Andreas Whittam Smith: Time to put some bankers in the dock

The key political fact about the present credit crunch is that the government didn't start this one. This is very different from what has repeatedly happened since 1945. The pattern had come to seem immutable. First inflation would become a problem. Then wages settlements would begin to increase. In turn the rise in prices would accelerate. Finally, to halt the spiral, the government of the day would sharply raise interest rates.

In other words, from time to time governments deliberately squeezed credit as an act of policy to curb inflation. And often for good measure they added cuts in public spending and tax increases. It was this boom and bust cycle that Gordon Brown, when he was Chancellor of the Exchequer, resolved to abolish. In fact he was never put to the test. For inflation remained subdued throughout his 10 years at the Treasury.

Now go back to early August 2007 when a small German bank got into trouble. At the time, inflation still remained modest. True, oil prices had risen sharply and food was becoming rapidly more expensive. But wages had scarcely shifted and governments weren't disposed to act. Yet it was then that the first spasm of fear convulsed the money markets and credit immediately began to tighten. Looking back we can see that from that moment in August 2007, a credit squeeze of unparalleled ferocity had taken hold.

Neither the British Government nor the American Government nor any other national administration deliberately brought it about. Quite the reverse, for as the credit crunch has steadily tightened, with money markets seizing up like engines deprived of oil, governments around the world have done everything they can think of to halt the process. Without success. Even the $700bn bailout approved by the US Congress last week may not ease the pressure enough for anybody to notice.

In the past, the question of who was to blame for a downturn seemed obvious. It was solely the Government's fault. It had raised interest rates and made everybody's life uncomfortable. This time, however, the perfectly understandable attempts by the Conservatives at their conference last week to blame Mr Brown and his government haven't worked. Polls show that the Prime Minister is earning a degree of trust in the midst of this crisis. This is significant; it represents an implicit admission that although the Government may have been lax in various ways, it is not the single author of our economic misfortunes.

Who then should stand in the dock? Should it be the banks, or the regulators, or the "short" sellers of banking shares, or persons as yet unknown? Whether this will remain just a talking-point will depend upon the severity of the coming recession. For if many workers lose their jobs and begin to wonder why has this happened to them, they may well become angry. Already the enterprising bookmaking firm, Paddy Power, is taking bets on which will be the first city to experience credit crisis riots.

Who, then, is chiefly at fault? In my view the banks are the guilty parties par excellence. They overtraded for years. Firms which overtrade, that is undertake business transactions at a level that exceeds their resources and use excessive borrowing to make up the difference, inevitably go bust sooner or later – unless, that is, they are banks and the government of the day has to come to their assistance.

That is why the regulations to which the banks are subject are designed to prevent overtrading. They do this by stating how much capital each bank must hold to support different levels of activity. Unfortunately ambitious banks came to see these restrictions as a problem to be overcome not as an absolute bar.

I confess I feel angry as I write the next sentences. Rather as rich people "legally" evade tax, so banks evaded prudential restrictions by setting up special purpose companies – Northern Rock's was named Granite – that could do what banking is, borrow short and lend long, without being called banks. And they created these entities in such a way that bank regulators would remain ignorant of their true purpose or, if they understood what was going on, they would not be able to reach them. And once clear of regulations, the banks gave their staff generous incentives to build business as fast as possible.

I have referred to banks but I wish to be more specific. The directors of banks carry the full responsibility. Nothing their bank does should escape them. Each month they see the numbers. They can always ask for more detail. They approve the budgets and then monitor them. Their support is required for new initiatives. In particular they must have regard for the risks that their bank may be running. They are also responsible for compliance with regulations. They have a duty to treat customers fairly. And they set the remunerations packages for the executive directors, and it is these that are taken as a model for managers below board level. All these duties I have listed above are well understood. Even Northern Rock and Bradford & Bingley ticked the boxes for good corporate governance in their annual reports.

Pause here and glance across to Wall Street. There, faced with a similar situation, the FBI recently announced that it has opened preliminary investigations into possible fraud involving Fannie Mae, Freddie Mac, Lehman Brothers and AIG. This is in addition to the 25 cases already commenced in recent months. Hundreds of Wall Street bankers are currently under investigation. That is as it should be.

Over here there has not been a peep from the law enforcement agencies. We do things differently. So I hope the Government will remember Lord Penrose's recent account of the fall of the Equitable Life Assurance Society, which it commissioned. It is a good precedent. The report was immensely revealing. There should be a similar enquiry, by a body with strong legal powers, into the recent conduct of banking. The bankers started this, not the Government. They must explain what they were doing. As unemployment rises, people will want to know.

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