Financial Markets: Stability

Lord Sharkey Excerpts

Thursday 3rd November 2022 Lords Chamber

Moved by

[Lord Sharkey]

That this House takes note of the importance of stability in the financial markets and its impact on pensions, mortgages and the rental markets.

[Lord Sharkey (LD)]

My Lords, I start, as is now traditional, by welcoming the return of the Minister, and by thanking the Library for the outstanding note it has produced for this debate.

The Motion before us seems simple: financial stability sounds like a common-sense kind of thing and obviously desirable. However, the reality is significantly more complex. There are at least two readings of the phrase “financial stability”. The first reading, in this context, is defined by the Bank of England, which has a statutory objective to protect and enhance the stability of the financial system in the United Kingdom. The definition is that

“financial stability is the consistent supply of the vital services that the real economy demands from the financial system (which comprises financial institutions, markets and market infrastructure).”

The FPC has qualified that definition by saying:

“Financial stability is not the same as market stability or the avoidance of any disruption to … financial services.”


This qualification was quite properly abandoned in dealing with the events of September and October.

The second reading of the words is the usual and common-sense one: things should not change violently, radically or without warning—and that definitely includes inflation. The mini-Budget of 23 September was probably the most incompetent, damaging and destabilising ever produced. It is still hard to believe that a Chancellor would put forward such a list of spending measures without any indication of how they were to be funded. It is astonishing that the Chancellor explicitly refused the offer of an input from the OBR. It defies belief that the Chancellor and Prime Minister took no account of the likely bond market reaction.

It is not as though the bond market reaction was unknown or of no importance: Bill Clinton famously encountered it when preparing the programme for his second term. His advisers told him that some of his policies would not be possible. Clinton said:

“You mean to tell me that the success of the program … hinges on the Federal Reserve and a bunch of”—


expletive deleted—“bond traders?” One of his advisers, James Carville, said at the time:

“I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.”


The bond markets certainly terrified our Government and probably most of the rest of us as well. Long-term gilt yields rose by 30 basis points on the day of the mini-Budget, and by another 50 in the next three days. On 26 September, the pound fell to $1.03, its lowest ever level. On 27 September, there was an initial fall in gilt yields and then a rise of 67 basis points. On 28 September, the Bank intervened with a short-term commitment to QE of up to £65 billion. In all, the Bank bought £19 billion of bonds to stabilise a market that the Government had directly caused to crash. That was added to the Bank’s existing QE stock of £875 billion. Given the asset-inflating effect of QE and the deflationary pressure imposed by the inevitable higher interest rates, some commentators noted that the Bank appeared to be driving with one foot on the accelerator and the other foot on the brake.

Katie Martin noted in the Financial Times on 7 October:

“The intricacies of bond yields rarely trouble the general population, but homeowners quickly figured out what this meant for mortgage repayments, making it a searing political issue. Plus, it all jacks up the price tag for the government’s plans”.


The Financial Times returned to the issue over two weeks later, with Patrick Jenkins writing:

“To describe the ‘mini’ Budget of outgoing prime minister Liz Truss and outgone chancellor Kwasi Kwarteng as ill thought-out is almost a compliment. If they underestimated how spooked the markets would be by £45bn of unfunded tax cuts, they clearly had no notion at all about the collateral damage it would cause—to mortgages, to government and corporate borrowing costs and most alarmingly to the £1.4tn defined benefit pension system, via the now infamous ‘LDI’ hedging structures buried within many schemes.”


So here we have rising mortgage costs, rising energy costs, rampant inflation, no increase in real wages over two decades and now a threat to the pension system. I think that it is entirely probable that neither Liz Truss nor Kwasi Kwarteng had heard of, or understood anything about, LDIs. I do wonder whether the Treasury had understood and had given sufficient warnings to the Prime Minister and the Chancellor. The Bank, the Pensions Regulator and the FCA certainly did know about LDIs: each of them has a partial regulatory role over some parts of the LDI sector, and each of these institutions has now written not very convincing letters of exculpation to parliamentary committees. We seem to have uncovered a remnant of the pre-crash regulatory regimes, where a plurality of regulators failed to deliver necessary oversight or control. It is surely time that the regulation of these LDI funds was made simpler, clearer and more rigorous, so that we can avoid further unpleasant surprises and outbreaks of finger-pointing. When the Minister replies, I would be grateful for her thoughts on the matter.

This all, emphatically, does matter. All this rather obscure and technical stuff has clear effects on the real economy: mortgage rates have been rising as the bank rate has risen—probably to 3% in a moment or two. In December, the average rate offered for a two-year fixed deal was 2.34%; by 3 October, it was 6.07%; by 18 October, it was 6.53%. Of course, this means a steep rise in mortgage repayments. The Resolution Foundation predicts that over 5 million families are set to see their annual mortgage payments rise by an average of £5,100 between now and the end of 2024. The chief economist of the Royal Institution of Chartered Surveyors took the view that mortgage arrears and repossessions would inevitably move upwards over the next year; of course, this influences the rental market.

In late October, Moody’s, having downgraded its assessment of the UK’s economic outlook from “stable” to “negative” because of instability and high inflation, also estimated that more than half of landlords looking for a new fixed-rate deal in 2023 or 2024 would be unable to remortgage without raising rents if mortgages were 4 percentage points higher. Given the fall in real wages, this might push rents up beyond what tenants could afford.

Rents were already rising anyway, driven by what Knight Frank described as

“an ever-deepening mismatch between supply and demand”.

Shelter has said:

“Private renters are disproportionately exposed to the cost of living crisis”


and

“the most likely tenure to already be in fuel poverty.”

When the Minister replies, I would be grateful if she could tell the House whether the Government are actively considering increasing the local housing benefit allowance rates—frozen since March 2020—to ensure that housing benefit keeps pace with inflation, as Shelter recommends.

The current economic situation and the ongoing cost of living crisis bear very heavily on households, exacerbated by uncertainty about the future. Is the triple lock on or off today? Will inflation really rise to 12%, as the Bank seems to think? Will benefits be uprated in real terms? What will happen to my energy costs? Is my pension safe? Will there be reasonable pay rises? What will happen to the NHS and our schools? The need for some assurance and stability in these uncertain times is absolutely clear.

The most comprehensive survey of household and individual finances is the FCA’s excellent Financial Lives Survey. The next survey is due to be published early next year, but the FCA has just released some of the findings from its 19,000 respondents—they make for very distressing reading. One in four adults in the UK was either in financial difficulty or would fall into trouble if they had a financial shock. Nearly 8 million people were finding it a heavy burden to keep up with their bills—an increase of 2.5 million people in the last two years—as wage growth fails to keep pace with inflation, which is now at a 40-year high.

Over 4 million people missed a bill or loan repayment in the six months to February and, unsurprisingly, these problems were worse in the most deprived areas of the United Kingdom. About 12% of people in the north-east and 10% in the north-west are struggling financially, compared with 6% in the south-east and the south-west. Already, by the end of June, over 2 million households were behind with their electricity bills and just under 2 million behind with their gas bills. Citizens Advice reports a sharp rise in people being forced on to prepayment meters, which are more expensive. Can the Minister confirm that to address at least some of this, benefits will be uprated by inflation? Can she stop our energy companies moving customers to prepayment meters?

Of course, the real question is what should be done about the mess we are in. How can a measure of stability be restored to our financial lives, our real incomes and the institutions on which we depend? We may know more on 17 November; I do not expect the Minister will be able to say anything of any substance about what the Autumn Statement might contain, but some things are already clear. Last week, the Institute for Government, of which I was a governor for five years or so, and the Chartered Institute of Public Finance and Accountancy published their annual government performance tracker, and it is worth quoting at some length from the introduction. It states:

“Public services are in a fragile state. Some are in crisis. Patients are waiting half a day in A&E, weeks for GP appointments and a year or more for elective treatments. Few crimes result in charges, criminal courts are gummed up, and many prisoners are still stuck in their cells under more restrictive regimes without adequate access to training or education. Pupils have lost months of learning, with little prospect of catching up, social care providers are going out of business or handing back contracts, and neighbourhood amenities have been hollowed out.”


The report goes on to say:

“These problems have been exacerbated by the Covid crisis but are not new. After a decade of spending restraint, public services entered the pandemic with longer waiting times, reduced access, rising public dissatisfaction, missed targets and other signs of diminishing standards … Governments since 2010 may have been seeking efficiency over resilience but achieved neither.”


All this is simply a preamble to the report’s conclusions that most services do not have sufficient funding to return to pre-pandemic levels of service and performance:

“There is no meaningful ‘fat’ to trim from public service budgets. If the government wishes to make cuts in the medium-term fiscal plan, it must accept that these are almost certain to have a further negative impact on public services performance.”


Perhaps the Minister when she replies can tell the House whether she agrees with the IfG and CIPFA in their conclusions and, if not, why not.

The economy needs stability of purpose, policy and direction. People and business need a stable and reasonably predictable environment in order to plan, save and invest. People need stability because many families have very low resilience to financial shocks or steep movements. The Government could make a start on all this. They could honour the triple lock. They could raise benefits in line with inflation. They could devote scarce resource to where it is most needed and most productive. They could be open and honest about the state of the economy and what that really means for us and for our children. I look forward to hearing the contributions from other noble Lords and to the Minister’s reply and I beg to move.

--- Later in debate ---

[Lord Sharkey (LD)]

My Lords, I thank the Minister for her response, much of which we will no doubt return to frequently. I also thank all other noble Lords for their contributions.

On 23 September, the day of the mini-Budget and the beginning of the period of extreme financial and political instability, Mark Carney was being interviewed by the FT in New York. In that interview, he pointed out that in 2016 the UK economy was 90% of the size of Germany’s but in 2022, even before the crisis, it was less than 70%. We need to put this right but we must not do that by increasing the burden on the poor, the sick and the old.

Motion agreed.