April 25th, 2010

djm4: (Default)
Sunday, April 25th, 2010 11:02 pm
'The ultimate result of shielding men from the effects of folly, is to fill the world with fools.' - Herbert Spencer

It has of late become fashionable to de-canonise St Vince Cable. This is understandable, and probably something that he, as a level-headed Yorkshireman would approve of. In fact, he’s complicit in it; he’s freely admitted that he didn’t see every aspect of the credit crunch coming, especially the US angle. The myth of ‘soothsayer Vince’ needs challenging, not least because it misses the point. Vince gets things right not because of some magical power of economic second sight, but because he’s clever, knowledgeable, patient and observant.

And he does get a lot of things right. As far back as the mid-1990s Vince was warning of the dangers of the demutualisation of the building societies. I’m unable to find a direct quote for this, (perhaps because at the time Vince was a chief economist for Shell rather than a politician) but Evan Davis says so and that’s good enough for me. He is on record (in Hansard, among other places) as warning about the continued levels of personal debt since 2003, warnings that were dismissed as scaremongering right up to the point when they suddenly and terribly came true.

It’s worth remembering, too, that he was calling for the nationalisation of Northern Rock from the moment it became clear how much trouble the bank was in. Nationalising a bank was a surprising proposal for even a Liberal Democrat to make at the time, but it turned out to be the right one, and would have worked considerably better if done to Vince's timetable.

All of which is to say that Vince may not be omniscient, but he is a pretty shrewd cookie, able to see some of the long-term consequences and not afraid to talk about them. Clearly he wouldn’t have been able to stop the credit crunch had he been Chancellor for the past five years - it was too big and too international for that - but he might well have lessened its effect on Britain. And he'd have known it was coming.

It’s interesting, in retrospect, to remember what the Lib Dems were doing while the credit crunch was closing in unseen around us. In September 2008, at the Liberal Democrat’s Autumn conference, party members were debating the Make It Happen policy. Make It Happen was an ambitious programme of policies, including paying for people who couldn’t get timely NHS treatment to go private, investing heavily in renewable energy and public transport, and paying for nursery education for all children. And it was fairly well costed, paid for by savings made elsewhere in things like scrapping child trust funds, and taxing polluters. There was much debate about possible tax cuts.

And then the whole thing - expensive policies and tax cuts alike - was overtaken a few weeks later by events. Well, not so much overtaken as crushed into the tarmac and left as roadkill. I’m not so keen on the tax cuts, but I hope some of the policies we lost can be resurrected when the economy’s in a better shape. But that won’t be for some time now. It’s unclear quite how bad a state we’re in - we’re running a £167 billion hole in the public finances, but how easily we can deal with that depends, crucially, on the speed of economic recovery. What seems certain is that servicing that debt will leave whichever party gets in very little room to do anything new.

We do, of course, have plans to reduce that deficit, which are well set out in our manifesto. Some of those I'll address in later posts. But we also have policies to reduce the need to bail out the banks again in the future, and the one of these that most excites me is the plan to break up the banks. In particular, it's the way we're planning to break up the banks; splitting them into low-risk retail banks and high-risk investment banks.

The normal business of the old-style High Street banks and building societies is well-understood and as safe as banking gets. We know how to do it without running a significant risk of going bankrupt. It doesn't make huge profits either, but that's OK; it needs to be stable, reliable and, well, boring. This low-risk retail banking is genuinely vital to the everyday running of our economy, not just for lending money for individuals to buy houses and for businesses to develop, but for less-known operations like letters of credit that allow global trade to continue.

This sort of business was not what caused the credit crunch; it was caused by them doing altogether riskier things, some of which were known to be risky (with that risk well-quantified and accepted), and others of which dressed up guesswork and optimism as a 'new paradigm', with predictable results when that guesswork turned out to be wrong.

It's not inherently wrong for investment banks to be doing the riskier business. It allows companies and individuals to innovate and be entrepreneurial, to raise funding for activities that are riskier or more speculative in nature, and there is much money to be made from it. But there's no need for the government to offer a safety net for it, and considerable moral hazard in it's doing so. If a financial institution knows that it is going to be bailed out if it gets into trouble, the incentive to stay out of trouble by making wise choices is reduced. Human nature and greed will reduce said incentive to zero, in many cases.

Furthermore, it means that banks and other institutions that do make wise, safe choices can be out-competed by those that don't; making wise, safe choices usually has significant overheads, and stops you going for the most potentially lucrative (but riskiest) deals.

So the solution is to tell banks that they have a choice. They can do the high-risk investment banking, but if they fail, they fail. No bailouts, no public money invested to help them. The failure of a large investment bank won't be painless for the economy, of course, any more than the failure of any major company. We won't be completely safe from an investment bank becoming 'too big to fail', but we should be safe from its failure putting people's houses at risk.

Alternatively, the bank can choose to do relatively safe retail banking. Retail banks will have their activities prescribed, and will not be allowed to partake in the riskier investment banking activities. I confess that I have a romantic notion of this meaning a return to the days of High Street banks where the manager knew all their customers by name. I know this to be unlikely (and a somewhat rose-tinted view of history anyway), but I suspect that it will lead to smaller, more approachable institutions. Coupled with our proposals for Local Enterprise Funds and Regional Stock Exchanges, it may also make our financial economy far less centralised and dependent on the City.

This will hugely change the banking sector, and almost certainly be unpopular with the investment banks. They will lose two safety nets at the same time; the safety net of having the relatively reliable retail banking to underpin their business, and the safety net of knowing that, in the end, the government can't allow them to go to the wall. There will be less money in banking in the UK; we may lose jobs and skills in that sector, and money currently invested in it may go elsewhere.

That's OK. The booms may be smaller in the future, but so will the busts.