HM Treasury

Part of Supplementary Estimate, 2008-09 – in the House of Commons at 1:15 pm on 15th October 2008.

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Photo of Peter Viggers Peter Viggers Conservative, Gosport 1:15 pm, 15th October 2008

I could not contribute to the debate yesterday for the agreeable reason that I was at Buckingham palace, so I welcome the opportunity to make a brief contribution today.

This banking crisis did not emerge from old-fashioned banking at all; it emerged from the kind of banking, known in the trade as "originate to distribute", that has developed in recent years, whereby banks put together packages of securities and then pass them on to each other in collateralised debt obligations, or CDOs, which have proliferated and become far more complicated. The amounts involved are enormous. The derivatives are inter-traded and cut in different ways; the original asset may go through many different manifestations and changes before it eventually ends up in the book of one bank. It has become a matter of enormous complication and vast financial implications. No bank can be completely confident that the asset that it holds is sound; all banks are contaminated to a greater or lesser extent by loans or investments that they may not be able to recover. All banks are toxic because of the massive amount of inter-trading that has taken place.

There is an urgent need accurately to identify each bank's assets and liabilities. The issue has to be resolved because most businesses, large or small, depend on bank gearing and bank borrowing to a greater or lesser extent. Most businesses have bank loans or facilities, many of which are not being rolled over. Many smaller businesses in particular are being offered much less advantageous terms; banks that had been borrowing at 8 or 9 per cent. are finding that their facilities are being reoffered or not offered at all. If they are being reoffered, it is happening at about 15 per cent. Moreover, all trade depends on bank facilities; goods in ships may not be unloaded and sent on to their ultimate destination unless the bank facilities for their transit are available. Something must be done.

In many ways this situation is unprecedented, but it is not completely so. A week ago, I drew attention in the House to the fact that what evolved at Lloyd's of London in the 1990s is a close analogue to the current situation. I became an underwriting name at Lloyd's in 1972. In 1989, when I ceased to be a Minister, I could see that things were going wrong at Lloyd's. I could come out of Lloyd's, stay there and worry or stay there and try to do something. I stood for the council of Lloyd's as an external member and was elected. I later became a member of its audit committee, so I was closely involved in the resolution of the problems in the 1990s.

The problems were similar to the ones that we have now. I put that point to the Chancellor of the Exchequer two days ago, but he brushed it aside saying that the Lloyd's situation was very different. But it is not: it is the nearest that we have to an accurate analogue. Lloyd's syndicates were underwriting risks and passing them on by way of reinsurance. The syndicate that had reinsured would then reinsure further, and there was a whole cycle of investment and reinvestment. The problem was that the syndicates were not entirely sure what risks they were underwriting. There was uncertainty because no one knew the reliability or soundness of the risks. That situation is very similar to that in which we find ourselves with the banks now.

Let us imagine—my comparison is a rather ugly one—that every single loan is a tiny piece of spaghetti, all the pieces are mixed up in a great big bucket, and we end up with a massive asset so that no one knows what they have got when they buy a share or slice of it. What we must do—this is the parallel that we draw from Lloyd's—is identify and isolate the unsound assets. Lloyd's created a new vehicle, Equitas, into which it transferred the unsound or questionable assets, so that it could move forward with purged units or entities that were free of the unsound or doubtful assets that were there previously.

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