First published in the Telegraph on 19 June 2009
The financial and economic crisis has led to a Cold War between the Treasury and the Bank of England, and this week saw its equivalent of the Cuban missile crisis. The setting was the gilded banqueting hall of the Mansion House in the City of London; upper lips remained stiff and manners impeccable. Nevertheless, the level of brinkmanship and tension as Alistair Darling and Mervyn King faced each other down was something to behold.
Standing a few feet from the visibly paling Chancellor, the Bank’s Governor delivered a speech that elegantly dismantled the Government’s reputation for both economic credibility and financial nous. In a couple of breaths, King effectively warned that the spending plans laid out in the Budget simply weren’t good enough, and nor were Darling’s initial attempts to overhaul the regulation of the financial system.
It may have been delivered in King’s customary academic drawl, but there was no concealing the brutality of the attack. The ill-will was compounded by the fact that the Bank wouldn’t even deliver a preview of the speech to Darling until it had already hit Fleet Street. Privately, Treasury figures now admit they regret appointing King to a second term last year.
But then, one can appreciate the Governor’s frustration. The country faces its worst slide in post-war history, but it does so with a disenfranchised, disenchanted Chancellor and a lame-duck Government. We are entering a brief, precious window of opportunity in which the malfunctioning financial system can and should be reshaped to head off future crises. The US and Europe have both presented far-reaching proposals on new regulation, how to clamp down on investment banks and hedge funds, and how to prevent credit bubbles from over-inflating. In Britain, meanwhile, the much-vaunted White Paper on financial regulation has been postponed three times.
No one is in any doubt that something needs to be done. The existing system, in which regulatory duties are shared between the Treasury, the Financial Services Authority and the Bank, had failed dismally even before the collapse of Northern Rock. None of the three carried out their job satisfactorily or communicated with each other, with the result that the entire financial sector toppled over. Since then, little has changed. The Chancellor, constrained by the fact that the apparatus was created by his boss back in 1997, has made it a legal obligation for the Bank to keep the financial system in good health without giving it the powers to actually do the job.
Let’s leave aside the institutions and the jargon. Complex and esoteric as regulation is, what needs to be done is at heart pretty simple. Banks (or, for that matter, insurance groups and other financial institutions) must not be allowed to become too big to fail. This means they must either be sliced up into smaller fragments, or a way must be found of enabling them to collapse without taking the rest of the economy with them. And that was the nub of what King spelled out to the Chancellor in the City on Wednesday night.
As things stand, those working in the financial sector know that they will be supported by the Government through thick and thin. If they make a loss, the taxpayer absorbs it; but a profit goes straight into their pockets. A little over a year ago, someone at a summit dinner in Japan asked the world’s leading finance ministers and central bankers what they would do if an investment bank collapsed; everyone cast their eyes towards the table and played with their food. That the Chancellor could do no better at the Mansion House this week is beyond embarrassing.
Given that Britain’s economic success over the past decade has depended so heavily on the expansion of the City, it is a leap of faith for a Chancellor to put his weight behind reining it in. But as King said, “something has to give”. If more tightly regulated banks with a less blistering rate of growth are the answer then so be it.
There is, at present, public clamour for a knife to be taken to the banking sector, as voters brace themselves angrily for swingeing spending cuts and perhaps even tax rises. This momentum, which will not last forever, should be channelled into sensible reforms. The problem – the seed of King’s frustration – is that the current Government seems incapable of finding a way through. And there is no guarantee that a dynamic, newly elected administration would do much better: President Obama’s reforms, also unveiled this week, are almost certain to be diluted and dissected by Congress before they pass into law.
Perhaps, having thrown so much at the recession in a desperate attempt to prevent a slide into full-scale, Thirties-style depression, we will now be unable to generate the impetus and energy for radical regulatory reform. But political torpor can be no excuse: if our hand is stayed then we will, deservedly, be harshly judged when the next financial crisis comes around.