Second Reading

Part of Financial Services Bill – in the House of Lords at 5:06 pm on 23rd February 2010.

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Photo of Lord Desai Lord Desai Labour 5:06 pm, 23rd February 2010

My Lords, I wish this would go on a bit longer as we have a lot to learn. I welcome the Bill. Like the noble Lord, Lord Lawson, I take the view that no matter what you do, the system will have crises and cycles. All you can do is learn from the previous crisis, do your best repair job and wait for the next one. The most interesting problem that we have seen recently is not that the banks failed-banks have been failing for ages. Indeed, it was the failure of Overend and Gurney which resulted in the Bank of England getting the power to become a lender of last resort and to do much more supervision over banking. At that time, banking was an innovation. Each time there is a wave of financial innovation, the regulators lose control over the system, the system crashes and on we go. That is roughly my view.

We have to examine this legislation in terms of whether it will take care of what we have learnt from previous crises and whether it makes adequate repair or caution for such a crisis recurring. I do not believe that the system in the 1990s was perfect. I came to your Lordships' House in 1991 and I remember Barings Bank and the BCCI going. At that time, the Bank of England also had the problem that while it had to regulate and supervise, it was also supposed to encourage the City to be a big player on the international field. There was a conflict between welcoming many more banks to work in the City and regulating them, which was a problem.

The latest crisis was not because the banks misbehaved because they were large banks-although that was one element. The much more important element, which we had not experienced for some years in developed economies, is that there had been six or seven years of excessively cheap credit, thanks to the global imbalances. At the same time, the pattern of global trade ensured us a low rate of inflation. Normally, under the monetarist idea, if you have too much credit, inflation happens and the system checks itself. We have learned that; I fought all those battles many years ago. This was the first crisis of the global system and we were not able to take it on board. The Chinese surplus balances were providing cheap credit for us, and the Chinese exports which earned that surplus credit were keeping inflation low. The Chinese were acting almost like a drug dealer by loaning back to the drug addict the money he had just paid to buy the drug.

You have to look at what the banks did in the context of this excessively cheap credit environment, with low inflation and central bankers not able to provide the kind of regulatory warning that they should have. We have it now in the memoirs of Alan Greenspan. We know, basically, that central bank after central bank failed either to tell their Governments to balance their budgets or to provide any kind of regulatory interest rate policy, except when it was too late. The problem was not that we had a crisis-many economists were muttering about one, we just did not know when it would happen-but that it cost us too much to rescue these banks. I agree with the noble Lord that, in a system of free market, the process of greed and so on has to be regulated by the force of the market. However, if you remove the threat of bankruptcy, you remove that regulatory mechanism, and that is where the problem was.

I, being a Hayekian libertarian, among other things, would have preferred the banks to go and for us not to have rescued a single bank. We were told that all sorts of dire things would have happened. I doubt that. The next time around, we ought to do some simulations as to what those dire things would be if it happened. So we rescued the banks despite all the warnings of moral hazard that Mervyn King muttered.

I should like to put one question to my noble friend-I am sorry that I have not given him notice of it. What will be the final cost of the bank rescue? Has he any estimate of what would happen if banks get better and restore profitability and we are able to get rid of all this bank equity that we have bought? What will be the final cost-not the current cost-to banking? It may turn out to be much smaller than what we are currently facing.

I like the Bill because it says what we can do next time around to minimise the cost of rescuing banks which are about to fail. The living will is an early warning system to the banks that they have to look after their own health; it is like a health check for banks. It will provide the Council for Financial Stability with an early warning of the banks that are likely to fail. That is a good thing. So the next time around we might not have to shell out as much money as we did this time.

However, there is a problem which I would urge the Council for Financial Stability to think about. We have found out that when the system fails, it is not only one bank that fails; the failure of one bank affects all other banks. Where we had systems of micro-prudential supervision, we are now talking about macro-prudential supervision- and I can assure your Lordships that most people do not know what macro-prudential supervision means.

Most people do not even know what financial stability means because we have not really worked out those concepts in detail in serious, mathematical computer modelling. These things have been done by physicists but not by economists. One of the tasks of the Council for Financial Stability will be to work out the theoretical part, to conduct research and development as to how it will know when the next financial crisis is likely to occur and not be surprised by it.

I would much rather worry about the interconnections within the banking system which spread the contagion. For example, Lehman Brothers, which, although it was not very large by any definition, still caused a lot of problems because of its interconnections with the rest of the system. Those are the problems which the Council for Financial Stability will have to address. If it can deal with them in terms of research and development, and if the living will can be done robustly, this Financial Services Bill will make a lot of difference.