Here we go again. Financial markets in turmoil. States stepping in to rescue broken banks. Frantic contingency planning for a renewed credit crunch.
It’s all looking spookily like the Great Crash of 2007/08 – except this time round, it’s not just individual banks, but country after country that is at risk of defaulting. With the UK back in recession, and the eurozone tearing itself apart, the sense of fear is palpable.
Bank of England governor Sir Mervyn King warned in his June Mansion House speech of the ‘large black cloud of uncertainty’ hanging over the world economy, while the European Commission has pointed to the dangerous interdependence between ‘weak banks and weak sovereigns’. No country, it seems, is too big to need bailing out.
Half a decade on from the near-collapse of the global banking system, the price is about to be paid for the trillions converted from private into public debt. And not just by Greece, Spain and other vulnerable nations on the European Union periphery.
For Sir John Gieve, a former deputy governor at the Bank of England, the parallels with 2007/08 are all too clear. He was there, in the thick of it, when Northern Rock was going under, and the collapse of Lehman Brothers sent the financial markets off a cliff.
As the Bank official in charge of financial stability, he had warned – in his twice-yearly reports – of economic ‘vulnerabilities’ in the run-up to the crash. But, as he now admits, they did not shout anywhere near loud enough. ‘We thought we were facing a correction in the markets, not a catastrophe,’ he says.
What they – and we – discovered all too soon is that once there is a generalised loss of confidence, everything unravels. The run on Northern Rock – and its eventual, fumbled rescue – graphically demonstrated this. ‘The Bank made up to £20bn available, but it wasn’t enough. It just alarmed people more. It was only when the government stepped in and gave an unconditional guarantee that confidence was restored.’ And once Lehman went down, they had to do it all over again – this time to the whole sector.
This is the position Europe now finds itself in, says Gieve. The European Central Bank’s €1 trillion boost to the banks, earlier this year, has not been sufficient to steady the markets. ‘This would be a much bigger rock in the pool than Lehman’s going under. The EU is risking a huge storm.’ Hence the desperate search for a supra-state solution – whether through the recent €100bn bailout for Spain, or via eurobonds, deposit guarantees, or deeper fiscal union.
‘What’s odd about all this,’ comments Gieve, ‘is that it’s a very soluble problem. Taken as a union, the euro area is not in bad shape. Its overall fiscal deficit is not as big as in the UK or the US.’
And globally, the banks – JP Morgan’s trading troubles notwithstanding – are in a much stronger state than in 2007/08, he maintains. Many governments, including the UK’s, have moved to regulate and recapitalise their banking sectors more effectively.
‘This is genuinely a political crisis,’ says Gieve, who is addressing this month’s CIPFA conference on the subject of economic growth. He fears that national self-interest might trump collective interests in Europe.
There is much talk about switching from austerity to a pro-growth strategy, but he is not sure anyone is really signed up to underwriting the debts of weaker nations – ‘the ones with nothing left in their cupboards’ – to the extent needed.
Personally, Gieve is in favour of eurobonds and other fiscal interventions to head off the crisis. And as a former Monetary Policy Committee member, he broadly approves the ‘elegant’ advice that Christine Lagarde recently gave George Osborne. The International Monetary Fund managing director told the chancellor to consider some fiscal loosening for the UK economy – something he belatedly signed up to in his ‘funding for lending’ Mansion House speech.
Not that Gieve is in much of a position these days to pull policy levers or influence events. After decades as a mandarin at the Treasury, as permanent secretary at the Home Office (often in the line of fire) and latterly at the Bank of England, his career at Threadneedle Street was cut short in 2008 when he resigned after taking much of the flak for the crisis.
Three years on, he is more a commentator than an actor on the economic stage. He has developed a portfolio career as a non-executive for companies specialising in payment systems, and is on the board of a number of charities and trusts. He’s also been getting fit by cycling everywhere, including from East London down to the City for our interview. It’s a ‘reasonably full’ life, he tells me. But you sense that the cataclysmic events of 2007/08 – and his role in them – are never far from his mind.
Memorably, Gieve was accused by the acerbic John McFall, former chair of the Treasury select committee, of having been ‘asleep in the back of the shop, while there was a mugging out front’. Was that fair comment? Or was he just the fall guy for the failure of the Bank, the MPC and the Financial Services Authority – the whole tripartite edifice erected by New Labour – to see the global crisis coming?
Gieve concedes that the initial handling of the crisis ‘was very ham-fisted’ – and that there had been a serious ‘group-think’ problem at the Bank and generally, of which he was a part. ‘For me, particularly as a former Treasury official, the previous ten years had looked fantastic. We were lulled by that,’ he admits. ‘We didn’t see the acute problems that were building up in the financial system.’
It is now clear that globally the whole cultural climate of the boom years led to a large degree of ‘regulatory capture’ that partially explains why central banks were so far behind the curve.
Even so, he insists, he was not asleep. But neither, he says pointedly, was he at the wheel. ‘I wasn’t running or regulating Northern Rock or the banks. All I was doing was trying to rescue them.’ And ultimate responsibility within the Bank rested with the governor who, as is well known, had major issues (not least with Alistair Darling and Gordon Brown) regarding the ‘moral hazard’ involved in bailing out failing banks.
The Bank of England’s handling of the 2007/08 crisis is, very belatedly, about to become the subject of an internal inquiry. But it is not at all clear that it will address the dysfunctional governance issues – particularly those between the Bank’s medieval-style ‘court’, its governor and the chancellor – that, according to Gieve, impeded a more rapid response to the crash.
‘There was a problem in the Bank. It’s been a very hierarchical structure. The governance wasn’t working well.’ The unspoken implication is that internal attempts to move more decisively on the rescue operation were being blocked.
The timing of the review is doubly significant. It coincides with reforms that will centralise even more supervisory power in the Bank governor’s hands (something the Treasury committee is seriously worried about). A financial ser-vices Bill will dismantle the tripartite structure, and create three new regulatory bodies, two within the Bank itself – an all-powerful ‘superquango’, according to some MPs.
At the same time, the government is implementing the Vickers commission’s recommendation to separate retail from investment banking in the Banking Reform Bill announced by Osborne. When King finally steps down in June 2013, his successor will have all this in their in-tray.
Gieve is fairly non-committal about splitting up the banks. He points out that failed banks come in all shapes and forms, and that ring-fencing does not free you from the ‘too big to fail’ problem – ‘But it does make it easier to manage failure, and to make private sector creditors bear at least some of the cost.’
He is much more critical of the new regulatory structures, which he says miss the key point about the way that, post-crash, central banks have had to change. Says Gieve: ‘The beautiful vision that if you have a central bank pursuing an inflation target, using interest rates or even QE [quantitative easing], this is enough to stabilise the economy, has been proved wrong. What’s clear is that we need more instruments, including countercyclical use of regulatory policy, to control the growth of credit and asset-price bubbles. That’s really a fundamental shift.’
The proposed structures don’t address this, he says – the committees and their remits are too discrete – and will undermine effective macroprudential policy. It’s proof that the ‘old paradigms’ are still dominant among economists and finance professionals: ‘The consensus lives on.’
This lack of joined-up thinking can be seen in Europe, he says. Gieve believes the squeeze on banks to raise capital ratios beyond even the latest Basel III regulations has been disastrous, and is economically ‘hugely depressing’ – a view that is in tune with the zeitgeist, after King’s announcement that liquidity restrictions will be relaxed.
‘Of course there has to be massive contingency planning for the euro risks. But that doesn’t mean we should do nothing to stabilise the economy, and get banks lending,’ says Gieve. ‘Regulatory policy is more contractionary than it needs to be.’
Jonathan Portes, director of the National Institute of Economic and Social Research, agrees that regulators have been ‘doing the wrong thing, at the wrong point in the cycle’.
But he argues there are many ways for banks to improve their capital ratios: ‘For starters, they could pay and reward themselves less.’
Critically though, Portes believes the regulatory reforms do not address the problem of the shadow banking system: the high-risk ‘casino’ world of derivatives trading. ‘These people are still out of control.’
Dan Corry, who was Number 10’s senior economic adviser during the crisis – and worked on the 2009 banking reforms – is also sceptical about what will change. ‘Mervyn has just sailed through it all as if it’s nothing to with him,’ he notes.
Corry doubts that much of the regulatory shake-up will ever happen. ‘The banks don’t want to be split in two, and they have plenty of time to kick the can down the road.’ With the chancellor already watering down the ring-fencing proposals, and the date for implementation set at 2019, it all feels a long way off.
Gieve concedes there’s are limits to what regulatory reform can achieve. ‘Let’s be clear: the causes of the crisis were bad property lending and contagion through the new credit derivatives markets, which meant that a loss of confidence in one bank swiftly spread to all.’
So, is there enough of a firewall now to prevent a systemic crash, especially when even post the Greek elections, the markets are still in full flight? Are our savings safe, or should we be putting them all under the bed?
‘Dunno,’ is Grieve’s candid response. ‘If there’s another major crisis, such as the collapse of large parts of the banking system in Europe, that would be a very stern test. It would require credible guarantees equivalent to those we had to put in place in 2008 – something very difficult to agree to at a collective European level.’
On the other hand, it might not happen. ‘It’s also possible that Europe will manage to save itself, but by next year will still be struggling with stagnation, and looking at what levers it’s got to generate growth.’
Either way, says Gieve, it’s going to be very messy. But then, we knew that, didn’t we?
Sir John Gieve will be speaking at the CIPFA conference being held in Liverpool on July 3–5
