiss with their house earning more than they did. It used to be if you lost your job you lost your house. Now it was lose your job and buy a holiday home to earn for you.

    House prices remain at least 30-40% overvalued on a free market valuation basis. And imposing lending restrictions makes no difference now that gravity has reasserted itself. If we want to avoid this all happening again we need a stable money supply, not one that needs continual expansion to survive. We need the gold standard back. You don’t need any regulation after that.

  17. Geoff M
    Posted March 19, 2009 at 7:16 pm | Permalink

    “Lord Turner is an intelligent…man”

    He swallowed, then peddled, the thoroughly discredited Stern report for all he was worth.
    He is either not intelligent or he is dissembling.

  18. Vanessa
    Posted March 20, 2009 at 5:35 pm | Permalink

    As I understand it the banks are the only people who are going to come out of this with zillions of pounds; exactly the people who got us into it. As the difference between the interest on savings and the interest on borrowings is larger than it has been for a decade they will make a killing. For as long as savers are demolished by earning virtually nothing banks are dancing all the way to……..well the bank!

  19. Nick
    Posted March 23, 2009 at 11:17 am | Permalink

    Looking at the current banking situation this has all been seen before starting in the Victorian era with undercapitilised Banks and little or no knowledge of good lending practice. Limiting lending to multiples of salary is not the solution as inflationary pressures over a mortgage term means the costs to the borrower effictively fall. The traditional repayment mortgage has to be reinstated with the ability for persons under 25 to have terms up to 40 years. Limiting borowing to a fixed percentage of a house cost also is not a workable system but a small deposit (5%) is key to show the borrower can save and afford payments. Bank capital issues are being addressed but to kick start the borrowing/lending system the press needs to communicate to the public how borrowing will work in the new era.
    The days of the secondary Lenders and Sub Prime should be heavily regulated toward proper Underwriting for both individual and SME debt. Cattles is now stuck between a rock and a hard place. How can a financial institution allow 240 days before a loan is deliquent on the books. May I suggest the directors of banks realise soon the public will react with class actions.

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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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