Overcome the crisis before designing a new regulatory system

The Prime Minister is strutting the world stage again. It is time to check your bank account.

He wishes to be the architect of a new Bretton Woods, a new set of institutions, regulations and government structures to ensure we never have a credit bubble again.

The sound of stable doors slamming after all the horses have gone resonates in our ears.

The trouble with this approach is obvious to anyone with any sense. We cannot yet know what parts of the pre 2007 system will still function. It appears that highly leveraged Investment banks on the US model have disappeared. It looks likely that there will be far fewer Credit default swaps and other derivatives. It seems likely the 125% mortgage and the highly borrowed hedge fund and private equity deals will be scaled back. We do not yet know how much more damage is going to be done, by Regulators and Central Banks reining in long after the bubble has burst. The authorities have not yet completed a proper analysis of what they and market participants got wrong in recent years.

It is foolhardy to seek to put in place new structures before you know why the old ones failed, or which ones have failed. It is asking for trouble to talk about how there will not be mistakes in the future, when you have not yet sorted out the mess created by recent regulatory and market errors.

All the attentions of the authorities should be concentrated on doing “whatever it takes” to limit the downturn and salvage what can and should be salvaged from the financial system of 2007. It is dangerous for governments to think they can plan a brighter tomorrow with better regulation, when they still have a massive task ahead in trying to get some normality back to money and banking markets. Banks still lend little to each other at rates well above the recommended rates. There is a dearth of lending on the High Street and to companies. In the UK, the US, Spain and other countries property prices are still falling, undermining security for more loans. Many more people are going to lose their jobs, factories will close, and much capital spending will be halted.

Creating a neat new architecture for global financial supervision is not going to change this. Appointing more expensive regulators will not make it any easier for the financial businesses they are regulating to raise the extra capital they need, or cut their costs to bring them back into line with the revenues they can now hope to earn on reduced business.

The Prime Minister should return home and do some detailed work with his Treasury team on the UK government budgets. In these hostile conditions the UK needs to show world markets that it has prudent government, recognising the need to keep its spending and borrowing under some control. We have seen how badly run countries soon face dramatic falls in their currencies, difficulty in borrowing for state purposes, trips to the IMF, emergency packages of cuts and higher interest rates to stem to outflow. The UK needs to show by taking strong and disciplined action that is well away from such a predicament. Thinking the state can take on all the bad debts and difficulties of the large banks that congregate in London is unrealistic. Support through providing liquidity, and ample funds through the Bank as lender of last resort is important. Everyone must understand there is no doubt that depositors will be paid out when they wish. Buying the equity is altogether more dangerous, as that means the state underwriting all the costs and obligations of the bank on top


  1. StevenL
    October 29, 2008

    "He wishes to be the architect of a new Bretton Woods, a new set of institutions, regulations and government structures to ensure we never have a credit bubble again." (JR)

    Now I'm confused. The PM seemed to like the credit bubble at the time. He spent year after year standing there at the dispatch box telling us how wonderful his credit bubble was. Every time the Daily Mail rolled out yet another headline revealing how much up to our eyeballs in it we were, his faithful minions strutted out armed with statistics to rebuke the very idea that there was any kind of a problem.

    I can only conclude that the PM knows he might be looking for a new job soon and is gunning for something at the IMF or World Bank. The thought of Gordon Brown diligently buring the midnight oil pouring over borrowing figures, money supply statistics and asset-price trends with a view to making some kind of clumsey intervention in any market he doesn't like the look of makes for a dour world if you ask me.

    Economic bubbles happen because of human nature, I've always had a feeling he doesn't really like people the way they are, and consequently does not trust us to run our own affairs. I get the impression he thinks the world would be a better place if he was in complete control, and we were all only allowed to make decisions that he had somehow approved.

    I hope the guys at the IMF just sit him in an office with a small army of research assistants, allow him to produce big reports, attend all their jollies, make the odd speech and pay polite lip service to whatever plans he comes up with. Gordon Brown, World Financial Regulator-In-Chief is not something I like the sound of.

  2. […] John Redwood on why we should wait before redesigning our financial regulatory system. […]

  3. Freeborn John
    October 29, 2008

    The key questions are (i) what was at the heart of the problem, (ii) will it happen again and (iii) if so how could we prevent it happening again? It seems to me that the heart of the problem was an unsustainable worldwide house price boom that coincided with an era of low inflation in a globalising economy. We cannot rely on high-inflation to wipe out our debts anymore because there is still an almost limitless supply of low cost workers in Asia to hold it down. The pain will therefore fall on those who borrowed too much and the banks whose equity is also being wiped out, but we need to minimise the problem by making sure that Britons have the jobs they need to pay of their mortgages in due course. That requires they remain competitive to workers in China, India etc. such that their jobs do not re-locate. Part of the answer is therefore devaluation of Western currencies relative to the Chinese Yuan. If the government wants to do some pump-priming they should consider more university places to train the young people who will not be able to find jobs in the next few years anyway. This will help our productivity long-term.

    To prevent a repeat of this in future we need to put an end to the culture of borrowing to the hilt that fuels these runaway property booms. In an era of global finance that may require regulations on maximum size of mortgages and for them to to be put in place worldwide.

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