Steve Richards: When regulation was purely optional

Why didn't Gordon Brown realise banks were losing control?
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Perhaps we need a regulator to regulate the regulator. The resignation of Sir James Crosby, the deputy head of the Financial Services Authority, highlights the near impossibility of monitoring an industry caught in a web of such complexity that only its most ardent practitioners have some clue as to what is going on. A banker was appointed to the FSA on the grounds of his forbidding expertise. Not surprisingly he is accused of being caught in the web from where he had come.

Sir James became deputy head of the regulator because he was supposedly a banker who knew the terrain, now there are claims that when he was Chief Executive of HBOS he sacked a senior risk adviser because of warnings that the bank was growing too fast. Sir James denies the allegation and Gordon Brown insists with a degree of cold comfort that it was not the cause of the bank's collapse. Yesterday the prime minister told the Liaison Committee of MPs, "It was because its whole business model was wrong".

Meanwhile the Treasury confirms that as Chancellor Brown would not have known about allegations relating to HBOS and the disastrously over-ambitious model. Again there is only cold comfort in being informed of Brown's lack of knowledge. The government has always believed in keeping an arm's length from the regulators and, in fairness, there is no other way regulation can work. If the government interfered on a day-to-day basis there would be no point in having a regulator. But of course the government appoints the regulators. It does so in semi-ignorance of what is really happening because of the distance it keeps.

Even if Brown or other ministers had probed more closely, would they have grasped the degree to which some banks were moving recklessly out of control? What was most revealing about the Treasury Select committee meeting with the former bankers on Tuesday was not the contrived and limited apology, but the former bankers' bewilderment about what had gone wrong. Each of them pointed out that risk advisers were on hand at every stage, including at boardroom level where there was apparently an intense scrutiny of the gambles the banks were taking. The risk advisers did not recognise the risks.

Not surprisingly, there is cross-party consensus that the banks require more effective regulation, but such a statement of the obvious evades the more awkward detailed question as to how this should be achieved. The regulatory framework in the UK was not the main cause of the crisis. If the Bank of England had retained its regulatory powers that it lost in 1997, would HBOS be standing tall now, a model of regulated restraint? I doubt it. The political debate in Britain was more about whether regulation should be lighter still – in order to give more space to these admirably bold institutions that were driving the economy forward.

Not that the regulators come to matter very much when political considerations overwhelm others. Regulators, however flawed, are drowned out altogether now by the chorus demanding that bonuses are stopped and these absurd salaries are capped. This has become a political issue and one that has led to more agonised thinking in Downing Street than just about any other. The preliminary outcome of the thinking was unveiled yesterday when Brown told the MPs' committee that the FSA would have powers to curb the short-term bonus culture. He did not say precisely how this stick would be applied, probably because he does not know. This was a holding measure, an attempt at a pause for breath.

The pause will not last for very long. The financial markets are in a state of flux. The vivid images and words of recent days are mere symptoms of the shapeless chaos – the appearance of universally vilified bankers affecting an apology, Brown's very generalised attempt to address the anti-bankers mood, the growing unemployment fuelled partly by a lack of credit, the calls for banks to go back to the old days and no longer be part of what Nick Clegg called yesterday the "casino culture". Something bigger is going on than a debate over whether a few bankers should apologise for their past recklessness.

In order to find what that is, look to America. The debate has moved on there to more fundamental questions over whether the Anglo-American model has failed. Even the august Newsweek magazine hails the European model this week, suggesting that the US is becoming increasingly like France, with its state takeovers and higher levels of government spending.

"If we fail to acknowledge the reality of the growing role of government in the economy, insisting instead on fighting 21st-century wars with 20th-century terms and tactics, then we are doomed to a fractious and unedifying debate," the magazine writes. "The sooner we understand where we truly stand, the sooner we can think more clearly about how to use government in today's world".

Take note, David Cameron, that with your advocacy of a smaller state and opposition to a fiscal stimulus, even Newsweek leaves you alone and looks to France. The wider point that President Sarkozy was making last week in his attack on Brown's VAT cut was that the stimulus would have been better spent on manufacturing industry, but that the UK, in its reliance on the financial markets, does not have much industry to boost. His comments were relatively mild given the patronising lectures from Brown and Blair to Europe over the last decade about the glories of the Anglo-American model.

Where America's debate turns, Britain's will follow soon. As part of the debate here, the calls for the nationalisation of the failed banks will grow. It is the only solution, at least in the short term, that resolves some of the dilemmas, the bonuses, the allegedly reckless regulator and credit in short supply. If these banks were publicly owned there would be no more need for impotent ministerial exhortation. Such direct involvement brings with it many obvious new problems, but none of them are quite as acute as lending billions and watching from the sidelines as voters erupt with a fuming anxiety.