Over the past couple of months, however, we have not been hearing from the paid representatives of the banking industry about this fundamental problem that threatens people all over the world. Instead, they appear on television shows to say, Oh, wouldnt it be horrid if we forced non-dom rich foreigners actually to pay some tax? or Oh, dont make people who disguise their income as capital gains actually pay anything like a fair share of tax. Those two issues, both to do with personal taxation, have been a godsend to the bankers because they have used them to distract everyones attention from the fundamental problems they have dragged us all into.
The banks have failed the global economy, the credit rating agencies fell down on the job and the monoline insurers failed in their job, so we now have the credit crunch. Sadly, the banking industry is not paying the price of its own failure. If people in other industries now lose jobs as a result of the credit crunch, it will be the fault of the banking industryof the overpaid and greedy people who were running it worldwide.
Mr. Greg Hands (Hammersmith and Fulham) (Con): I have been listening to the right hon. Gentlemans tale of woe. May I make a few corrections? First, collateralised debt obligations and collateralised mortgage obligations have been around for 30-odd years. Secondly, they have allowed a huge number of home owners in the United States to have their own home for the first timesuch people possibly would not have even dreamed of that 30 or 40 years agothrough the ability to transfer risk. The issue is not the quality of the product or the characters involved in that industry, but the pricing of the products in recent years and the extent to which the activity occurred. That is a fundamentally different question.
Frank Dobson: The hon. Gentleman has not changed the terms of the discussion one jot by that statement. The banks got it wrong and dropped every single one of us in it. It is a tale of woe, because some people will lose their jobs and have their homes repossessed as a result of what has gone wrong, and the banks should take responsibility for it. If the Chancellor has to raise taxes in his Budget on Wednesday, it will be the fault of the banks that messed up the British economy[Hon. Members: Oh, come on.] Of course it will. Even the people who write in the financial pages say that the credit crunch will lead to problems for the Chancellor in raising the taxes he needs to provide public services.
That is why what happens to banking regulation is not just a matter for the banks or the political wing of the banking industry known as the Tory party. The issue affects everybody, and this time everybody must have their say about what goes on. The regulations must be in place in future to protect everybody, not just a charmed circle in the City. We cannot leave the debate about the future regulation of the banking industry to the failures who are running it now. Interestingly, they are exactly the sort of the people who talk about keeping the state out and not wanting the state to interfere. Apparently it is only the British state that they do not like, because some of them are going cap in hand to the Chinese communist state and its sovereign wealth funds, to the Singapore state or the Dubai state. No one in this country has ever been consulted on whether it is a good idea that major considerations
about this countrys future banking policy should be affected by the interests of foreign Governments. Generally speaking, even the Tory party has been against that sort of thing, but it is what is happening.
We should not rush into a new regulatory system, because we need carefully to examine how we regulate the banking system. As my right hon. Friend the Member for West Dunbartonshire (John McFall) pointed out, we must have a system in which banks are allowed to fail. The basis of the competitive capitalist system is that people who get it wrong lose out and go down the pan. Our system is that when someone who produces useful IT equipment, builds ships or runs a road transport system gets it wrong they go broke and lose their job, but when someone in banking does the same they do not go broke and do not lose their job, and when someone at the top of the industry loses their job, they get a huge pay off thank you very much. We need a system that allows banks to fail, apart from in respect of depositors. We do not want a system containing 1 million loopholesthat is what this House, for at least the past 30 years, has managed to create in relation to banking regulations.
No Spanish banks have any of the problems[ Official Report, 19 February 2008; Vol. 472, c. 206.]
That is because Spanish banking lawnot an old Spanish custom that appears to prevail in the City of London, but the new Spanish banking lawwill not allow banks not to consolidate off-balance-sheet debt. Spains new law requires that all debts and obligations be consolidated, recorded and transparent. Lo and behold, the Spanish did not get substantially involved in mad mortgages in the United States.
I gather from the Financial Times that the Spanish law has another merit. It has a counter-cyclical arrangement designed to ensure that banks capital and lending capacity is not reduced during an economic downturn, and that excessive credit is not made available during an upswing. We might discuss what financial stability is, but by and large it is a sound idea for the economy as a whole. It seems that the Spanish system has been fairly sound, which might be why the socialist Government have been re-elected with a bigger share of the vote and more members of Parliament.
There might be better methods than those used in Spain, but certain aspects of the Spanish system might be of benefit if they were applied here. We certainly need to do better than we have in the past, and we need more effective regulation. What has gone wrong affects every family in the land. We hear a lot about choice, whether it is the parental choice of schools or patients choice of hospitals, but nobody has had any choice in this case. The banks have lumbered us all with this problem. None of us volunteered for it: the banks created it, and they need to be constrained and restrained if the interests of people in this country are to be protected.
We have a choice in the next few months. We can either rein in the banks so that they are never again allowed to drop us in it, or we can allow them to bring
about the financial ruin of all sorts of people, companies and neighbourhoods. That is our choicewe either do it properly and get it right, or we let things stagger on. If we listen to the representatives of the banking industry, staggering on and feathering their own nest will still be their theme.
Dr. Vincent Cable (Twickenham) (LD): I start by congratulating the Chairman of the Select Committee, the right hon. Member for West Dunbartonshire (John McFall), and his colleagues on producing a timely and substantial piece of work. Perhaps most remarkably, given the wide dispersal of political views on the Committee, they reached a consensus while being hard-hitting. That was a substantial outcome.
Rather than go back over who said what to whom when, and who was to blame, it might be useful to be more forward-looking. I shall first ask some of the questions that I do not think the Select Committee asked, and that it certainly did not answer. I shall then turn to the policy implications of its conclusions.
There were two important sets of questions on which the Select Committee did not focus properly. The first was the nature of the assets of the bank that we have taken over. The major theme of the Committees criticism, which was right as far as it went, was that the banks managers and directors made one massive mistake: over-relying on international wholesale markets. The Committee stated that the Financial Services Authority was negligent in failing either to pick that up or, if it did pick it up, to do anything about it. That criticism is fair. However, the Committee largely seems to have taken at face value the assumption that the banks assets were basically sound. In paragraph 13 of The run on the Rock, the Committee approvingly cites a quotation from Mr. Sants, stating that Northern Rock had had
high quality assetsthere is no suggestion here that this is an organisation taking on poor quality assets.
What I would say about Northern Rock...is that most of the staff that worked...on the lending side, all the evidence shows, did an excellent job in appraising the loans that they were making, and that they monitored very carefully and did not lend money to people who should not be borrowing from them. The lending side was handled extremely well.
I wonder how that came to be accepted. I have worried about this from the outset of the Northern Rock affair. The worry centres on the so-called Together mortgages, which are one of the main products of the bank. We know that there are 200,000 of those out of 900,000, which is a big chunk. Those mortgages varied, but the basic principle was that they were well over 100 per cent. of the value of the propertythey were usually something like 125 per cent. It seems that the bank was lending a fairly conventional 95 per cent. mortgage to its borrowers and adding on a 30 per cent. unsecured loan, which was typically £25,000. A lot of that happened when the housing market was at its peak last year.
I wonder how that could possibly have happened. The Governor of the Bank of England and the chief
regulator concluded that this was straightforward and uncomplicated and that the assets were perfectly sound. That does not ring true. The Select Committee pointed out that managers were asked to undertake a stress test to see what would happen if house prices fell by 40 per cent. and concluded that the bank was safe and would have survived. I cannot understand how it could possibly have passed that test. Nothing we know about the bank leads us to believe that it would have survived that test, but it has become written into the orthodoxy that it was perfectly sound and secure.
Mr. Kevan Jones: Is it not correct that there are two separate items in the mortgage book? There are traditional long-term mortgages, and I know from once applying for a Northern Rock mortgage that they are very difficult to get. There was also the activity described by the hon. Gentleman. His point was backed up by my constituents who worked in the Sunderland processing centre; in the last 12 months, mortgages were being given without any reference to payslips or anything else simply to get the market share up, which was Mr. Applegarths key thing to boost the share price.
Mr. Redwood: The way that some might look at it is that what matters is the persons ability to pay the interest and to repay the capital. As long as they do not lose their jobs or mess up their family budgets, it will be quite possible for them to service those debts and repay them even if house prices have fallen. I understand the hon. Gentlemans point that it is not helpful because the security is undermined if there is a big reduction in the market value of properties. In such conditions, it is more likely that people will lose their jobs, but 40 per cent. of the mortgages will not go wrong just because house prices have fallen by 40 per cent.
Dr. Cable: That is a helpful correction. However, the point in answer to both the right hon. Member for Wokingham (Mr. Redwood) and the hon. Member for North Durham (Mr. Jones) is that we now know that over the past few months the Northern Rock management has refused to accept any individual voluntary arrangements. Northern Rock is the only bank that has refused to do that. It is clearly worried about the security of the people who have been lent to. There have been complaints from the Insolvency Service that that is bad practice and against policy. Northern Rock is the only bank that is taking that extremely aggressive approach towards the people who have borrowed from it, as it is worried about conditions such as those described by the right hon. Member for Wokingham.
We also know that whenever borrowers have got into any kind of difficultyfor example, when they have failed to make one months mortgage paymentthe bank has immediately come in to get a first charge on the property. That behaviour is much more aggressive than that of any other bank around, so why is it doing that? There is clearly a lot of worry in the bank about the quality of its assets.
The question then arises of what happened to all those mortgages. The answer is that we do not know. They may have been dealt with entirely separately, as the hon. Member for North Durham said. One possibility is that they were bundled together and sold, through the Granite vehicle, on the market. A more likely possibility that follows on from what the hon. Gentleman said is that the mortgages were separated, with the good, traditional mortgages being sold off through Granitesold through intermediation into marketsand all the unsecured loans being left behind in Northern Rock, which is now a nationalised bank. If that is what happened, the outcome is worrying. It has been worrying all along, both when Northern Rock was nationalised and when it was not, but that is what we are left with.
I have been trying to secure a proper, independent audit, as have hon. Members from different parties. Clearly, the FSA failed in that task. We need to get a proper understanding of how good the assets really are. The honest answer is that we do not know. I hope that the Select Committee goes further into the issue in future.
Mr. Mark Field: I agree with much of the hon. Gentlemans careful analysis. He made the point that ultimately we do not know the quality of the asset book, but he suggested that the fact that Northern Rock was being very aggressive in relation to arrears was somehow a reflection of poor security. It may actually be a reflection of good market practice; it may be ensuring that it protects its interests. That may reflect well on its approach for the futurea subject that I am sure he will come to later in his speech.
Dr. Cable: It may well do so, and as we now own Northern Rock, it may be protecting the taxpayer by taking that approach. None the less, an awful lot of people in distressed situations are being treated far more harshly by the bank than other borrowers. We simply have to take note of that. The hon. Gentleman is quite right: we do not know the answers, and I hope that the Select Committee will go further into the subject.
There is another set of questions to which we still do not really know the answer. They are about the Granite vehicle. As many hon. Members will remember, the issue surfaced in the last stages of debate on the Banking (Special Provisions) Bill. The Select Committee refers to the issue in its report, and it obviously heard evidence on the subject, but there are big outstanding questions about what is really going on and how Granite will operate in future.
My first major group of questions is: what are the circumstances in which the Granite vehicle will have to be topped up in future with new mortgages from Northern Rock bank? How will that happen? What mortgages will go into it, and what is the scale envisaged? How will that affect the nationalised company that we have acquired? The other question that I have is: in the documentation relating to Granite, what is meant by the pass-through event? I have no idea what the phrase means, but it refers to circumstances in which Granite is effectively closed down and has to pack up. Presumably, in those circumstances, the bondholders lose their money and a complicated set of legal and financial processes are
engaged. I hope that in its future work, the Select Committee will help us to understand the issue, because the Government have not been very enlightening and the Select Committee does not say much on the subject.
Those are two sets of questions that we ought to pursue further. Then there are the policy issues that arise from the Select Committees work. The Committee is rightly damning about the FSA, but I am left asking, What does it mean for the future of the FSA and the way in which it carries out regulation? If it has been excessively indulgent in supervising the bank, what will it do in future if it sees banks behaving in a rather high-risk way? Is it supposed to intervene to stop them immediately? Is it supposed to issue a formal instruction, such as, You must stop lending? Is it supposed to have a quiet word in the ear? In future, will much more explicit, complex, prescriptive rules be applied to banks through the regulator, as the hon. Member for Sevenoaks (Mr. Fallon) suggested, and will we have a much more regulated system? If the system were much more regulated, what would it mean for the concept of banking as we have traditionally known it? Banking would then become much more like supplying electricity and water; very tightly controlled conditions would apply. That raises the question of what the banking system is forsomething that the right hon. Member for Holborn and St. Pancras (Frank Dobson) mentioned. It is fine to criticise the FSA and its failures of regulation, but I am still not clear what the implications of doing so are for the way in which the FSA operates in future.
The second set of recommendations by the Select Committee, and probably the most important, relate to deposit protection. There is general agreement that there must be proper deposit protection, that the American model in general is the best available, that it must be, in practice, 100 per cent. protection up to a limited sum£50,000 seems about rightand that that is the direction in which we will proceed. I have one worry about that, which was not dealt with by the Select Committee; that is, what happens to competing institutions, such as insurers, who do not have the same quality of compensation? They are competing with banks in many respects. There is the outstanding problem of Equitable Life, whose investors were just as exposed as investors in Northern Rock and who have not been compensated and presumably will not be. Why should one set of financial institutions have a fundamentally different type of compensation mechanism from others?
Mr. Hands: The hon. Gentleman referred to the US style of deposit insurance enacted by the Federal Deposit Insurance Corporation, which was mentioned earlier. Is he aware that the system in the United States is not exactly parallel, and that in the States there are still more than 1,000 deposit-taking institutions? Some of those are very small, and the concept of deposit insurance may be far more relevantfor example, at the Montana state bankthan it would be at Lloyds in the UK. The hon. Gentleman is comparing apples and oranges. There is a case for deposit protection, but the US example is not quite all it is made out to be.
If the banking industry in this country develops in the way that it could develop and as some of us feel it ought to develop, which means becoming
much more competitive and having a much wider range of deposit-taking institutions, the models would become closer and the analogy would be more directly applicable.
Mr. Hands: In the States, the movement is more in the opposite direction. As banking consolidation happens in the States, more and more people are questioning the need for the FDIC to be there for very large institutions.
Dr. Cable: No doubt we could continue this conversation all afternoon. The one conclusion that we drew from the events of last year is that if there is no such structure, the old system of compensation was not adequate, partly because it did not cover 100 per cent. but more particularly because it was not timelythe payouts were not rapid enough. That is the lesson that was learned, and my understanding of it is that the American system is much better in that respect. Clearly, there are differences and we should be careful about blindly copying that system, but I am trying to make the more general point, reinforcing the views of the Select Committee.
Mr. Redwood: If the problem of compensation can be resolved or the answer improved, one of the options to look at is what the Department of Trade and Industry, as it then was, used to do with insurance companies when it was the insurance regulator. If it felt that an insurance company was over-trading or not liquid enough, it would stop it writing all new business and put the company into run-off, which meant that the assets and the liabilities both had to be managed in the interests of all the counterparties to try and salvage as much as possible.
Dr. Cable: We are talking about slightly different things. Is not the purpose of deposit protection to prevent a panic run on the industry? That is what it is designed to achieve. The right hon. Gentleman is right in saying that if the institution itself gets into difficulties, there are various ways of handling it, including closure. I entirely understand his point.
The third set of questions that arise from the conclusions of the Select Committee are about how banks should be regulated in the broadest sense of liquidity. There was an interesting passage in The run on the Rock which I had not understood previously, about what happened when the Northern Rock bank managers discovered that they had excess capitalthat they had over-complied with the capital adequacy requirements. As I understand it, they simply blew it on a big payout to their shareholders.
That raises the question what those capital adequacy ratios are for. Common sense suggests that in a boom period, as those bank managers were, with a massive expansion of lending and a booming housing market, the requirement should have been tightened rather than relaxed. Similarly, a period like the present, when the market is going down, should be the point at which it was relaxed. I ask, and I do not know the answer, whether it is possible to design a system that is counter-cyclical, and whether that is compatible with the rules of the European Union, under whose auspices these institutions now operate. That is the kind of mechanism we should consider.