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“History repeats itself, first as tragedy, second as farce.”
Maybe it will be farcical this time, maybe not. If it is to repeat itself, how well placed are we to cope with something similar? The lessons of the period when the hon. Gentleman was at school and I started at university, before working first as an economic consultant and then in the City, was that countries that had run a very tight ship experienced far fewer problems during the latter and more painful unravelling of events than those that had run large budget deficits and a less tight ship. The sad truth is that we now have the highest budget deficit of any major country, with the exception, as my right hon. Friend the Leader of the Opposition pointed out, of Bangladesh, Pakistan and Hungary.
Mr. Lilley: Egypt, Pakistan and Hungary. My apologies to Bangladesh. It is sad that one must apologise to Bangladesh for being compared with the UK; there were times when it would have rather welcomed such a comparison.
Running a tight ship is important. We have not done so and the prudent period of the early stage of the Government—when they committed themselves to following the spending plans they inherited from their Conservative predecessors—gradually eroded. At precisely the time they ought to have been starting to be more cautious, they became less cautious. They ought to have been repairing the roof while the sun was shining; instead, they were squandering the money coming into the Exchequer.
The second feature that helped countries in those difficult times was that they had strong foreign exchange reserves. The Prime Minister squandered our gold reserves; had he known history, he would have realised that gold is one of the things that increases in value most during these cycles. The losses that he incurred by his decision to sell off the gold reserves
exceed the losses of any of the Jerome Kerviels or Nick Leesons of the past, making him the biggest rogue trader of all time. The fact that our reserves are not as healthy, to the tune of many billions of dollars, is a sadness.
Countries that had lower tax burdens did better in those circumstances than countries with high tax burdens. It is sad, too, that we have moved from having one of the lowest tax burdens in Europe to having one of the highest. We have overtaken Germany, not just because our burden has been going up but because other countries, prudently and sensibly in the good times, have been cutting their tax burden; we have not.
The fourth feature that helped countries weather the storms was flexible labour and other markets. I am happy to say that we did liberalise our labour markets and reform our trade unions during the 1980s and 1990s. The Government inherited that and have retained a good part of it, which puts us in a better situation than we might otherwise be in. But they have been adding burdens to businesses and companies, regulating and collectivising, which means that we will be a bit less flexible than we might have been and a bit less well placed to deal with the possible dangers of coming years.
We should also ask why the credit crunch is occurring: why are we facing the current difficulties in international banking and credit markets? It has been suggested that the crunch has been caused by a lemming-like move by banks and other financial institutions to invest in high-risk and imprudent investments. However, banks and financial institutions—some of them, at least—have always been prone to being imprudent. Some have always made bad investments, but those bad investments do not normally provoke a credit crunch. So what is different this time? It is a moot point whether imprudent investments, which have undoubtedly been made, have caused the crunch or whether the crunch revealed the imprudence. I drew an analogy in a recent debate: when the tide goes out, we see who was swimming naked, but the fact that some people forgot to wear their bathing trunks did not cause the tide to go out. Likewise, when the tide of credit ebbs, we discover who was making imprudent investments, but those imprudent investments might not have been what caused the credit crunch.
The usual criticism of banks is that they will not take risks. I constantly meet businessmen who say, “I’ve got a terrific idea and project, but the trouble with the banks is that they will not take a risk.” As the banks are usually criticised for preferring safe investments to risky ones, why have they apparently moved towards investing in riskier assets in recent years? I suggest the answer is that interest rates have compelled or encouraged them to do so. We have been through a period of low interest rates in real terms. That is to do with the supply of savings relative to the available investment opportunities. The supply of savings comes above all from China, but it transfers itself across the world economy, and in order to bring about a balance between borrowing and lending and saving and investing, interest rates had to be held lower. That meant that people had to invest a large sum of money in lower yielding assets because there were not enough higher yielding assets—in less secure assets because there were not enough highly secure assets. They did so because that was all that was open to them—not because they suddenly became
transfixed with the idea of taking high risks for low yields, but because there were not any high yields for low risks. If they had not done so, we would not have had a balance between supply and demand in savings and investment, and we would then have been in the classic situation of a Keynesian credit slump.
Suddenly, the banks are now holding off from investing. Instead of everyone praising them, saying, “Oh, good, they are being prudent; how wonderful,” the central banks of the world are saying, “For God’s sake, resume lending. We will flood the banking markets of the world with money—cheap, easy, readily available, often secured against rather dodgy assets—because we want you to start lending again.”
The problem has been aggravated by the fact that the banks thought they had security by lending against collateral. They took as collateral solid bricks and mortar: property. The banks and financial institutions of the world—including Northern Rock—invest in mortgages secured against physical assets. The trouble is that the value of physical assets is a financial issue, not a matter of physical bricks and mortar. For a while it all seemed wonderful. They took property as collateral. That encouraged more investment in property. That drove up the price of property. That seemed to validate their decision to take property as collateral. It was all hunky-dory until there was a feeling that the money created by that lending was flowing into other markets and inflation was beginning to rise. The central banks across the world began to raise interest rates again to choke off the prospect of inflation. Their doing so initially choked off inflation in the housing market in America—it is beginning to do the same in the UK. Suddenly, the collateral was worth a lot less; there have been sharp falls in property prices in America. The property bubble burst, and that had a synchronised effect. It was not the random effect whereby someone dealing with different businesses in different markets will find that some experience problems while others do well. Because the banking system as a whole was relying on property as its collateral, the banking system as a whole found itself in difficulty.
The whole world financial system is hugely brittle; we are sitting on a knife edge. The financial institutions—the monetary authorities, led by the Federal Reserve and with our own central bank joining in—are trying to flood the system with money to start people lending and borrowing in order to prop up the value of collateral. They are dealing with a difficult problem and there is no guarantee that they will succeed—I think Keynes described it as like pushing on a string—but I hope that with enough cheap money they will. The difficulty lies in whether they can restart things without going to the other extreme and triggering greater inflation next time round.
Bob Spink (Castle Point) (Con): On a point of order, Mr. Deputy Speaker. I wonder whether you could advise me on how I can inform the House that I have, as of today, resigned the Conservative Whip because the party has failed to deal with serious criminal and other irregularities in my constituency.
Mr. Deputy Speaker: Order. I think that the hon. Gentleman has done enough to inform the House on that point. It is certainly not a point of order for the Chair.
Mr. Lilley: Well, not only is the world financial system brittle and on a knife edge, but so is the future of my hon. Friend the Member for Castle Point (Bob Spink).
All this House can do is recognise that those monetary authorities have a delicate task in trying to get us back to a position of balance between the risk of deflation and the risk of inflation renewing. We must recognise that the solution will not be found simply in piling regulation upon regulation on to the financial system. The problem was not caused by regulatory inadequacy, although there have been such inadequacies. It was not even caused primarily by a spontaneous eruption of imprudence, although there was imprudence. It was caused by a basic problem in the financial system, which built up over quite a long period and will require the greatest delicacy and wisdom to resolve. The Budget was presented in that context, but I fear that it did not prepare this country adequately for the difficulties that may be ahead of us.
3.58 pm
Barry Gardiner (Brent, North) (Lab): Conservative Members have spoken about the burden of taxation—that is how they regard it—but I regard taxation as the price that society pays for civilisation. Taxation is the Government’s key instrument for delivering social justice. Taxation is not only certain in life, but necessary. It is needed to bring about the equality upon which any cohesive society must be based. On that view, equality does not undermine liberty—it undergirds it. I therefore look to the Budget to use fiscal policy to redistribute wealth and create social cohesion. The Chancellor’s proposals to take a further 250,000 children out of poverty do that, and I welcome them. I also welcome the rise in the winter fuel allowances for the elderly for the same reason.
The background to this Budget is clearly in the United States of America. Some 63,000 jobs were lost there in January alone, and the word “recession” is now being spoken quite openly in American boardrooms. The Federal Reserve has already cut interest rates by 1.75 per cent since last summer, and on Friday it pumped $200 billion of liquidity into the financial markets.
The US sub-prime market was based on such liquidity, and I echo the sentiments of the right hon. Member for Hitchin and Harpenden (Mr. Lilley) and the hon. Member for Beckenham (Mrs. Lait) on that point. It was based on liquidity within and between lending institutions. When that liquidity dried up, it was no longer possible to bring in more debt at the bottom of the pyramid, and the turning point in the market was reached. But liquidity is not an answer on its own. It is capable only of masking a bad business model for a time, not of curing it. The sub-prime market was a bad business model, for the reasons that hon. Members have outlined. It was aimed at people who should never have been drawn into such a level of debt.
My right hon. Friend the Member for West Dunbartonshire (John McFall), the Chairman of the Treasury Committee, discussed Northern Rock and the FSA’s role as regulator. I wish to make some broader remarks about regulators and credit rating agencies and draw some lessons for other sectors of the economy, such as the utilities sector.
UK utility regulators have trusted in credit ratings. Their use of ratings was always a misuse, but now it flies in the face of increasing evidence that they can be dangerously wrong. Northern Rock, of course, is a prime example of that. Regulators have allowed increasing debt at a time when the impact of global warming is causing severe financial shocks to utility companies. The regulators’ reliance on credit ratings now looks dangerous and out of date. The UK’s economic regulators have a legal duty to secure licence holders’ ability to finance their activities. That duty has been viewed as a need to check, inter alia, that companies are not over-leveraged, which regulators have achieved by requiring a combination of investment-grade credit ratings and a secure ring fence around the regulated legal entities.
Two major problems with that approach have emerged: the first is with the credibility of credit ratings and the second is with the stability that the ring fence can create. Rating agencies have made a series of systematic errors in many of the world’s major industry groupings. The list of those affected in this decade alone is staggering: in power and energy, it included the independent power producer sector from 2001 to 2004; in telecoms and media, it has included major telecoms companies such as WorldCom. It has also included financial institutions such as Northern Rock, and of course property, with the US sub-prime sector.
It is also at least arguable that the regulators are abusing credit ratings. The rating agency Fitch Ratings defines a BBB rating as indicating that
“there are currently expectations of low credit risk.”
Note the use of the word “currently”. The rating agencies clearly use a probabilistic approach and state that ratings are not immutable, whereas the leveraged financing structures allowed by regulators may stand for 25 years. The credit rating downgrade of some monoline insurers who guarantee junior debt in many securitisations highlights the degree of systematic change possible, even in a relatively short time frame.
There has been a strong and coherent argument supporting leveraged financing structures in utilities: high leverage focuses management attention on delivering tight budgets and reduces the cost of capital, thereby allowing lower tariffs. The corollary to that is that it may also reduce flexibility, and we need to heed that warning. Decision making by utilities dealing with the crisis should not involve seeking permission from creditors to spend money. Given typical restrictions in leveraged finance agreements, circumstances in which that is exactly what would be required are perfectly plausible.
Last summer saw widespread and devastating floods across many parts of the UK affecting all types of infrastructure, including utilities. Fortunately, the utilities affected, such as Severn Trent Water and Central Networks in the midlands and CE Electric in the north-east, are owned by well capitalised holding companies. Severn Trent Water alone reported costs of between £25 million and £35 million to respond to the floods. It is increasingly important that utility companies are able to withstand a financial shock. Global warming is causing freak weather, and the financial flexibility required by utilities has to be increased if they are to be able to respond immediately and effectively to the type of incidents that we have seen in this country.
Regulators have powers to impose cash lock-ups on licensed utilities and to apply for a special administration if a company cannot finance its activities, but both courses of action are problematic. A cash lock-up can be imposed, but if a company has no cash at the time it will still not have immediate access to funds, and special administration is not straightforward. An administrator’s duties in some areas conflict with those of a regulator: an administrator is appointed by a court and has a duty to a company’s creditors, whereas regulators have duties regarding customers, such as the economic delivery of services and, of course, the security of supply.
Our regulators all have access to significant investment banking and capital markets expertise. The increasingly prevalent model of leveraged finance—both Norweb and Southern Water were subjects of leveraged acquisition at the end of last year—covers a range of water, electricity and gas companies. There is now sufficient evidence that credit ratings are not a suitable method for regulators to discharge their duty to ensure that companies can finance their licensed activities to justify a move to a more bespoke approach. High debt levels have helped to keep tariffs low, but low tariffs are not more important than keeping the lights on and the water flowing. I hope that we will apply the lessons learned from the events in the sub-prime market and our experience of Northern Rock to a wider range of service sectors in this country. If we do not, similar problems could arise in future.
In 1993, the first Labour suggestion that non-doms should be taxed on their worldwide income was made. At the time, I ran a company of general average adjusters in the City, and I well remember the concern that that suggestion caused in the shipping world and the financial services sector. I took a delegation to meet my good friend Paul Boateng, now our high commissioner in South Africa but at that time our shadow Minister with responsibility for banking and finance, to point out that the potential loss to the economy was greater than the potential gain. I am glad to say that he and the shadow Chancellor drew back from the suggestion.
Looking at the figures now, it is clear to me that estimates vary—well celebrated fag packets have been used in the calculations. There are figures suggesting that between £4.5 billion and £7.5 billion is contributed to the country in revenue by non-doms. Estimates of further spending into the UK economy range as high as £16 billion.
One of the principles of taxation was expounded by John Rawls in 1973 in his great work “A Theory of Justice”—the maximin principle: one does not do anything without ensuring that it will improve the lot of those who are worst off in society. The point of taxing non-doms must be that more revenue will be gained than will be lost from the off-putting effect of the revenue-raising measure. It has not been shown that that will happen as a result of the moves made in the pre-Budget review. I am extremely pleased that the Chancellor appears to have backed off from a number of suggestions that would have been quite wrong and improper, and that would have violated the maximin principle. They would have actually caused a net loss to the Treasury overall.
I welcome the fact that income and gains in offshore trusts will be taxed only when they are remitted to the UK, even if they come from UK assets, and the fact that children will not pay the £30,000 charge. It would
be better if the £30,000 charge were per family, rather than per adult in a family. The £30,000 charge should be creditable against foreign tax. That is significant when it comes to dealing with workers from American companies in the UK, and with regard to the risk of double taxation.
There has been talk today of a flight of non-doms. It is important to recognise that owing to turbulence in financial markets, what has been going on in the sub-prime market in the US, and the situation as regards liquidity, debt markets across the globe are contracting, as are credit markets. All those in the City working for big American or overseas banks face a contraction, too. There is already a flight—an exodus—and it is due not to anything that the Chancellor proposed in the pre-Budget report, or anything that he is proposing now, but to that contraction in the market, which is the result of what has been going on in the sub-prime and other sectors in the United States.
I welcome the change to the position regarding art works brought into the UK for public display or repair and restoration; they will face no new taxation. I also welcome the fact that people with unremitted offshore incomes and gains of under £2,000 are exempt from the charge and the changes to personal allowances.
The biggest problem with opening the Pandora’s box of reassessing the position of non-doms is that non-doms bring revenues and expertise to the country, and form the epicentre—the honey-pot—of the shipping world, the legal world and the financial world in the UK. We do not want to lose all that that brings into the City of London, and the revenues that flow from that, which are used for the benefit of the rest of the country.
Treasury officials’ valuations of how much a measure relating to non-doms would bring in are between £500 million and £800 million. That is nonsense, and it has to be seen as nonsense. The introduction of such a measure was rejected by Margaret Thatcher, by Labour in opposition, and, at first, by Labour in government. Why has Pandora’s box now been opened? It is because the Opposition came up with a proposal for a simple £25,000 levy on non-doms, and officials in the Treasury thought, “That gives us cover to see whether a Labour Chancellor will go for such a measure.” The real problem is uncertainty. To raise the issue is to open Pandora’s box. People need certainty in their tax planning. International businesses need certainty and clarity in that regard. In view of the position of the two parties, people will not be clear whether they should locate in London and continue to bring their expertise and finances here.
Rob Marris: I agree with my hon. Friend that the issue is delicate, but I caution him, because it is a delicate matter for a Labour MP to stand before the House and effectively say, “Let’s stand up for the rich, and let’s have one law for the rich and another for the poor.”
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