Jeremy Warner: Out goes light touch, in comes the iron fist
Thursday 19 March 2009
Outlook As you would expect from McKinsey man, Lord Turner has done a masterful job in steering his way through the conflicting demands of the politicians for root-and-branch changes in the way banks are regulated and the need to preserve at least some elements of the free-market system.
Measured and reasonable, it's hard to find much to disagree with in yesterday's 122-page "regulatory response to the global banking crisis", or indeed much that is particularly new in its recommendations, lest it be an endorsement of the idea of a new European institution as a standard-setter and co-ordinator in the area of banking supervision with legal powers of enforcement.
Lord Turner implicitly criticises the Government for its previous championing of "light-touch" regulation, reaffirmed by Gordon Brown as recently as his Mansion House speech of less than two years ago, yet as the FSA chairman points out, this was very much the political and economic orthodoxy of the time. It ill becomes the Tories to complain, as at the time they were even more gung-ho for the deregulatory agenda than Labour.
Stock markets seemed to think that Lord Turner is suggesting a more penal capital and liquidity regime than is really necessary, but what did they expect? That these requirements would be eased? The upshot is that banks will become lower return, but by the same token also lower risk. Is that such a hard thing to swallow after the devastation of the last two years?
Lord Turner's review is actually much longer on analysis of the causes of the crisis, and the failings in regulation it highlighted, than it is on concrete proposals to prevent repetition. If you want to understand more fully what's happened, read this eloquently written analysis. Yet he's very much within the parameters of international consensus in his recommendations as to what should be done about it, as indeed he has to be, for much of it wouldn't work unless the suggested reform agenda commands global support.
The case for a Glass-Steagall type separation of commercial and investment banking functions is pretty comprehensively rejected, if only because both in the US and Europe, there's not much support for it. To my mind, Glass-Steagall would produce a more effective solution without the need for intrusive product regulation, but plainly it is not to be.
None of this is to underestimate the significance of Lord Turner's musings. The age of "light-" or "soft-" touch regulation is gone, and in its place is ushered a period of much more oppressive supervision and regulatory oversight. Bankers won't in future be able to so much as go to the loo without first seeking the FSA's approval.
Tellingly for the rocket scientists that gave us credit default swaps and Structured Investment Vehicles (SIVs), Lord Turner dismisses much financial innovation as of minimal social value, representing instead economic rent extraction that has swollen some parts of the financial sector beyond their economically efficient size. Such "innovators" can expect to be out of a job for an awfully long time.
Lord Turner is also surely right to criticise the hopeless, confusing and in some cases downright deceptive way in which banks have accounted for their assets and expanded the banking system's risk profile through use of off-balance sheet vehicles. Bailing out the banks has given the FSA a much clearer understanding of what banks have on their books and how they account for them. Significant differences have emerged in the way these assets are valued. Step forward, perhaps, Barclays, which markets have long suspected of being economical with the actualité.
Yet the key change in approach is not in the detail but the philosophy. In the past, the FSA's oversight has been based on the idea that markets are in general self-correcting, that market discipline is effective, and that management and directors are better placed than regulators to identify risk, and provide processes, structures and systems, not to mention determine pay.
The prevailing philosophy of the last 30 years that the market is always right has been well and truly exploded by the current crisis. Actually, it is quite hard to understand where this philosophy came from in the first place, for even a cursory understanding of history shows that capitalism is prone to repeated crises, many of them by the standards of their time just as serious as this one.
One of the unifying features is that each is preceded by a period of liberalisation and deregulation that has the effect of greatly expanding credit and the supply of money. Why is it, then, that economies are cursed constantly to repeat the mistakes of their forebears by eventually allowing the financiers to let rip? When I first came into financial journalism there used to be something known as the "30-year rule", which had it that really serious banking crises happen approximately every 30 years because this was the length of time it takes for all institutional knowledge of the last major bust to die out. The politicians too fast forget the lessons of the last crisis and fall prey to the deregulatory lobby, which invariably promises wealth beyond the dreams of avarice.
Yet somehow or other capitalism always survives these cyclical implosions. It is not hard to see why. Deregulation may contain the seeds of its own self-destruction, yet despite the misery and despair of the bust, it also produces long-term results. In the round, free and open societies progress more rapidly than state-controlled ones. There is no market failure quite so bad as government failure, as the experience of societies once controlled by the former Soviet bloc amply demonstrates. Mistakes in public policy are capable of far more damage than failed banks.
So if I have a slight gripe with the Turner review, it is this. Lord Turner is clever and accomplished at capturing the zeitgeist and emerging political consensus of the moment, as he has done with similar Government-sponsored reviews of the pensions and climate-change agendas. Yet who is he to say that regulators and their political masters are any better than markets in assessing risk, and in deciding what products are socially "useful" and which are not?
Annoyingly, he's got an answer for this one too, which is that he broadly agrees, but that once taxpayers are forced to bail out the banking system, it is reasonable for them to want to limit the risks of it ever happening again. Bankers only have themselves to blame for what's now happening to their industry.
The moment they were forced to go cap in hand to the Government for support, they lost the argument on deregulation and opened the floodgates to a period of intrusive and heavy-handed supervision. In pursuit of the fast buck, banking lost its sense of ethical and social purpose, and eventually became careless with its depositors' and investors' money.
Lord Turner's suggested remedies are easily dismissed as irrelevant, since the Tories are likely to be in power in little more than a year, determined to lay waste to the regulatory structures that Labour created. Maybe so, but much of what Lord Turner is proposing is politically uncontroversial, except of course that it tramples all over the "light-touch" approach to regulation Gordon Brown once used to champion. Like everyone else, he's been forced to change his mind. In any case, whatever happens to the FSA, Turner's reform blueprint should survive a change of government.
Never again? Well, not until the next time, anyway. Fast-forward another hundred years and it is certain that Turner will be as much a relic of a bygone age as the reform agenda of the 1930s. It is equally certain we'll have seen at least one banking crisis just as serious as the present one, if not more so.
As Mervyn King, Governor of the Bank of England, never ceases to remind us, banks may be vital to our economic prosperity, but they are also dangerous when left unattended. For the time being, Lord Turner is determined to keep a tight leash.
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