Article

Mending the banks is part of the solution - John Redwood comment

March 31, 2010

The banks are unpopular with the public for a variety of good reasons. They are the whipping boys of the politicians for less good reasons. Governments have every wish to blame the whole economic crisis on greedy bankers, to suppress the role of incompetent government, regulators and central bankers. The UK public dislikes the banks, because it sees it has had to put huge sums of money into them, only to watch as their senior personnel continue to take large sums out by way of pay and bonus.

It is high time we had a proper debate about what went wrong and what should be done to have a better banking system in the future. Investors need to understand what type of crisis we have been through, to understand current valuations and preoccupations of the authorities and other savers.
What went wrong?

1. The UK Monetary Policy Committee followed boom and bust policies, bloating money and keeping rates too low for too long, then squeezing too hard and keeping rates too high. The US authorities followed a similar course.
 

2. The UK government followed boom and bust policies - expanding its own balance sheet too much, spending and borrowing too much in the boom, and then forcing the private sector to take all the hit when the economy lurched to bust.

3. Between August 2007 and the end of 2008 the UK authorities kept the markets starved of money when over borrowed banks needed access to funds. That is when the Central Bank should have made more cash available in the usual way - by way of short term loans against good security - to avoid the crash. There was no need for any major UK bank to go down.

4. The UK regulators led by the government blamed the banks for the crash from September 2007 onwards, and decided to make it worse by lecturing the banks in public on how weak they were instead of working behind the scenes to make them become stronger. Usually transparency is right, but in this area the regulator needs to work in private to avoid triggering a run on a bank. Having made the errors in the boom, the Regulators should have given the over borrowed banks time to adjust, allowing them to raise new capital, sell assets, split off businesses, run down their loan books, cut costs or however they chose to do it.

5. The US authorities moved from accommodating all the pressures with more loans and liquidity, to deciding to let Lehmans go under.
What should they do now?

The approach of the UK government should be different for RBS from the rest. RBS is state owned. It has received large sums of subsidy. It cannot go offshore or hit back against the UK authorities. It should be broken up, into a series of competing banks. These should be sold to maximise the returns for taxpayers.

Other banks should be placed under a prudent regime controlling their cash and capital. There is no need for a future banking crisis if we have competent regulators who understand the mistakes made in 2007-8. Today the regulator should relax the cash and capital controls, because they are too tight for the conditions.

The US authorities have got further in extricating themselves from their special measures, though they too have ended up owning large institutions by nationalising Freddie and Fannie. These like RBS remain work in progress.
Will taxpayers get their money back?

The UK government wants to ease taxpayer grief by claiming close to the election that taxpayers are poised to get their money back from Lloyds and RBS. They are adjusting the figures to try to create this happy outcome. They are knocking all the fees, charges and special revenues off the purchase price of the shares. Yet these receipts were connected to the whole package of financial support, not just the share purchases. This flatters the position.

The one luxury the next UK government will have in an otherwise bleak fiscal predicament is the opportunity to sell bank shares or to break up and sell banks that the state owns. The privatisation receipts may be an important way to narrow the deficit in the first couple of years pending the reductions in spending that will be needed to complete the job.