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10 Nov 2008 : Column 516

The immediate imperative must be to help those caught in the fall-out of this rapid economic decline—families facing repossession, sound businesses caught in a short-term cash crunch, employers who are having to face the agonising decision over letting valued staff go because their orders have dried up—and to fix the broken transmission mechanism in our monetary system. However, we must not lose sight of the lessons of the past few years as regards how we got to this point. A recession caused by excessive borrowing cannot be solved by borrowing and spending our way out of it. That will not work, and anyone who doubts it should ask the Japanese.

A responsible approach combines immediate, fully funded help for families and businesses to weather the recession; action domestically and internationally to restore confidence and thus liquidity to financial markets; a rejection of the superficially easy route of a massive increase in borrowing to pay for an unfunded spending splurge; a careful and considered response to the weaknesses that have been exposed in the regulation of our financial system; a proper, sustainable medium-term fiscal framework to restore market confidence that does not crumble at the first hurdle and will get the public finances back into a position where Governments will be able to help families and businesses in future downturns; and a focus on fixing the underlying weaknesses in our economy—the productivity gap, the skills gap, the unreformed welfare system, and the negative productivity growth in significant parts of the public services—all of which must be resolved if Britain is to maintain its prosperity and resume a sustainable growth path long after this immediate crisis has passed. That is the approach that Her Majesty’s Opposition will continue to pursue.

Several hon. Members rose

Mr. Deputy Speaker: Order. Before I call the next hon. Member to speak, may I remind the House that a 15-minute limit on all Back-Bench speeches will apply from now on?

5.3 pm

John Reid (Airdrie and Shotts) (Lab): I should like to start with several welcomes. First, I welcome the fact that we are having this debate, because given the enormity of the challenge we face, the more time that we spend discussing it and seeking solutions and responses, the better. Secondly, I welcome the steps that are already being taken by our Government. I hope that that is widely recognised. Whatever other areas of disagreement might exist in this House, the Prime Minister, the Chancellor and the Government should be congratulated on the courage, decisiveness and leadership that they have shown not only in this country but internationally. It would be churlish for anyone in the Chamber not to recognise what has been recognised in so many other countries. Thirdly, I welcome the fact that the Government, and indeed many Opposition Members, recognise the requirement to address these complex issues in a multi-layered way: at the international, global level; at the level of central banks; at the sovereign, national level; at the level of inter-bank relationships; and at the level of individuals.

I understand that this evening, according to news reports, the Prime Minister will again urge a restructuring and reformation of the international monetary regulatory
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system. I do not know why that makes news; he has been doing so for years. Indeed, not only has the current leader of the Labour party been doing so, but the one before that, and the one before that. I have been here long enough to remember the one before that, Lord Kinnock, calling for a revision of Bretton Woods in the early 1980s. It just shows that if we stay around long enough, common sense—born out of a crisis—afflicts everyone.

Mr. Redwood: Does the right hon. Gentleman think that one of the priorities should be to put more capital into the International Monetary Fund so that it has enough money to lend to impecunious countries that are borrowing too much?

John Reid: I certainly think so, but there has been a shift in economic predominance from the west to the east, and we cannot merely ask other countries to inject liquidity into the international monetary system or the IMF without having regard to the fact that they may want something in return. That is an element of the international rearrangement of the mechanisms set up in the late 1940s, and since the 1970s it has been obvious that those mechanisms are inadequate in some respects.

I welcome many of the measures that have at least been hinted at regarding the protection of individuals, particularly those who need the most protection, through targeted cuts in taxation and so on. I do not know whether the Government are considering such measures. If so, I feel that they are to be welcomed. Of course, such measures need to be responsible and prudent, and there are automatic stabilisers in the system anyway, which entail an increasing dependence on Government finances because of the reduction of incoming income, and the increase in outgoing expenditure to protect the poorest.

Mr. Philip Hammond: Will the right hon. Gentleman clarify whether he is advocating to his colleagues on the Front Bench unfunded tax cuts that create a fiscal stimulus, or the sort of funded tax cuts that both Opposition parties have talked about?

John Reid: Ultimately, all tax cuts have to be funded from some quarter. I agree entirely with the Prime Minister and my Front-Bench team that a recession is not the time to cut back on public expenditure. Some of the increase in borrowing is automatic through the stabilisers, some of it comes through capital programmes, and some of it could be the result of targeted taxation cuts that result in borrowing. The overall limit to indulging in such borrowing has to be set at a responsible level. The point has been made that we are in a stronger position to do that than many other countries because of the stewardship of the economy during the past 10 years.

In the limited time that I have, I want to address a point that I raised with the hon. Member for Runnymede and Weybridge (Mr. Hammond), not for partisan reasons but because I am genuinely interested in the solution to what I regard as the central problem, which is that of inter-bank lending. My hon. Friend the Exchequer Secretary said that that was the primary task. It is
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relatively easy to envisage how we would address the reconstruction of the International Money Fund and associated bodies, and to see how we would address the problems of an individual bank through recapitalisation. It is a controversial matter, but it is relatively easy to see how we would help an individual.

It is not relatively easy, however, to see how we might get long-term, sustainable acceptance and confidence among banks that resurrect inter-bank lending, and I would like to deal with that point today. In doing so, I want to make it plain that what I have to say is a result of my involvement in very unusual parliamentary practices in the recent past—effectively, staying silent, listening and thinking. I apologise, and I include that because the ideas that I refer to are not my original ideas but those of some of the people I have been speaking to.

We all know that the global banking system has been under severe stress for more than a year, largely owing to a lack of trust between banks. Lack of confidence has resulted in banks largely, although not exclusively, being prepared to lend to each other only at accentuated rates on an overnight basis. That makes it impossible for the banks to provide the necessary funds to industry or the public—both need funds for a much longer time.

However, if a bank is not fully confident that it can get money in future, it cannot take the risk of lending the money that it has to customers. That problem is easily described. In dealing with the difficulties in the inter-bank markets and in trying to make funds available for industry and the public, several Governments have guaranteed the inter-bank markets. I contend that that can be only a temporary solution and that none of us can be confident that the crisis would not happen again if the Government withdrew the guarantees. That gets to the nub of a thorny problem. Indeed, in the absence of change, a crisis is likely to recur. Once confidence has been lost in the working of the banking system, it becomes far more fragile because everyone knows that it has broken down once and that, therefore, it can happen again. That clearly points to the need for a new structure.

Susan Kramer: The right hon. Gentleman is talking about an incredibly important matter, which, as he says, has been neglected. Does he realise that in the United States, several states—for example, California—are initiating major efforts to try to identify whether fraud lies at the bottom of many of the problem loans on banks’ books? There is concern that fraud and extreme mis-selling, which has not been unravelled in the UK and other markets, is holding up reinvigoration.

John Reid: I do not intend to deal with fraud today—the issue of confidence is difficult enough to tackle.

The essence of the banking system is intermediating between the essentially short-term nature of deposits and the longer-term nature of loans. In addition, the banking system intermediates between areas where there are surplus funds and those where there is excess demand for them. The inter-bank market has evolved to deal with that intermediation. The problem is that the market has evolved largely on a self-regulating, principal-to-principal basis. The market is also extremely opaque, with participants having only limited, historic information about their intended partners, whether borrowers or lenders.

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The problems that have arisen require a new structure for the inter-bank market, one which instils confidence, is transparent to the regulators at the very least, and is fully controlled. Regulation must be enhanced to focus on all exposures rather than operating in a world where exposures can be made to disappear by being taken off balance sheet.

There is no doubt that the problem is huge. I make a modest suggestion, which may catch the Government’s attention and that of other hon. Members as a possible solution. In summary, it would entail the world’s central banks establishing an international monetary exchange, through which all future inter-bank transactions would go—let us call it “IMX”. It would operate like any normal exchange, with the central banks fully and unconditionally guaranteeing the exchange counterparty performance, so that no bank would have a reason not to supply funds to the exchange. All central banks would be fully responsible for the liabilities to the exchange of the banks for which they were the primary regulator. The central banks would own and run the IMX.

In the time available, let us consider the mechanism carefully. The IMX would operate like any other exchange, with the critical benefit that exchange participants could deal freely with the exchange without having to inquire about other participating members’ credit status. Exchange technology is already well established and is available from many vendors. In my view, and that of those with whom I have discussed the matter, an exchange could be established in a matter of months by adopting the proven technologies from established exchanges.

There should be an exchange for each major currency, with the initial establishment of a global euro exchange, a global dollar exchange, a global yen exchange and a global sterling exchange, which would be owned and run by the respective central banks for each currency. Each central bank would guarantee the performance of its relevant currency exchange and set rules for the institutions that would be eligible to borrow from the exchange.

It is possible to identify some key features of such a system, even in the limited time available. First, anyone could offer liquidity to the exchange at a set price, including the central banks. Secondly, all inter-bank lending of participating institutions must be transacted through the exchange. Thirdly, borrowing from the exchange would be at the same price irrespective of the borrower, that price being set by the providers of liquidity to the exchange at any point in time. Fourthly, each central bank would set limits on local institutions and charge them for use of the guarantee.

It is also possible to identify the major benefits that might flow from such a system if established. Such a system would restore the necessary trust and confidence to inter-bank lending, allow for an innovative and free market to operate, and provide regulators and Governments with consolidated real-time information on global liquidity flows and counterparty exposures, thereby helping to prevent excesses before they occur. One of the problems that we have experienced in the past is the lack of forewarning, just as the asset valuation of lenders and borrowers was opaque. Such a system would reduce redundancy through inter-bank netting at the exchange level and significantly reduce counterparty management and friction costs. I therefore put my proposal forward as one worthy of consideration.

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Such a system would do one further thing: assist in providing the basis for regulation. The current structure of the inter-bank market, coupled with the off-balance-sheet nature of many products, makes proper regulation of the financial system almost impossible. The unregulated nature of inter-bank and derivative activity, to which spokespersons in all parts of the House have referred, together with the many off-balance-sheet products, has facilitated the largely uncontrolled growth of credit and provided no early warning system to central bankers on either a global or local basis.

The introduction of an exchange would provide central banks with the complete and instantaneous information required to regulate those banks that they stand over. The inability of any institution to access the exchange without receiving the approval and meeting the requirements of the authorising central bank would provide that central bank with a formidable array of controls, information and potential regulatory levers.

We could ultimately provide an exchange that was self-funding, because institutions that would be members of the international monetary exchange should be charged for the access to funds which the scheme affords them. The unit cost of exchange participation could be set based on the stand-alone rating of the bank and the maturity of its net obligations—namely, on the degree to which it is a net borrower from the exchange.

I do not pretend that there are not many other considerations that would affect my proposal, such as the central bank limit and over-the-counter transactions, such as credit default swaps and so on, which can be moved into it. However, such a system would at least begin to tackle the central problem that we face when we consider the recession, the acute crisis that we have come through and the chronic problems that we are somewhere near the beginning of addressing. In many ways, the most intractable problem is restoring sustainable confidence in the inter-bank lending system.

I thus conclude by saying that, irrespective of the economic actions that are taken to stimulate national economies or, indeed, the global economy, it is essential that structural change should take place in the global banking market to avoid a future reccurrence of the collapse in confidence and the freezing of the banking market that we have seen. I am entirely with the Prime Minister and condone his leadership in attempting to reformulate the international monetary institutions. However, in the absence of an exchange, it is unlikely that full confidence will ever be restored in the global banking system, as today’s problems can easily reccur.

The essence of banking is ensuring the efficient use of funds for the benefit of industry and society, with a fully functioning inter-bank market being the cornerstone of that intermediation. However, the current inter-bank market is not working. It is inefficient, opaque and largely unregulated. Introducing a regulated exchange would restore confidence, and it would be more efficient and transparent, as all inter-bank and even derivative-type activity could be instantaneously, centrally recorded. It would also greatly enhance the regulatory power and information of the central banks. It would not solve all the problems, but I believe it would be a major contributory factor to addressing the central problem.

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5.20 pm

Mr. John Redwood (Wokingham) (Con): The right hon. Member for Airdrie and Shotts (John Reid) has made an important speech, and his idea is worthy of longer consideration, although some of the details would need to be fleshed out in order to see whether it was practical or could work. What motivates it is a sense shared on some parts of the Labour Back Benches, and certainly on the Opposition side of the House, that the twin crises that we are living through—the financial crisis and the recession—are not yet responding to treatment as quickly as we would like, and that the Government would be well advised to listen to friends on their side of the House, and to people on my side of the House who wish them well in trying to tackle the crisis, when we offer them advice on the other things that they could do to head off some of the worst disasters that might still lie ahead.

Listening to the Exchequer Secretary, I felt that she was being very complacent. She wanted everyone to believe that this was a global, rather than a British, crisis. Let us go back to August and September 2007, however. Northern Rock was a very British bank, lending too much money to British mortgage holders to pay too much for their houses, and getting into difficulties because it and its customers were greatly over-extended. It was regulated by British regulators, and they let it down very badly. They allowed it to expand too fast, and then starved the money markets of money in August and September. The Chancellor and the Governor of the Bank of England then lectured Northern Rock on how it had to live with its own mistakes. They brought the bank down and, afterwards, decided that the taxpayer should stand treat. That was not good management, or good regulatory practice, and I hope that the Government will learn from that and not do it to another bank.

If we look at the problems that the Government now have with Northern Rock, we can see what a bad so-called solution that was. Taxpayers were put on risk for more than £100 billion, and they have lost £580 million in the first half year in owning 100 per cent. of the equity. That was the stated interim loss. The second half losses might be bigger; there will certainly be such losses. Extra capital amounting to £3 billion has had to be sunk into the bank, and I do not think that we shall see a return on that any time soon. Half the staff are being sacked, £14 billion-worth of mortgages have now been repaid, and the bank is unable to make new advances. It is crippled, higgled and gravely damaged, and the taxpayer is going to have to pay all the costs involved in winding up a lot of the business, getting rid of the staff and shrinking the thing that was once a flourishing institution.

I invite hon. Members to cast their minds back to what the directors and owners of Northern Rock were debating in the spring and summer of 2007, as recorded in their annual report, which came out just before the crunch. They were discussing their response to the regulatory signals that were being sent out. The British and global regulators, but particularly the British regulators for Northern Rock, were telling them that they had too much capital for the volume of loans that they were making, and the discussion within the Northern Rock boardroom related to how it could get its capital down, or its loans up, in order to get nearer to the ratio that the regulator said was needed.

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