Jeremy Warner's Outlook: Rock crisis prompts Darling intervention

Click to follow

In any crisis, of one thing we can be reassuringly confident – that once the politicians have woken up to it, there will always be an eventual and largely unnecessary regulatory crackdown. They can't help it really; it's in their blood, for what is the purpose of government if not to secure the stable doors long after all trace of equine life has bolted for the hills?

Even so, it was faintly surprising to see Alistair Darling, our still newish Chancellor, attempting to lead from the front in the rush to address the present credit crunch by calling on the G7 group of industrialised nations to impose tighter regulation on credit markets.

Perhaps it was the shock of having to approve a Bank of England rescue of Northern Rock, the first such City bail out since the secondary banking crisis of the Seventies.

The British Government has to date been vigilant almost to the point of religious zealotry in its defence of the City from the European propensity to regulate to death any market innovation. Its liberal approach to such matters has been in stark contrast to the growing political clamour from France and Germany for action on hedge funds, private equity and anything else that Anglo-Saxon capital markets have given rise to. Is Mr Darling now throwing in his lot with Angela Merkel and Nicolas Sarkozy? Certainly he seems to have drawn closer to their point of view. For two months now the Chancellor has been completely silent on the banking crisis unfolding before his eyes. As long as it remained a complex problem of the wholesale banking system, Mr Darling could afford to ignore it. But now it seems to be spilling out into rising mortgage rates and a possibly slowing economy. Worse still, it is hitting the front pages. As a politician he feels compelled both to find scapegoats and to be seen to take action. His response is depressingly predictable and pointless.

In fairness, it ought to be said that Mr Darling was careful in his letter to ECOFIN colleagues yesterday to warn of the dangers of regulatory over-kill. The primary responsibility for managing risk, he stressed, must remain with individual financial institutions and investors. It is also unclear precisely what he is proposing in terms of extra regulation.

If all he is saying is there needs to be greater transparency, nobody is going to argue with that, but nor does it need regulatory intervention to bring it about. After what's just happened, bankers have a powerful incentive to be more transparent, so as better to understand the nature of the credit risk they are taking on. Yet the Chancellor's underlying message is clear enough. Any weaknesses in the financial system highlighted by the present crisis must be addressed with firmer regulation. The Financial Stability Forum of the G7 is to be asked to look at how better to control all the naughty little financiers who have been running amok.

This is a complete waste of time and energy. For the moment, bankers have learned their lesson and are already well ahead of the regulators in sorting out the mess they have created. They won't quickly repeat the mistakes just made. Whatever the new regulations put in place, markets will inevitably find a way of circumnavigating them. Come the next crisis, it will be a different door altogether through which the horse bolts. Worse still, any new regulatory obligations will likely help create the next crisis, such is the ingenuity of markets and the law of unintended consequences.

As for Mr Darling's call for a return to the values of "good old fashioned banking", that was just silly, a bit like John Major's sentimental evocation of warm beer and the sound of leather on willow. There was never any golden age of banking; in fact the banking crises of yesteryear were a good sight more serious than what we are seeing today.

Nor should Mr Darling need any reminding of how much of Gordon Brown's 10-year "economic miracle" was predicated on the easy credit provided by the very markets he now complains of. If the credit boom is over, his own tenure as Chancellor is going to be a good sight tougher than that of his predecessor.

Poor Mr Darling. He's not been dealt an easy hand and of course it is perfectly reasonable for him to be examining the role of the credit rating agencies in structured finance, reviewing the procedures used by practitioners for assessing and managing risk, and indeed all the other issues raised by the credit debacle. If there's been a disaster, there has to be a public inquiry. Yet he should beware of throwing in his lot with those jealous of the City's success and a with a misguided appetite for seeing it undermined.

Markets await the Fed's decision

Even the reluctant the Mervyn King, Governor of the Bank of England, has now been forced to act on the gathering crisis in credit markets. Despite insisting that the City was on its own, the Bank was forced to come riding to the rescue of Northern Rock, the beleaguered Newcastle-based mortgage bank. Next it's the turn of Ben Bernanke, the chairman of the Federal Reserve, to step up to the plate. It is hard to recall a more keenly awaiting meeting of the Fed's open markets committee than the one that happens on Tuesday next week. 9/11 doesn't really count, because everyone knew what the Fed would do on that occasion. For a better comparison you have to go back as far as 1998, when a very similar crisis to the one we are seeing today gripped the capital markets.

A little bit of optimism returned to stock markets yesterday, but any renewed confidence is very much based on Mr Bernanke doing "the right thing" at next week's meeting. Anything less than a half-point cut in the Fed Funds rate is going to be seen by markets as a disappointment. Nothing at all would be thought a total disaster, with Mr Bernanke sleep-walking the US economy into recession. Even a quarter point with an accompanying vaguely hawkish statement about the need to be vigilant on inflation would be thought bad.

A quarter-point cut in the Fed Funds rate in conjunction with a 75 basis point reduction in the discount rate, bringing the interbank facility into line with the Fed Funds rate, would be an interesting nuancing of the Fed's response to the credit crisis which just might satisfy markets, but it is really the full half point that investors are looking for.

The short-term outlook for equities thus depends crucially on what Mr Bernanke does. If he disappoints, we can expect a lot more turbulence into Christmas culminating possibly in a US recession. If he pleases, stock markets will surge. Unfortunately, there is a quite potent reason why he may feel obliged to disappoint, and that's the lessons of 1998.

By cutting deeply in response to a credit crunch and an accompanying collapse in economic confidence, the Fed only stoked the latter stages of the boom and arguably made the downturn of subsequent years that much worse. Something similar happened in the aftermath of the stock market crash of 1987 too. Mr Bernanke won't want to repeat these errors in policy. But nor is it at all common for the Fed to allow the US economy to drift into recession in the run up to a presidential election. The Fed has a duty to maintain economic health and employment.

Whatever the Fed does, it is now in all probability too late to save the housing market, certainly in the US and quite possibly in Britain too. Depending on which survey you believe, UK house prices are already in decline. Higher mortgage rates, a direct response to the present credit crunch, will further undermine confidence and ability to pay the current, very high prices. Yet this is not necessarily negative news for all asset classes. In a reversal of roles, all but the highest quality debt is suddenly seen as inherently risky while many equities, with the backing of strong balance sheets and reliable profits, have taken on safe haven characteristics.

Despite the best efforts of public policy to kill off equity and encourage its replacement with debt, a much needed rotation is promised. Even the most impenetrable of company accounts have turned out to be more reliable than some of the triple A rated debt that has been rammed down the throats of hungry investors in recent years. Share price ratings are also undemanding enough to allow for an economic slowdown.