First published in the Telegraph on 19 August 2009
What would you say if I told you I had discovered a solution to the credit crunch? One that didn’t involve throwing billions in good (taxpayers’) money after bad (bankers’); one that would leave the country and the economy in healthier shape; one that, while we’re at it, could stop bankers paying themselves such massive bonuses. What if, to top it off, it also doubled as a money-spinner?
I know, it all sounds too good to be true. As the Bank of England Governor Mervyn King spelt out earlier this month, although the most intense period of economic decline may now be over, we are on track for a protracted, feel-bad recovery. Even so, although there is no silver bullet for the mess made of our financial and economic system, there is a step which could fix two of the big problems facing us over the next year.
First, the problems. The banks will not lend enough to their customers: terrified at the prospect of implosion, they are hoarding cash in their vaults and charging enormous mark-ups to those seeking to borrow. This is, in other words, a credit crunch. As far as King is concerned it will take “several years” for the banks to bring their balance sheets back to health, and for them then to lend freely again.
Further, even as millions of households appear to be heading for penury, a small number of bankers are still making far more money than is justified by their contribution to the economy. Not only are bonuses back, they threaten to be bigger this year than ever. The fact that most banks are either explicitly or implicitly supported by the taxpayer has seemingly done little to stifle their generosity to themselves.
The Chancellor and the Bank are trying desperately to resolve these two issues, from pumping more money into the system to employing plain coercion tactics; but so far nothing has worked. Here’s why: the authorities crave a top-down solution when what is needed is a bottom-up response. That is where my simple, one-word solution comes in: competition.
Because the banking world is intrinsically associated with economics and finance, most of us assume that it is a highly functional, competitive market built on the foundations of supply and demand. Nothing could be further from the truth.
For many years, the sector has been an oligopoly. Mainstream banking has been dominated by a relatively small number of large companies – there was no bona fide high street bank set up in Britain in the last hundred years. Investment banking has also been controlled by a small cabal of big names. Barriers to entry are manifold. Well before the crisis, Philip Augar documented in his book The Greed Merchants how this model has, perversely, enabled the banks to charge flat, immovable fees. Hedge funds and private equity groups have, likewise, been able to levy fees on investors which allowed them to pocket 2 per cent of the total invested and 20 per cent of the profits.
In a healthy market, one would expect new entrants to come in, undercut the opposition and bring down costs across the market – what we might call the Ryanair effect. But this didn’t happen in the banking sector: by bringing in such spectacular profits – which we now know were illusory – during boom times, the incumbents created the illusion of being so efficient that no newcomer could take them on.
In this oligopolistic world, where profits are shared among a small group of banks, is it any wonder that so much cash has trickled down to their employees in the form of bonuses? The financial crisis has only made things worse. Bankers feel they can charge customers higher rates and pay themselves so much because, quite simply, so many of their competitors no longer exist.
What is needed, of course, is more banks. I have lost count of the number of people – from wonks inside the Bank of England and the Treasury to high-rollers in the City – who have told me that now is a perfect, once-in-a-lifetime moment to set up a new bank. At the start of the year, the billionaire investor George Soros declared he would pour cash into a decent new banking proposition – if he could find one. Any new enterprise, whether operating on the high street or in the investment markets, could charge a fraction of the fees levied by existing institutions. Without the burden of billions of pounds of bad debts, it would make a killing. Nor could there be a better branding opportunity than being able to tell customers you did not dirty your hands in the great financial collapse.
In the US, the market is already reacting as it should. Since the onset of the crisis there have been around 200 banking start-ups. The newest hedge funds have discovered that, without results, investors are unwilling to pay them the traditional high fees. This is called competition, and it is the most encouraging “green shoot” you can find.
In the UK, however, there has been little to compensate for the disappearance of some of the biggest names on the high street. Tesco and a few of the other supermarkets have plans to bolster their financial operations. One enterprising private equity firm has set up a fledgling bank called Aldermore. I have heard word of a couple of other smart City folk with plans to set up both high street and investment banking operations. But there has been nothing like the flurry of activity seen in the US.
In part, this is because a bank is no ordinary business to establish. You need a branch network, a lot of shareholder capital, money to put towards a deposit insurance scheme in case anything goes awry and, most importantly, a healthy slug of cash in the coffers that you can then lend to your customers.
But these obstacles are not insurmountable. The Government could and should be doing more to encourage the creation of new banks through special loans and capital injections.
Instead, the end result of most of its policies to tackle the crunch has been to exclude new enterprises: by providing unlimited support for the existing, poisoned banks it has given them an unfair competitive advantage, uprooting the laws of supply and demand which, if left to their own devices, would help to renew the system.
The financial rescue package at the end of last year may well have prevented the collapse of important institutions; but the perverse financial topography left in its wake could prevent the economic system from ever making a full recovery.
We are told Gordon Brown is spending his summer playing video games with his son. Might I humbly suggest that he also sets aside a bit of time to reacquaint himself with his self-professed favourite book, Adam Smith’s The Wealth of Nations, and the rather simple ideas of competition, and supply and demand.