Darling’s report: good in parts but flawed overall
THERE will be no return to business as usual, not by any stretch of the imagination. But yesterday’s Treasury white paper also confirms that financial capitalism as we know it is here to stay. The authorities want to reform global finance to make it work better and to try and avoid extreme booms and busts; there is no appetite to scrap it. Innovation and speculation will still be allowed. Talk last September of banks being turned into nationalised utilities, of 95 per cent tax on bonuses and of returning to a autarkic, non-globalised financial system has long since been forgotten – thank God.
And some of the main points – banks need to hold more and better capital, this needs to be adjusted to reflect whether the economy is doing well or badly, excess leverage is dangerous, compensation policies need to promote value creation, not just pure risk-taking – make sense, at least in theory. If implemented properly, these shifts would make the system more robust and allow Britain to continue to specialise in financial services, safe in the knowledge that banking need not be akin to sitting on a nuclear bomb that is about to detonate.
That said, the White Paper is also deeply flawed. Most laughable is its absurdly biased analysis of the causes of the bubble. Those economists who argue that the biggest single reason for surging asset prices was the fact that central banks, obsessed with consumer price inflation, mistook cheaper imports from China as a sign that they were doing the right thing and thus failed to hike interest rates to stem the explosion in money and credit, are no so much dismissed as ignored. Yet according to the report, the Fed or the Bank of England did nothing wrong. Instead, it was merely failures of market discipline, in particular of corporate governance, risk management, and remuneration policies, that were to blame (these were a problem, but merely a secondary one).
Of the dozens of bubbles that have plagued the global economy in the past few hundreds years, all – or almost all – were caused by too much money sloshing around (ranging from the discovery of gold in South America to the Federal Reserve losing its brain). We need a more grown-up discussion: the M4 measure of the sterling money supply grew much too fast in 2005-07, as highlighted by yours truly at the time. Yet this is not even mentioned or alluded to. The paper dismisses calls for the Bank to target asset prices, an all too predictable missed opportunity.
Darling also repeats the assertion, without any evidence to back it up, that banks, boards and investors did not fully understand the complexities of their own businesses. While many investors certainly didn’t, it is a cop-out to blame the errors of RBS, Northern Rock and HBOS on a lack of understanding of what they were up to. The truth is that Sir Fred Goodwin understood what a CDO or sub-prime mortgage was – he just took ridiculous risks, assumed that money markets would never fail and embarked on a disastrous acquisition that destroyed him. The entire financial establishment – bankers, regulators, central bankers and especially politicians obsessed with promoting home ownership at any cost – failed to properly grasp the consequences of a collapse in house prices. I’m simply not convinced that top bankers “didn’t understand” their business – they did but dismissed the risks, which they thought were too tiny to be worth bothering with. They also felt that if a 1 in a 100 disaster occurred, they would be bailed out – and they were right. I will end with two more flaws in the paper: first, the idea that a group of central bankers and regulators will be able to gauge whether the economy is healthy or whether it faces a bubble. Yet nobody agrees today whether there is a bubble in gilts, for example, or whether house prices are stabilising or whether they have another 20 per cent to fall. So a group of wise men will be able to figure it all out? Darling must be joking. And second, his obsession with preserving the Tripartite agreement – and his face-saving proposal for a Council for Financial Stability to boost cooperation between Bank, FSA and Treasury – is a waste of space.
The one thing that the Tories will definitely change out of all this when they are elected is that they will give the Bank far more power and decimate the FSA. Of that we can be sure.