Banking Reform

Michael Meacher Excerpts

Monday 29th November 2010 Commons Chamber

[Mr Michael Meacher (Oldham West and Royton) (Lab)]

I beg to move,

That this House, concerned that no action has so far been taken which would prevent a recurrence of the financial crash, calls upon the Government to establish a clearing house for approval of all financial derivatives and to set in place alternative mechanisms to remove the implicit taxpayer guarantee, other than to purely deposit-taking banks, in the event of any future banking collapse.

The motion is on the Order Paper through the good offices of the Backbench Business Committee, and I take this opportunity to congratulate the Committee and its Chair on the way in which, in my view, they have already opened up Parliament to valuable new procedures and paved the way for important debates that might otherwise not have happened. I hope and believe that this might be one of them.

I begin with the words of the managing director of the International Monetary Fund, Dominic Strauss-Kahn, who a few weeks ago told Stern magazine that he thinks a second financial crisis is almost inevitable given the paucity of reform and the vulnerability of the financial system, and that next time round it may well be impossible to persuade taxpayers to fund bail-outs. I do not believe that is an exaggeration, and the latest travails of the eurozone serve only to underline those fears.

It is worth noting that we in the UK have more bank lending as a proportion of our gross domestic product than even the Irish—some £7 trillion, which is five times our GDP. If we are to prevent a repetition of the financial crash, it is clear that its causes must be identified and dealt with by appropriate means. I argue that those causes, in the main, include: an over-lax monetary policy that encouraged an excessive leveraging culture; extreme light-touch regulation that left too much to the markets; the development of a vast global market in credit derivatives, which were not well understood, and which Warren Buffet, the world’s second richest man, notably described as

“financial weapons of mass destruction”;

the role of enormous bonuses, which drove recklessness; a banking structure so over-concentrated in the lead banks that when disaster struck, they were judged to be too big to fail, with catastrophic consequences, as all hon. Members well know, for national debt and the budget deficit; and a banking model that linked speculative investment with retail deposit taking, both of which were protected by an implicit taxpayer guarantee. I hope that that description is accepted on both sides of the House.

All those causes need to be dealt with, and yet none has been. Given the limited time, of which I am very conscious, I want to concentrate on the most important. First, financial derivatives are a perennial candidate for causing the next crisis, because they add opacity and leveraging to the financial system. Credit default swaps, a £65 trillion market, and collateralised debt obligations, which are one of the most common derivatives, urgently need regulation.

[Mr John Redwood (Wokingham) (Con)]

rose—

[Mr Meacher]

I will give way to the right hon. Gentleman, but having heard what Mr Speaker said, I am reluctant to take more interventions, precisely because this is a very short debate—only three hours—and many wish to speak. We already have a six-minute limit, and I have too often been at the back of the queue, unsuccessfully waiting to be called at the end.

[Mr Redwood]

I am grateful to the right hon. Gentleman, and I shall refrain from intervening at great length for the very reason he gave. Will he explain to the House why over the past decade the UK banking regulator allowed the huge expansion of balance-sheet risks of all kinds, and why it did not demand more cash and capital?

[Mr Meacher]

I mentioned light-touch regulation in the City of London, which we have had since the Thatcher era and through the Blair era. I believe that that needs to end. We want not excessive but adequate and proper regulation, and for the past three decades, in the so-called neo-liberal era, we have not had it.

Derivatives should be approved by the regulatory authority before they can be issued. At that stage, they can be either prohibited or accepted, perhaps with certain conditions attached. The key point is that transparency is essential. It is worth noting that the recent Dodd-Frank Wall Street Reform and Consumer Protection Act seeks to achieve that by requiring that all derivatives are traded on public exchanges.

Linked to that is the role—or perhaps the scandal—of the credit rating agencies in allocating a spurious status to some highly dubious securities. Light-touch regulation in this country has evaporated into virtual deregulation. Credit rating agencies were paid by the very institutions whose credit worthiness they were supposed to be assessing. By granting the highest rating, as they so often did, they made it easier for the banks that were securitising and further repackaging debt to create the greatest possible number of securities with the lowest possible regulatory cost. That practice should never have happened, and I believe that it should always be prohibited where there is a serious conflict of interest, as there was in that case.

[Sajid Javid (Bromsgrove) (Con)]

rose—

[Mr Meacher]

I know of the hon. Gentleman’s expertise in this matter, and I will give way to him, but I will not give way subsequently because I want to speak for only about a quarter of an hour.

[Sajid Javid]

Does the right hon. Gentleman realise that the price of credit derivatives over the past three or four years has been far more accurate as a predictor of default risk than the credit ratings given by rating agencies?

[Mr Meacher]

The hon. Gentleman makes a good point of which we need to take account, but I still think that the credit rating agencies potentially have an important role. They are listened to in the market, are the basis on which financial transactions take place, and should be trusted, but in the present circumstances they are certainly not. However, I am grateful for his question.

On bonuses, there is outrage among not just Opposition Members but, for example, right-wing Governments in Germany, France and Sweden, that a banking system that owes its continued existence to massive Government intervention should pay itself mega salaries and bonuses entirely out of line with the top of business, let alone ordinary taxpayers. There is outrage especially because those gigantic bonuses often drove the recklessness in the first place. The overweening power of the banks attracts almost universal hostility, especially given that 90% of investment bank profits, in an era of austerity, are directed not at strengthening balance sheets, at shareholders through dividends, at customers through lower fees or at taxpayers, but at bonuses.

France, among several others, has demanded a mandatory cap and that there should be no guaranteeing of bonuses, but Whitehall, as usual of course, argues that it would not be practical. However, if the G20 Governments insisted on limits and made continued liquidity provisions dependent on compliance, no bank could refuse. I believe that Her Majesty’s Government should now be taking the lead in the G20 not in succumbing to lobbying from the City of London and the British Bankers Association, but in reining back bonuses on a much greater scale than we have so far seen, and to much lower levels, and in ensuring that they be paid only in exceptional circumstances.

On the broader question of averting future financial crises, attention has so far largely focused on enhancing capital control, but that does not actually have a good record in this regard. At the outset of this latest crisis, virtually all financial institutions across the globe had capital adequacy of between one and two times the minimum Basel regulatory requirements—at least at that level, and in some cases twice as much. Basel III, which has just reached its provisional conclusions, is scarcely any improvement. The core top-tier capital requirement is only 4.5%, and the contingency capital requirement is only 2.5%. Of the EU’s top-50 banks, 45 already meet that standard, and Basel III is actually proposing that the requirement not be introduced until 2019. This is simply nowhere near good enough. A much better possibility might be counter-cyclical capital controls, enforcing different levels of bank capital at different stages in the economic cycle. I can see the point of that, but I suspect that it would leave open the problem of the degree of ratchet and the timing of it. I suspect that that would be far too problematic.

An alternative approach—many have talked about this—is the introduction in Britain of something like the Volcker rule, restricting banks from undertaking certain kinds of speculative trading, notably proprietary trading. Of course that would certainly stop banks doing what they are doing at the moment, which is trading on their own books with the money of depositors. The key point, however, is that it would not overcome the too big to fail problem when applied to investment banks. For example, I do not think it would prevent a repetition of the collapse of Lehman Brothers; neither would it address the interconnectedness—the Chancellor was speaking about this a few moments ago—of today’s banks, with counter-party relationships and exposure between commercial and investment banks, and insurance companies. That is the problem. I say this with regret, but any rule-based reform is almost certain to face the risk of regulatory arbitrage, because financial institutions invent ever more sophisticated products that are simply aimed at getting around regulatory controls. I therefore do not think that what I have described is an adequate answer. For all those reasons, the force of argument and the balance of advantage point strongly towards separating retail from investment banks, in establishing distinct, narrow banks that are conservative, transparent institutions with no financial instruments or incomprehensible balance sheets.

[Mr Andrew Tyrie (Chichester) (Con)]

rose—

[Mr Meacher]

I am being intervened on by someone whom I cannot resist. I am only too glad to give way to the Chairman of the Treasury Select Committee.

[Mr Tyrie]

I am grateful to the right hon. Gentleman. On that point, does he agree that the Government have done the right thing by creating the Vickers review? The review will examine, in depth and carefully, without rushing a reform, whether structural reform of the banks is required, and will give us guidance on how to protect ourselves from the too big to fail problem.

[Mr Meacher]

I entirely agree with that, and I was just about to make the same point myself. I hope I can also take the hon. Gentleman with me when I say that Parliament should have the opportunity to express its views to the Vickers commission before it reports, rather than simply making comments when its work is virtually a fait accompli. Indeed, that is one of the purposes of this debate.

The key advantage claimed for the model that I am describing is that it would remove the implicit taxpayer guarantee—that is, the capacity of the financial conglomerates to use retail deposits, which are implicitly guaranteed by Government, as collateral for proprietary trading; or, as the Treasury Committee put it, I think rather nicely, banks playing

“at a high-stakes casino table with…taxpayers’ chips.”

I have a lot of respect for this model, but the crux of it is that the withdrawal of the taxpayer guarantee would be a sufficient deterrent to prevent investment banks from engaging in highly risky investments that might collapse, with serious and far-reaching consequences for the national economy. The real question—which I do not think enough people have asked—is whether that is likely to be true. The fact is that if a financial institution outside the protected narrow banking boundary threatened systemic contagion, it is difficult to believe that the Government would not attempt some form of bail-out. I therefore have to say, regrettably, that I doubt whether the narrow banking model could, by itself alone, be relied on to overcome the problem of moral hazard and too big to fail.

Does that mean that there is no solution to the too big to fail problem? Not necessarily. There is an alternative to narrow banking as a means of preventing a bank from gambling away other people’s money, which is the recent Kotlikoff proposal in the US. It is a proposal that deserves serious consideration—consideration that I hope the Vickers commission will give it. In the US context, it is proposed that all financial companies become pass-through mutual funds. They would have a 100% equity ratio, to ensure bank solvency, and the payments function of banks would be performed by cash funds that would be 100% reserve—for example, through Treasury bonds. Such banks could, of course, still initiate new mortgages and new loans, but these would not be funded through deposit accounts until they had been sold to a mutual fund. The key point is that the bank would never hold them; in other words, the bank would never have an open position. Banks would not own assets—apart, of course, from their offices and so on—and they would not then be in a position to fail or trigger a bank run. That is a significant proposal.

For those—and there are plenty of them—who want to take greater risks beyond a cash-based mutual fund, there are already hundreds of investment avenues that would continue to be available, such as foreign exchange, derivatives, real estate, hedge funds and all the rest. The key difference with this limited-purpose banking would be that any failure in such investments would be incurred by the investor, not by the bank. That is the crucial point. There would be no problem with the banks being too big to fail or trying to insure the uninsurable risk of financial contagion. Critically, there would be no future claims on the taxpayer.

This reform would overcome a critical market failure without the need for any vast new complex regulation. I say that for the benefit of those on the Government Benches. It is, in effect, a market solution. It is true that it would not necessarily prevent asset bubbles—I do not think that anything can do that, certainly not in this area—but under limited-purpose banking, such bubbles would not threaten the entire financial system. Anyway, there would be nothing to preclude some form of macro-prudential authority from having oversight in this area. I think that that would be a very good idea.

I am not suggesting that this reform would be a panacea, because I do not believe that a panacea exists in this area. It should, however, be thoroughly investigated by the Vickers commission and, I hope, by the Government. I do not think it is an exaggeration to say that at present Britain has the most profoundly dysfunctional banking system of any G7 country. It came nearer to collapse than any other in the autumn of 2008. I believe that we need to break up the mega-banks, with their addiction to mortgage lending. We need smaller banks and, in particular, specialist business banks such as infrastructure banks, housing banks, green banks, creative industries banks and knowledge economy banks. Only that kind of fundamental reform of the banking system, involving all the elements that I have described, can provide the foundation for the economic and social transformation of this country that we all want. I commend the motion to the house.

[Several hon. Members]

rose—

--- Later in debate ---

[Matthew Hancock (West Suffolk) (Con)]

I want to speak briefly at the end of what has been a very interesting and informative debate, which I commend the Backbench Business Committee on securing.

I welcome some of the measures that the Government have already taken, so in the light of this debate, I hope that the motion, which states that the Government have taken no action, will not be pressed to a vote. Many Members have accepted that the measures on tax, including a permanent tax on banks, the Vickers review into banking structures, the international push for transparency and the action taken to bring banks together to work on bonuses show that a strong work programme is in place already.

[Mr Meacher]

I do not want to take up time, because I have a couple of minutes at the end of the debate, but the hon. Gentleman picks up on a point I was going to raise. I did not say that no action has been taken. My motion states that

“no action has so far been taken which would prevent a recurrence of the financial crash”.

That is a very different proposition.

[Matthew Hancock]

I thank the right hon. Gentleman for that intervention, because it brings me precisely to the final thing that the Government have already proposed, and which I think is central to preventing a recurrence of the financial crash: the decision to move the powers for prudential regulation to the Bank of England and to strengthen those powers.

Having quickly welcomed the action already taken, I want to concentrate on prudential regulation. The removal of powers of prudential regulation in 1997 was central to many of the things that Members on both sides of the House have talked about. The hon. Member for Islwyn (Chris Evans), who is not in his place, spoke passionately about how his managers were telling him to lend more no matter what the customer needed. That was part of the rapid expansion of banks’ balance sheets, because there was no prudential regulation at the top of the size of those balance sheets. We also heard, from Government Members, about the rapid, uncontrolled run-up in balance sheets.

The idea of prudential regulation and having an institution exercising judgment, instead of just lots more rules-based regulation, has come of age. After all, the system before 1997, although imperfect, had prevented a run on any bank in the UK for 140 years, so it deserves some credit, and it deserves studying. So why would more discretion and judgment based in strong institutions work better than more rules? There are three key reasons. The first, as we have heard in many contributions, is that although rules can be set down in statute, statute can take a long time to change, whereas bankers can change and adapt very quickly. We have heard a lot this evening about regulatory arbitrage—another example of how financial institutions will change quickly to make the most out of whatever rules have been put in place on the ground. But the system cannot then adapt quickly.

Secondly and crucially, the system cannot adapt to innovations. We have seen massive financial innovation, especially with the development of computers over the past 30 years. However, to blame that innovation itself for the mess we are in ignores the fact that it was the lack of regulations—as my hon. Friend the Member for Warrington South (David Mowat) pointed out so eloquently, regulation is crucial to a functioning market economy—around these new developments and the attempt to regulate through explicit and specific rules, rather than the exercise of judgment, that was the problem.

--- Later in debate ---

[Mr Meacher]

I was astonished to hear the Financial Secretary say he thinks that the regulation of financial derivatives in the last financial crisis was adequate, since it seems to me to be clear that that was not so.

This has been one of the most thoughtful, high- quality and rewarding debates I have taken part in, or heard, in the House for a very long time, and we must thank the Backbench Business Committee for bringing a new tenor of openness and genuine discussion into debates, rather than adversarial confrontation.

For Members who may be considering how to vote, let me state once again that I did not say that no action has so far been taken by the Government; I think they have taken action. I said that no action has so far been taken that would prevent a recurrence of the financial crash, and simply shifting regulation from the Financial Services Authority to the Bank of England is certainly not going to achieve that.

I took a brief note of the most important points made by each Member who contributed to the debate, and I was astonished at the high measure of agreement—I will not say consensus—on the issues and, to some extent, on what ought to be done. These included the following: the problem of the creation of runaway credit; the importance of Basel counter-cyclical capital controls; the separation of retail and investment banking; the need for a rebalancing of the economy, with the banks giving more emphasis to industrial investment; improved accountability and competition; the need for universal banking and the re-mutualisation of some banks, perhaps including Northern Rock; the need for higher ethical standards; the overriding need for greater transparency; the need for equity financing; and the need for greater diversification in banking structure. These are all issues—and I have missed out some—on which I think there is broad agreement across the Chamber.

Having had an extremely valuable debate, I hope Members will carefully consider the terms of the motion, as it is quite modest. It was designed to get broad cross-party agreement, and I hope it will achieve that.

Question put.