Second Reading

Part of the debate – in the House of Lords at 5:13 pm on 16th December 2008.

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Photo of Lord Saatchi Lord Saatchi Conservative 5:13 pm, 16th December 2008

My Lords, it is a pleasure to follow the speeches of the noble Lords, Lord Barnett and Lord Smith. As they will hear, I shall attempt to amplify both the content and tone of what they have said. One of the most attractive aspects of your Lordships' House is that we listen intently to what Ministers say at the Dispatch Box and try to understand what is in the Government's mind. To that end, I say to the Minister that it would assist the House's appreciation of the context of the Bill if he was prepared to withdraw a statement that he made in the House on 12 November 2008. He said:

"the Government are not of the view that we are in extreme economic circumstances".—[Hansard, 12/11/08; col. 654.]

The Minister does not seem to want to withdraw it, so he stands by it.

We are then asked to believe that what the Bank of England calls,

"the largest financial crisis ... in human history", must have blown up in the 12 days between 12 and 24 November, because by the latter date the Government had a completely different view. On that day in another place, the Chancellor of the Exchequer, describing where we were, used the phrases,

"not seen for generations ... extraordinary ... times ... exceptional economic circumstances ... disastrous ... unprecedented global crisis".—[Hansard, Commons, 24/11/08; cols. 489-90.]

I do not know whether the Minister wants to withdraw the statement now.

Apart from torturing the Minister—a totally honourable activity, by the way—it is for your Lordships' House to be crystal clear about the true context of the Bill, to which the Minister himself referred. Apart from the Minister, the rest of us see this Banking Bill as a response to a crisis that was at the heart of an economic crisis that is now claiming jobs, careers, companies, families and livelihoods every day. The beleaguered citizens of Britain want to know what the Banking Bill will do to prevent this from ever happening again. If the Bill had a subtitle, it would be, "How to Lock a Stable Door After the Horse Has Bolted". But that is not what we want, nor what the people in the Gallery and the public are interested in. We want to build a stable with such solid doors and such a powerful lock that this horse can never bolt again.

I am not interested in apportioning blame for this crisis. I am well aware that some people would say that it was a failure of free markets, while others would blame a failure of regulation. I do not mind at this moment. I would like the Government to accept the help of your Lordships' House and the many experts in it—we heard from two of them just now—in ensuring that this never happens again. To do that, we have to know how this banking crisis came about. The noble Lord, Lord Smith, touched on that. I shall attempt my own description, and I assure noble Lords that it will make their hair stand on end. If it is complex, I hope that your Lordships will forgive me; it is in order to assist your Lordships' House in identifying precisely how the crisis came about. Perhaps in his winding up the Minister will point your Lordships to the clauses in the Bill that will prevent the recurrence of the events that I am about to describe.

The record seems to show that this economic war was started by an acronym. The noble Lord, Lord Smith, said as much. To explain, I recommend a game for your Lordships to play. It will be a fine game at dinner parties over Christmas. It involves uttering a sentence and then inviting participants to translate it into plain English. The game is best played with people who own or run a bank. Here is the sentence: "I use CFDs in my SIV to buy CDIs, or CDOs, in the CDS". Some of us have great friends who own or run banks, and I have played this game with them. They know that these acronyms exist and they can say what the letters stand for, but I assure your Lordships that they cannot explain what they mean. For example, the most distinguished former Governor of the Bank of England, the noble Lord, Lord George—the iconic Eddie George—confirms the point in a recent pamphlet for the Politeia think tank. Writing about these banking acronyms, he says that, as Governor of the Bank of England, he did not understand,

"how they were rated or related".

These are the acronyms that brought the world to its knees.

This horse bolted with two leaps. We have to take our hats off to the startling simplicity and creativity with which it was done. I hope that noble Lords will forgive me for this description; I think that it is important to explain. In the beginning, the banks took deposits and it was understood that they made loans equal to the deposits that they had taken. That was the original idea of banks. The centuries went by and the view arose that that was unnecessarily restrictive on banks and that, as all the depositors did not ask for all their money at the same time, it was reasonable for the banks to lend a multiple of the money that they had on deposit. Then the question arose of what the multiple of what was on deposit might reasonably be.

At this point, I have to introduce your Lordships to the Basel Committee on Banking Supervision, a body consisting of central banks and the regulatory authorities of the world. They look at what they call the key point—how much capital banks need to put aside against the types of financial operational risk that banks face. In the history that I described, they arrived at Basel II in 2004. The important thing about Basel II is that the committee makes recommendations, provides a forum and encourages. In other words, it has no force of law.

The brilliant and creative people to whom I referred earlier, in the investment banks and probably in Wall Street, wanted to find a way to lend more; they wanted to find a way around those capital ratios. They hit on a brilliant idea—this was the first leap—in the SIV, the structured investment vehicle. This SIV, for reasons that I do not understand but on which the noble Lord, Lord Smith, may enlighten us at another stage, could be taken off the balance sheet of the banks. That was a key point raised by the noble Lord, Lord Barnett. That was the benefit of the SIV: it was there to take the loans out of the balance sheet so that the banks could lend more and stay within the ratios laid down by Basel II. But they were no longer loans; they were investments. This was not a loan book but a market for investments. That is what happened to enable the banks to lend more, which they did.

That was leap number one, but it was not the end of the brilliance. The banks started to lend more and got interested in the so-called sub-prime market of residential property in America. The sub-prime market is not, as one might imagine from reading the newspapers, some sort of ghetto in Cleveland. It is pretty much all the US residential market, apart from 64th Street and Madison Avenue in New York. The banks started to lend more and move down this enormous amount of residential property. Here they came to a second restriction, requiring a second brilliant leap. The reason why I am putting this to the Minister is that I am anxious for him to say what this Bill will do to prevent a recurrence of exactly what I describe.

The second leap was that, as they went further down the sub-prime market in America, the rating agencies started to say, "Well, this doesn't look to us like triple-A-rated security". Apparently you cannot sell anything in the banking world that is not triple-A. The banks hit on a really brilliant, original, creative solution, which was insurance. If they could say to the rating agencies that there was nothing wrong with these loans or investments that they had made and that they deserved a triple-A rating because they were insured, who could argue with that? They were insured and, therefore, they received their triple-A rating.

I hope that noble Lords will forgive me for the history, but they can now see how, when this crisis arose, it was all such a shock and why it is all still unravelling today. The noble Lord, Lord Barnett, said that he did not know. I assure him that not the Minister, not the Treasury, not the FSA, not the Bank of England, not the US Federal Reserve board, not the US Treasury Secretary and not the Chancellor of the Exchequer knew. Nobody knew about what I have just described. So we arrived at a position when the shock arose, when a request that banks routinely make to their customers—that they show them their balance sheet—was one with which the banks themselves could not promptly comply. One day, as the noble Lords, Lord Smith and Lord Barnett, said, the auditors of the banks will explain how this was possible. It is a mystery to me. It would be helpful to your Lordships' House if the Minister could say in winding up how the Bill will deal with those two specific crucial moments that led up to and made this crisis.

I end by imposing on the House my own small suggestion for how such a crisis can be averted in the future. This does not relate to the two points that I have made, which I leave to the Minister. I was pleased to see that the Government do not regard the remit of the Bank of England as sacrosanct. This Bill amends the remit of the Bank of England, as set out in the Bank of England Act 1998. Proposed new Section 2A(1) in Clause 228, Part 7, gives the Bank a new objective, which is,

"to contribute to protecting and enhancing the stability of the financial systems of the United Kingdom".

The Government have opened the door to amending the remit of the Bank of England and I hope that noble Lords will accompany me through it.

Shakespeare taught us that human beings can have a fatal flaw. So, too, can legislation. The Bank of England Act 1998 has a fatal flaw. It has three words too many, which my Bill aims to delete. Section 11 in Part II of the Bank of England Act misdefines the role of the Bank by obliging it to focus on controlling inflation to the exclusion of all else and then compounds the error by defining inflation to exclude all the debt/housing/mortgage problems that caused the crisis.

The record seems to show that the top officials of the Bank of England were like top generals given the wrong orders. The fault lies not with them but with the legislation that created them. This is why I introduced in your Lordships' House just after Questions today—and I am grateful to the usual channels for allowing me to do so—the Bank of England (Amendment) Bill. I will bring forward an amendment in Committee stage of this Bill to give effect to the change in the Bank of England's remit proposed in my Bill. The amendment is based on the unremarkable proposition that officials of the Bank of England have sufficient wisdom and breadth of vision to see the whole economic picture and that they should not be forced to wear legislative blinkers that blind them to how an economic disaster such as this one can arise during a period of low inflation.

A Labour Prime Minister once won a famous post-war election with the slogan:

"We won the war. Now let's win the peace".

One day soon I hope that the Government will be able to say—and we will help them—that we won this economic war. Let us be sure to win the peace, too.