Part of the debate – in the House of Lords at 6:35 pm on 3rd November 2008.

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Photo of Lord Burns Lord Burns Crossbench 6:35 pm, 3rd November 2008

My Lords, I thank the noble Lord, Lord Myners, for introducing the debate and join other noble Lords in welcoming him to the House. We are former board colleagues at a well-known retailer, and I warmly welcome him to his position as Minister for the City. I am sure that he will enjoy the Treasury a great deal and I wish him well in that role.

Given the nature of the debate, I should remind the House that, as set out in the Register of Members' Interests, I am a non-executive director of Banco Santander and chairman of its two UK banking subsidiaries, Abbey National and, now, Alliance and Leicester.

My first comments are about the current economic cycle. I understand the temptation to make the case that this is not just a normal boom and bust for which the Government are responsible, but a boom and bust made elsewhere for which the authorities cannot be blamed. There is something in that assertion, but surely the Government overstate their case. The key feature of any bust is the boom that precedes it, and the run-up to this bust has many of the characteristics of other booms. We have seen over-optimism about the underlying growth of output; we have watched a house price and equity boom go without any response in interest rates; we have had a commodity and oil price boom that was put down to long-term resource problems rather than the cycle; a boom in financial activity and rising levels of leverage; and, of course, the boom in consumer lending. In this case, more of the unsustainable increase in world output came from activities outside the advanced industrial countries than was the case in many other cycles, but we have clearly played our part and should not exaggerate the position.

To me, the difference in this cycle is less about how the boom happened and more about the way that it came to an end. Here, there is of course a big difference. Normally, an upswing comes to an end with rising inflation and interest rates whereas, on this occasion, the boom was brought to an end by the emergence of bad debt, an abrupt freezing of the inter-bank market and huge losses on asset-backed securities that far exceed the impairment of the underlying assets. These losses have inflicted severe damage on the capital resources of many of the banks, noticeably the British banks. Not surprisingly, the banks are now cutting back lending and trying to avoid being too dependent on wholesale financial markets. Instead of interest rates rising to choke off the pressure, declining availability has done the job for us.

Along with others, I still have a lot of uncertainty as to the severity and length of the recession. The outcome still depends a lot on what happens in the financial part of the crisis. The noble Lord, Lord Griffiths, is surely right to say that we are not facing a 1930s-style meltdown, but everything that I have seen from the perspective of the banking industry tells me that we face a very painful period. How the UK economy performs relative to other advanced industrial countries is also uncertain. Along with many other noble Lords, I would hesitate to argue that we are better positioned than they are.

We still face a painful time. Resolving the crisis will take time. In my view, it is right that the Government's attention should be focused on doing what they can to maintain levels of lending within the economy. Along with others, I welcome many of the actions that they have taken. As the noble Lord, Lord Lawson, pointed out, there are lessons for the future for regulation and supervision but, to my mind, that is for the future. As a regulated person, I hesitate to criticise my regulators at this moment.

The noble Lord, Lord MacGregor, asked me about Spanish regulation. I am sure that we will hear a lot more about the future of supervision in later debates. In response to his question, I shall make a couple of points. First, the Bank of Spain has done what we have all been told not to do throughout our lives; that is, fight the last war. Its actions were the response to the banking collapses in Spain in the early 1980s from which it learnt a lot. We live under three aspects of the regime in Spain. It has had a regime of insisting that banks hold capital against off-balance sheet vehicles, which meant that none of the Spanish banks had any off-balance sheet vehicles. Therefore, they had no toxic assets and largely escaped from this first round of problems. Secondly, banks were required to hold general provisions against all loans and not only against specific bad debts when they occur. Thirdly—I hesitate to say this—it is a long way from light-touch regulation. The Bank of Spain has 27 permanently resident people going through the books in Banco Santander, which is a rather different regime from ours—thank God.

The result of our financial crisis is that the banks are now in a difficult position. Given their capital position and the present dangers of relying on wholesale lending, they are all being forced to deleverage their balance sheets, which means a combination of lower lending and raising more capital. That is why it is right for the Government to underwrite injections of capital, which is to be welcomed.

The banks need access to liquidity. Again, it is important for the authorities to continue to play the part that they have in underwriting wholesale borrowing by the banks, and being an intermediary and recycling cash between banks. It is to the credit of the Government that they have taken action on each of those fronts, as well as working to find solutions for banks that have been in serious difficulty. Only time will tell whether that is enough. The Government have to stand by ready to do more if they are to help to unwind the blockages that I fear still remain in the financial system for inter-bank lending and wholesale lending generally.

As other noble Lords have argued, these actions need to be buttressed by an aggressive cut in interest rates. Monetary policy has to be the main lever to support the economy. Effective market interest rates have risen sharply relative to bank rate and it is my judgment, along with many others, that the bank rate needs to adjust to compensate. As my noble friend Lord Skidelsky reminds us, we cannot be sure that market rates will decline in line with the official intervention rate, but, in time, it will make a significant difference. We will also get some easing from the decline in sterling.

I have some particular concerns about fiscal policy. If I read the newspapers correctly, we seem to be being briefed that the budget deficit could be as bad as in the early 1990s. I no longer make forecasts, but I would simply observe that at this stage in the cycle the tendency of all forecasts is towards over-optimism. It is generally accepted outside Whitehall that the fiscal rules, although worthy in their intention, have not in practice been a success. The extent to which they seem to be more influenced by the re-writing of the past than a judgment about the present or the future has been a problem, particularly taking the view that the cycle has been as long as it has.

With the prospect of a period of falling output and a relatively slow recovery, the budget deficit will grow rapidly. To the extent that it is because of the cycle and what we know as the automatic stabilisers coming into effect, that is not a matter of great concern, as many have argued. As output returns, some of that deficit will decline automatically. I belong to the same group as many noble Lords who have spoken today who say that to go beyond that would be very dangerous at this point. We begin from a position of a structural budget deficit. Adding to that structural budget deficit can only increase the problems subsequently.

Each of the three serious downturns that I have observed at close quarters—1974-75, 1980-81 and 1991-92—have had two striking characteristics; namely, the emergence of a budget deficit that increased to a point where the restoration of structural balance was a long and painful process, and at some point a depreciation of sterling that moved from just about being welcome to becoming very painful. Let us hope that we are not forced to repeat those experiences.