More recently, the British regulators have said to all the banks in Britain that the ratios to which they used to manage are no longer sufficient for the current circumstances, and they are making all banks have more capital, relative to the amount of lending that they do. So in the good times, when there was too much credit, the regulator was saying, Dont worry. Lend some more. You dont need to have a very high ratio. In the dreadful times, when there is very little credit available for anyone, the Government and the regulators have decided to send the alternative message that banks in the middle of this crisis have to raise a lot more capital, relative to their lending. That does not strike me as wise regulation on either score, but once the regulators have taken such action it becomes the new hurdle or standard, and every other organisation must do the same, not just to meet the regulatory requirements but in an effort to rebuild confidence. The Government need to understand the important point made by my hon. Friend the Member for Runnymede and Weybridge (Mr. Hammond), who observed that the £250 billion package of guarantees was not being taken up to a great extent. That is a sign that the package was not properly constructed.
I fully support the action of Government and the Bank of England in standing behind any major bank that is in trouble, and have always done so. Only a lunatic would want to see a major bank go down, and in view of the impact of Lehmans going down, I would think that even someone who was a lunatic before that event might now understand that it is better to manage institutions through crises such as this rather than precipitate a major crash on the back of a very large institutions biting the dust. That is why I supported the Governments £200 billion of extra loans; and it is why I supported all the extra money that they flushed into the money markets, and the £250 billion guarantee scheme.
I think that that guarantee scheme should be revisited. It is not the case that the lending rates in the market between the banks have fallen to the extent that they have returned to their normal relationship with the rates that the Bank of England is signalling, and it is not the case that there is now a fluid and functioning inter-bank market. The best chance that the Government have of getting that market going again is to tweak, or change, the guarantee scheme in the short term, so that more money can flow between the banks. They should be warned, however, that it will never function as well as it did before the crunch, because the regulatorsperhaps for good reasonsare now requiring much more capital relative to the amount of lending. All the banks are now fighting to reduce, rather than increase, their loan books, because that is what the regulator and the Government are asking them to do. The inter-bank markets cannot be expected to be as fluid and successful as they were in June 2007, because the regulatory moodalong with the confidence moodhas changed in the banking market.
An additional problem is that the twin difficulties of the financial crunch and the banking crisis are reinforcing each other. While we have lived through some of the worst parts of the financial crunchlet us hope that we now have more stability, because there is a clear understanding in the markets that Governments around the world stand behind their banks in one way or anotherwe are only on the edge of the serious recession that is now being widely forecast by independent bodies
as well as by most Governments. I suspect that this Government will soon be forecasting one, when they get around to revising their figures.
That factor is particularly damaging to an economy such as that of the United Kingdom. The last 10 years in particular have seen very lopsided growth in Britain. Growth rates in London, with its financial services, professional services and business services, have far outpaced those in the rest of the country. Indeed, the growth rate in London has been more than double that in the north and west of the United Kingdom, reflecting the success of those financial institutions and the impact of the credit bubble on property-related and finance-related activity emanating from the very expensive districts in the centre of London. That concentration of effort makes the British economy doubly vulnerable to the downturn now hitting it. The epicentre of the crisis is the financial services and property sector, which is going to fall furtherand we have more of it to fall than more balanced economies on the continent and in the Americas.
As the recession bites, the loan experience on all the bank books will deteriorate further. To date, we have been discussing the mortgage mess. The Government would like us to believe that the only mess that we really had to face was the sub-prime market in America, and it is true that some of our banks foolishly lost some money on that market, but we know that a far bigger crisis for the British banks was the mortgage crisis in Britain, where too much mortgage advance was made on house prices that were too inflated. There are big losses coming through as a result of that, which is why it was Northern Rock and Bradford & Bingley that needed special treatment in the United Kingdom. British banks under British regulators built a British property bubble.
The next phase of the crisis, unfortunately, will be a sharp deterioration in the loan experience that constitutes lending to everyone else, not just those involved in property and finance. The economy is now falling off a cliff, and activity is falling dramatically in sectors beyond finance and property. That means that there will be many more bad loans throughout the range of business activities and the industrial and commercial services sector, from here to John oGroats. All around the country, the same pressures will be felt as the recession bites.
That is why I repeat my adviceit is heartfelt, as I love my country and wish it to do wellthat when thinking about buying banks, the Government should be extremely careful about how much equity risk they take on. If they are really going to persist in taking major shareholdings in banks the size of RBS, which has an average balance sheet over the year of £2 trillion, a sum that is bigger than the national income and five times the tax revenue of the country, they should understand that it requires only a small mistake in terms of a banks assets and liabilities that falls on the wrong side for taxpayers for them to have very major losses on their hands.
That is why, in this period of relative tranquillity before all the deals go through, the Government should be looking again at the terms and the balance sheets that they will be taking over. They should be sending in the forensic accountants now. We all know they will stand behind the banks, so there will not be a confidence problem. There will, however, be a confidence problem
in the Government, and in the amount of Government debt they will have to issue, if they do not behave sensibly by doing some basic accounting work and risk assessment on these huge banks that they are now thinking of nationalising or buying major shareholdings in. The Government should be warned by the fact that they lost £580 million in the first half on a very small bankNorthern Rock. They should remember that RBS is 20 times the size of Northern Rock, so if something goes wrong they will be playing not for a few billions of pounds, but for tens of billions. That is serious money, even for a rich country with a Government who collect as much in tax revenue as the current Government do.
If the Government press on, they must understand that where they are majority owners of a bank, they are responsible for everything. Ultimately, they are responsible for the lending policy, the bonuses and the number of highly paid staff, and for whether a loan is made to Mr. Snooks or Mrs. Smith. They will be made responsible by their electorsthe people out therewho will not understand if they say, This nationalised bank is not actually run by the Government. Yes, we the Government put in all the money on behalf of the taxpayers, but we have no control over how the money is spent.
Kelvin Hopkins: I am following with great interest what the right hon. Gentleman is saying. He seems to be supporting my earlier contention that the Government ought to put in people to regulate the internal operation of the banks, to make sure that they act in the public interest.
Mr. Redwood: There is at least one difference between us, in that I would not nationalise a bank at all, as I think that would be too dangerous for the taxpayer. The hon. Gentleman is right, however, that if the Government persist in nationalisingtaking a majority stake or complete controlthey cannot avoid ultimately being responsible for the financial consequences of their actions. I think that Ministers are completely responsible for Northern Rock. They own 100 per cent. of it on behalf of the taxpayer, and I quite understand why people will want to make that an issue with Ministers.
Why did the Government take this huge stake in Northern Rock? They presumably did so because they felt they could do a better job in the public interest by backing the bank than by enforcing a market solution. They did not seem to want a private sector bank to take over Northern Rock, and they did not want just to lend it some money to see whether it could then find ways of making more profit or raising capital in the normal way. I therefore think the hon. Gentleman has a point. When Ministers say they will not intervene, they do not really mean that, of course, because they have already told us they have views on bonus payments and on how much lending should be done. When Ministers try to enforce elements of those views, they will discover that they are trying to do so in respect of very complicated institutions that could lose the taxpayer a fortune if the wrong guidance is given, and which might lose them quite a lot of money even if they do not give any guidance at all. They will find this situation extremely difficult.
It is also crucial to offer people the hope that, in the process of settling the banking crisis in the way we have been debating, more will be done to try to offset the real
damage being done to the rest of the economy. I welcome the new enthusiasm in all parts of the House for tax reductions. It is vital to put more spending power into peoples pockets as quickly as possible. Income tax cuts for those on lower and middle incomes would be extremely welcome, as it would be the quickest way of injecting more spending power into the economy.
Mr. Redwood: I would not start from where the right hon. Lady and her Government start from. I would be running a much more prudent show than they are, because I would not want to spend all this money on bank shares; I would do it by short-term loans and in the other ways that have been identified, so I would have room for a fiscal stimulus in my Budget. My Front-Bench colleagues have backed the banking package in full, which was very generous of them. However, they are absolutely right: given that amount of borrowingthe banking package as well as the rest of the borrowingit is too risky to borrow yet more for the fiscal stimulus. They are drawing attention to the fact that Britain is not well equipped to do what it should be doing, which is to give a fiscal stimulus by cutting taxes and borrowing in the short term to pay for that tax cut. Given where the national accounts are, it would be ruinous to add yet more to the borrowing.
The Labour Government seem to believe that there is a free lunch out there. They believe that because a recession is coming, they can say that they can borrow any amount they like, and the markets will miraculously supply it. They need to be very careful. Past history in this country shows that markets can be very forgiving for quite a long time. Of course, markets are just groups of people: they are all the people in the country and overseas counterparties, and they, like Ministers, want the economy to do well and would like all these packages to work. However, if the Government start to present markets with too big a burden of borrowingif they say that they need to borrow such colossal sums that the markets say, But were not sure we can find that money any morewe will be in a far worse crisis than we are currently experiencing.
At the moment, the Government seem to think that the answer to too much borrowing and lending in the private sector is to transfer it to the public sector. That is not the answer. If the problem really is, as they described, too much borrowing and lending, we have to go through a process of reducing it. We can do that in a very sharp, quick, deep, damaging way; or we can try to manage it over a longer period, so that there is not such a sharp downturn, but a longer period of slow growth, no growth or modest reductions in activity. The Government seem to have lurched from wanting a very sharp reduction in private sector debtthat is what their regulators and the Monetary Policy Committee were saying last year, with the Chancellor saying that it would serve the private sector rightto wanting a much slower run-down. If they simply transfer it all to the Government sector and build up even more Government debt, they might
have another problem on their hands: that of finding it very difficult to finance their borrowing at a sensible price.
The Government have already taken a big hit on the currency. We are about a quarter worse off against the dollar compared with a few months ago, there has been a very big slide against the yen, and against all the strong currencies of the world sterling is very weak. If the Government are not prudent enough, they could also have a further leg down on sterling, which would make us all a lot poorer and make it more difficult to raise the money that they need to carry out their tasks.
Ruth Kelly (Bolton, West) (Lab): I congratulate my right hon. Friend the Member for Airdrie and Shotts (John Reid) on making a really innovative proposal today; for some time, I have not heard expressed in this House a new proposal on dealing with the issues that confront us today. It could be a way genuinely of dealing with counterparty risk, and of providing incentives for different countries across the worldsurplus or deficit countriesto co-operate and abide by certain international rules of the game. His proposition certainly deserves to be explored further.
I have listened with interest to the contributions, particularly as I am a relative newcomer to this debate. The Liberal Democrats have at least been consistent in their critique of the Government. It was quite interesting to hear the sharp change in tack from the official Opposition Front Benchers. One moment they were espousing bipartisanship; now they seem to have lurched to the opposite extreme of criticising everything that the Government do. Both Opposition parties have come together in blaming the Government, and particularly my right hon. Friend the Prime Minister, for presiding over a build-up of personal and public debt during his time as Chancellor of the Exchequer. They seem to think that the credit crunch and the global issues that we face are largely the result of domestic policy errors in the United Kingdom. I argue that those accusations are fundamentally misguided. They misdiagnose the problem, and when one misdiagnoses the problem it is impossible to provide accurate solutions or to learn the lessons necessary for the future.
The Government should be judged on whether they understand the nature and scale of the current crisis; on whether they are putting in place the right actions to deal with it, both for now and for the future; and, lastly, on the state of the economy as we enter the forthcoming downturndid we fix the roof as the sun was shining? On all three counts, the Government will be proved to have had the insight and the character necessary to deal with the global downturnon all three counts, the official Opposition, at least, have failed.
Nobody disputes the severity of the current crisis. When, at the end of August, my right hon. Friend the Chancellor described the financial circumstances as arguably the worst for 60 years, he was widely derided, so I was interested to read the following in the Bank of Englands financial stability report, which was published last week:
In recent weeks, the global banking system has arguably undergone its biggest episode of instability since the start of the first world war.
Mr. Redwood: Does the right hon. Lady think that the Chancellor was wise to make his moral hazard speech in September 2007, in which he said there would be no support for any bank, and that it served the banks right if they got it wrong?
Ruth Kelly: We have all learned lessons during this credit crunch crisis and its implications. A natural fear of moral hazard at the emergence of the tightening of credit conditions has turned to a preoccupation with trying to fend off a global slump, as the reality of the impact that a severe credit crunch can have on the economy has dawned.
The seeds of the crisis can be traced back to the development of current account and trade imbalances over the past decade, fuelled by financial market liberalisation and abolition of capital controls in the late 1980s, one symptom of which was the unfettered access of businesses and individuals to credit. Of course, many businesses and individuals are perfectly good credit risks, and not for a moment would I suggestI hope that few Members of this House would suggest itthat we should roll the clock back to the days when individuals and businesses were denied credit lines.
The soaring of current account surpluses in Asia led to low global real interest rates, which, combined with cheap exports, created downward pressure on inflation. The consequence was a sharp increase in borrowing in a number of countries, including the United Kingdom, partly financed by the inflows of foreign capital lending. As we all know, that was accompanied by the greater integration of capital markets, an increase in risk, a reduction in transparency and an explosion in credit derivatives as a response to the huge market in securitised assets. Credit derivatives were supposed to make securitisation less risky, but they ended up making it far riskier.
As a result of that global interdependencebetween banks and between banks and other financial institutions the global system became particularly vulnerable to any shock. The immediate shock in this case were the losses in the US sub-prime mortgage market. Those losses made credit derivative contracts prohibitively expensive, securitisation ground to a halt, and banks became fearful of lending to each other and fundamentally reassessed each others creditworthiness. Overnight lending dried up and this systemic risk was noticed and perceived not just in one country but across boundaries.
That was the beginning of the real credit crunchwhen it started to bite; the market turmoil; the halving of the capitalisation of world stock markets; the losses of $2.8 trillion, which are now being felt with dire consequences for businesses and individuals; and, of course, the risk of a global slump.
In such circumstances, I would argue that the urgent need was for bold action to get the inter-bank market moving. I apologise for not taking up the proposition of my right hon. Friend the Member for Airdrie and Shotts as an automatic conclusion, and for not dwelling at length on that issue. As has been acknowledged, he was right to concentrate on that fundamental weakness in the system, but capitalisation and the degree of capital injected into the system were key ingredients in confidence. My right hon. Friend the Prime Minister and my right hon. Friend the Chancellor were, I think, right to take bold and urgent action to re-inject capital
into the banking system, to inject liquidity and, of course, to institute the guarantee of inter-bank lending. We might need to reassess whether that guarantee is working, but I certainly would not jump to the conclusion that it was not being taken up and that that was a clear sign of failure: far more important is the price of inter-bank lending, which, of course, as my hon. Friend the Exchequer Secretary said, has fallen recently.
The Bank of England is to be congratulated on its bold move to cut interest rates by 1.5 per cent, although many of us might wonder whether it did so soon enough. My right hon. Friend the Chancellor, too, should be congratulated on persuading the banks that they should pass the cut on to mortgage holders. It remains to be seen whether any further cuts in interest rates will have the same impact on personal lending rates.
What about fiscal policy? It is absolutely right that the key macro-economic question, rather than the one of inter-bank lending, is whether there should be a fiscal stimulus. It is clearly right that borrowing should be allowed to rise during a recession, because accommodating an increase in benefit bills and a reduction in tax receipts will naturally lead to an increase in borrowing. I am glad that the official Opposition have now made up their mind that it is right to allow borrowing to rise and automatic stabilisers to be used during an economic downturn.
The big debate is whether there should be a discretionary fiscal stimulus or loosening on top of the use of the automatic stabilisers. The judgment on whether there should be an additional fiscal stimulus seems to depend on whether we think that foreign investors will have confidence that we are not going to default on our debt, and, in particular, on what will happen to long-term interest rates. For any fiscal stimulus to be effective, it must be seen to be temporary. Were the Government to embark on such a venture, they would also have to plot a clear path back to a more sustainable or more balanced position.
Such a move would be much more effective if it were co-ordinated internationally, rather than it resulting from unilateral action. When I look at the figures for the deficits and the public sector net debt as a share of GDP, I find it hard to accept that the markets would not think that the UK was a pretty good bet that could tolerate the running of a pretty large fiscal deficit for a while.
I do not know how the Opposition explain the fact that public sector net debt, relative to GDP, is the lowest of any single major industrialised nation other than Canada. Of course, there is Northern Rock. The right hon. Member for Wokingham (Mr. Redwood) shakes his head. I think that the nationalisation of Northern Rock was essential, but the question is not what the level of deficit is but what the level of public sector net debt was when the situation began.