One good Regulator or an army of useless ones?

The government just does not get it.

Today we learn they are proposing new and much more extensive mortgage regulation, and regulation of everything else in the financial sector that they think should be regulated more.

I remember Labour introducing massive amounts of new mortgage regulation before the crash. I wrote explaining that their style of regulation would not stop a disaster, and that what they needed to do instead was make their regulation of banking cash and capital effective. They latched on to my former remarks and misrepresented them endlessly. I presume they did this because they realised their very intrusive mortgage regulation had comprehensively failed and I had been impolite enough to mention it.

The UK’s banking crisis could have been prevented by just one senior Regulator. That could have been someone senior at the Bank of England, if Mr Brown had not taken the powers away from the Bank in 1997. All that one senior person had to do was to say some years ago they would not allow banks and mortgage banks to go beyond a specified limit for the amount of money they could commit for a given amount of capital.

Instead, a large number of regulators all ticked boxes, carried out audits, intruded into huge amounts of detail on transactions, and looked the other way on the one thing that mattered. None of them noticed the huge increase in leverage, and none of them called time on it.

Employing an even bigger army of useless regulators after this crisis will not prevent another one. It will add layers of cost and complexity, but will not prevent extreme events.

Let’s just find one good person to be the banking regulator at a newly strengthened Bank of England, and cut out a load of the nonsense. Regulating mortgage process did not stop a single bad loan to someone who now cannot repy the mortgage. Controlling banks cash and cpaital would have stopped a lot of loans. It would have taken just four phone calls to the four main banks, a day’s work for someone who knew what he was doing. On the next day the senior regulator could have made a few phone calls to the Shadow banks to tell them that because he was controlling the main banks capital there would less borrowing for them too, as they got some of their excess leverage from the main banks as well.


  1. backofanenvelope
    March 15, 2009

    Come on Mr Redwood! If this paragon had been in place and had behaved as you suggest – what would The Great Helmsman have done?

    He would have countermanded or amended the decisions your regulator made.

    Would a Tory Chancellor have behaved differently?

  2. DBC Reed
    March 15, 2009

    What this prescription amounts to is more centralised regulation of the banks instead of the diffuse range of influences now in play
    .Also the talk of capital and cash sounds very much like the reserve ratios that the Conservatives recklesslygot rid of in the 80’s in favour of something altogether more sophisticated and whizzy.

  3. Ian Jones
    March 15, 2009

    What deposit to capital value ratio would you propose and what income multipliers would you propose?

    As the boom resulted in 120% mortgages and 7 times income mortgages, if the bar is set too low then house prices will crash.
    Although the banks seem to be doing it themselves, I saw recently that a 24% deposit is required and on 2.5 times income provided.

    Maybe the UK will finally realise blowing all its capital on unproductive housing does nothing for the real economy! It may also get rid of the stupid planning laws which completely under supply the market.

    I doubt it.

    Reply: the levels of 1997 were stable ones.

  4. David
    March 15, 2009

    I really can’t think what could have been done to stop the banking collapse. Their loans/debts were “safe” according to cutting edge mathematical models of financial systems. If a regulator had attempted to interfere he’d have been laughed out of the house – how could he know more about the systems that the collective intelligence of those put the models together ?

    It would have to have turned into an argument over the maths in the models and that is something a regulator should not be involved in.

    Any regulation would effectively have limited the ability of our banks to make profit, making them vulnerable to takeover (could we prevent a takeover by a bank valued higher in another country because the other country was not forcing its banks to follow our own regulation ?).

    The whole thing is a very tricky question which i’d like to see more discussion on.

  5. crown
    March 15, 2009

    I would add that if the banks had followed due diligence and actually checked the applicant’s details on mortgage forms the mess would be smaller. Up to the first half of 2007 you could get an interest only mortgage of 5 times your joint income with a 5% deposit and your income would not be checked. As long as you felt the payments were affordable, you could go ahead. Many tens of thousands of mortgages were processed in this way with applicants inflating their incomes by maybe only a small amount to secure the property that they wanted.

    Shame on Brown’s regulations

  6. Denis Cooper
    March 15, 2009

    So where did the EU come into this?

    Are we to suppose that Gordon Brown came up with his own ideas on how to radically restructure financial regulation in the UK, which ideas bore no relation to any ideas which had previously circulated in Brussels?

    Whether or not those EU ideas had already been crystallised in some EU agreement or law.

    Putting this another way – would George Osborne have a free hand to reverse the changes made by Gordon Brown, without first securing a new agreement within the EU?

  7. Acorn
    March 15, 2009

    JR, are there any MPs on the Board of the new Trotter’s Independent Trading Company; or as the BoE call it, “Bank of England Asset Purchase Facility Fund Limited”?

    Do we know who the Arthur Daley is running it? (it is going to need an Arthur if we taxpayers are going to get an earner out of this).

    As this is a wholly owned subsidiary of the BoE, do I take it that its accounts will be consolidated with those of the BoE?

    Will you be allowing bets on this site as to how big this fund is going to become over the next few years? Will the conservatives privatise it at their first opportunity?

    Is it possible to dump all the un-funded / under-funded public sector pension schemes in the fund and give it a target of breaking even in a decade say?

    Redwoodians. As this is now the premier web-site for political thinking, I suggest there be a lot less whining and a bit more positive, out of the box, thinking. We know the nation is wading in the products of a socialist colon; we need to start designing some new shovels to dig our way out of it. With all due respect for our host, the Conservative Party is not exactly exciting me with new ideas yet.

  8. guy de Moubray
    March 15, 2009

    How right you are. The late Per Jacobsson, Managing Director of the IMF 1956=1963, for whom I worked 5o years ago, in an article written in January 1948, said:
    “Wise planning consists, on the one hand, in giving the individual citizen an incentive to act voluntarily in the manner desired by the control and, on the other hand, in bringing about a situation in which the control can be gradually lifted. It must not be forgotten that control measures are costly, involving a waste of time and the upkeep of a huge staff of officials; account must be taken of the fact that employees in private industry are kept busy answering letters from official controllers, so that the cost is generally doubled. If all these people could be released for productive work, the national income in real terms would go up, and the standard of living with it.”
    60 years later and we still haven’t learned.

    1. alan jutson
      March 15, 2009

      Says it all really.

      If Labour were in charge of the football league.

      They would have a referee in each half, one for each penalty box, and a man at each end for the goaline decisions, those incidents which took place on the lines between those in charge, would be subject to a vote after they had written a letter to each other asking for permission for a discussion.

      The committe of referees who sat in the stand marking them all out of ten, would comment on the ability of those in charge, in time for next season, after having a conference abroad with their wives.

      Oh I forgot.
      At half time all officials would change, as they would have earned enough to retire on full pay.

  9. Matthew Reynolds
    March 15, 2009

    The fact is that the excess army of regulators are employed as part of the Brown created Client State of government dependent people who will mostly vote for Labour to keep their taxpayer funded salaries & pensions. They where lent on not to ask too many questions by HM Treasury as the credit boom gave the illusion of prosperity and it was a mixture of this and the number of people working for the state that gave Labour victory in many marginal seats in 2001 & 2005.

    That is why we are in this mess because Labour had no real policies to improve things for people and so the only way to get re-elected was to flood the economy with cheap money via excess personal debt and turning on the public spending taps resulting in a ballooning budget deficit and to employ extra public sector employees.

    Labour never had a real long-term economic policy – they just wanted to get away with irresponsible policies for as long as possible while maintaining an image of prudence. If government spending had gone up only by average GDP growth every year since 1999 then the national debt would be dramatically lower and big tax cuts could come in thus rescuing the economy from the present recession.

    The New Labour Emperor really has no clothes……

  10. David
    March 15, 2009

    Defaulting homeowners is not the genuine cause of this mess, it was just the trigger (in the US mainly) for the change in sentiment.

    The change in sentiment resulted (somehow, come back to that in a second) in a total dry up of liquidity in the interbank loans.

    So bank X, who had borrowed Y hundred billion (and had subsequently loaned this forward at a profit to homeowners who were by and large not defaulting) on short term (lets say 2 years) loan, was faced with “rolling over” the loan. But the inter bank loans completely dried up – the money was just not there at any price since due to panic sentiment noone was lending. Suddenly bank X is basically insolvent and needs a bail out, or goes bust.

    The models which assumed that there would always be a quantity of money available to borrow, at some increase in price over the standard interest rates just proved to be wrong.

    I would like to see more discussion of this, or some kind of independent group of economists/mathematicians organised to look at what happened and come up with recommendations, as a starting point for further discussion with the ultimate aim of some kind of practical legislation which with minimum regulatory intereference can prevent or minimise this kind of thing in the future.

    Reply: Yes, you are right. The immediate trigger for the drying up of liquidity in the UK money markets was the mad monetary policy pursued by the MPC – a long period of easy money followed by a period of money that was too tight, as warned here. Banks then started to distrust each other once money was tight, and realised they and the regulators had allowed balance sheets to balloon too much. Go back to 1997 ratios for banks capital and cash and all would work fine.

  11. David
    March 16, 2009

    What were the ratios for capital to cash in 1997 and what are they now ?

    Can the difference really account for what we have seen ?

    It wasn’t just drying up in the UK money market anyway, it was/is international in a big way.

    My gut feeling on this is that economists looking back on this in 50 years will be saying:

    “The financial markets got far too complicated; the banking bodies were too huge and diversified to accurately and conservatively keep track of what their various sub-parts were involved in, making it impossible to accurately weigh the risks. Many transactions were considered only as stand-alone entities, not realising that other parts of the same banking entity were already exposed to the counter-party for the transaction. This resulted in inadvertant reduction of risk and and the corresponding increase in “virtual” liquidity.

    When sentiment changed and the bodies involved in these transactions realised that not only could they not accurately tally their own exposures, and that in many cases were caught in vicious circles of debt, the result was a run on liquidity as they in unison stopped short term lending and attempted to swap out their own loans with much longer term debt.”

    The ultimate cause is of course excessive regulation ensuring the absence of many more small scale bodies with a better handle on their funds, and more aware of their overall exposure. I’m not quite sure the why the gobbling up of banks and building societies over the past 20 years did not result in a wave of “start ups”, perhaps it was regulation or something.

    I think that to prevent this kind of thing we need more diversified banking – one bank to rule us all (or as close as we have been getting in the past few years) is a recipie for ultimate banking chaos (in the same way that one european state to rule us all is, or one managed economic system etc).

    Reply: Bank balance sheets ballooned from around 20x narrow capital to around 34 x narrow capital in the last decade. Yes, that did cause the problems.

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