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“While some have dubbed this severe global downturn a ‘great recession’, it will remain far from turning into a repeat of the 1930s Great Depression, thanks to the quality and intensity of government policies that are currently being undertaken.”
The hon. Member for Tatton (Mr. Osborne) talks about fighting domestic battles on an international stage; I would argue that it is the Conservative party that has been attempting to do that. Unfortunately, the debate at home has constantly been subject to distortion from the Conservative party, so I want to take a moment to explore some of its hypotheses before outlining the measures that I think that we ought to take, as well as some of the most pressing risks to the current approach taken by the Government, particularly for those in the developing world.
Let me start with the statements of the Leader of the Opposition. I was reading a speech that he made last week, which continued his well-worn theme, attributing the cause of this recession to the weakness of the British economy. He said:
“Our banking system is not separate from our economy, it is a reflection of it...The unsustainable debts in banks are a reflection of the unsustainable debts in our households, our companies and our government.”
At first sight, that seems a completely unremarkable thing to say, as well as politically expedient. But unfortunately that leads him and his party to formulate completely the wrong policy prescriptions to deal with the current crisis, because he continues:
“So while of course it’s true that some of our problems are global...we’ve got to recognise that the underlying policy failures were national.”
I do not know of any serious economic commentator in the world who says that this synchronised global downturn is due to British national policy mistakes.
Mr. George Osborne: I am sure that the right hon. Lady has read the report from Lord Turner, the first chapter of which states that one of the reasons why Britain is particularly exposed to the international storms is that we had very large macro-imbalances. Our banks were highly leveraged, our households had borrowed more than households in the United States and our housing boom was larger than that of the United States. Surely she will accept that national policies put countries in different positions in terms of their ability to weather the storm.
Ruth Kelly: I do accept that, but I want to go on to quote the Governor of the Bank of England, whom the hon. Gentleman is so fond of quoting, who so pithily expressed it by saying that
“banks are global in life and national in death.”
That is precisely the opposite argument to the one that the Conservative party has been making. In other words, of course Britain was exposed to the global economic downturn because it had a large financial sector. It had lots of global banks based in London. Those banks
were indeed global; they operated across the world. When it came to saving those banks, it was the responsibility of the British Government, as of course it should be. We need only to think of the Icelandic banking crisis, which affected individuals and local authorities across the UK, or the collapse of Lehman Brothers, which reverberated across global boundaries, to realise that that is true.
Mr. Redwood: How does making very weak banks lend more strengthen them?
Ruth Kelly: The right hon. Gentleman’s Front-Bench colleagues are arguing that the only thing we need to do in this recession is to try to get our national banks, and international banks based in London, lending more to people who want to borrow for mortgages and businesses here. I see he is distancing himself from their remarks. I think there is a danger there, too, as I said in an intervention on the hon. Member for Twickenham.
One of the key differences between the 1930s financial crisis and the current one is the extraordinary degree of interdependence that has developed between our complex major international institutions, so that the failure of one part of the system reverberates around the globe. Indeed the Deputy Governor of the Bank of England, Paul Tucker, put it like this in answer to the Treasury Select Committee about the Government’s new toxic asset scheme:
“We cannot cut ourselves off from the international nature of this crisis.”
To go back to the Turner report, Adair Turner says:
“The origins of the crash lay in the US housing market”.
[Hon. Members: “Read the rest of it.”] The rest of the quote is,
“with growing evidence that excessive credit extension and weak credit standards had resulted in rapidly rising credit losses, with implications for the price of many asset- backed securities”,
the point being that asset-backed securities are held by institutions right across the world and have been affected by the sub-prime mortgage issue in the United States.
If the Conservatives cannot understand the nature of the credit crisis, how on earth can they be expected to be the ones entrusted to solve it? Indeed many of their policy prescriptions seem to stem from that flawed analysis; putting forward a prescription based on fiscal rectitude; promoting saving and living within our means; and reining in public debt at a time when liquidity and demand both need to be supported to prevent this recession from turning, indeed, into a great depression.
I am glad that the Conservatives seem to have rowed back from immediate cuts in inheritance tax, now to be implemented, I think, within the first term of Conservative Government, rather than on day one. However, they still seem to be recommending £5 billion of public spending cuts in this financial year—the same prescription that was made in the Thatcher recession of the early 1980s, which led to the massive unemployment that became entrenched for a generation.
It may suit the Conservatives as a matter of political strategy to pin the downturn on the British Government, but that is plain wrong. Not only is it wrong, but the argument is further confused by obscuring the situation on debts and deficit. The facts of the matter are that we entered the recession with public debt low by international
standards. Even after the recession, after any fiscal boost, according to the OECD, we are likely to come out of the recession with public debt, although significantly higher, still likely to be one of the lowest in the developed world.
I accept that we have run and will run very large fiscal deficits in years to come. We are likely to do so largely because as tax receipts fall and benefits rise—we have to accept the fact that automatic stabilisers are much stronger in this country than in other countries—we naturally support our economy through any downturn. How much will the VAT cut, the fiscal boost that we have already seen, contribute to the deficit?
The Institute for Fiscal Studies has said that the VAT cut and the fiscal stimulus package more broadly will make little difference to the scale of the deterioration in the UK’s public finances over the next five years. The stimulus package contributes only one fifteenth of the increase in public sector net debt that the Treasury expects by 2013-14. In fact, providing a strong economic stimulus, both fiscal and monetary, to support spending during the downturn is precisely what the British economy and the global economy need.
As the IMF said in a note this month:
“Some countries entered the crisis with greater fiscal space to expand, including more favourable levels of deficits, public debt, contingent liabilities and interest rates”,
referring to Canada, China, France, Germany, the UK and the US. It is a travesty to misdiagnose a problem that is clearly international as a domestic regulatory failure in order to pin blame on the Government.
I accept that there was a collective failure around the world to see the downturn coming. In retrospect, the huge global economic imbalances that emerged between China and the west were never going to be sustainable. As those surpluses searched for yield across the globe, that gave a huge impetus to global financial institutions developing more complex financial instruments.
The G20 comes at a critical moment. The first priority must be preventing the recession from turning into a depression. Secondly, we must craft principles to reform the international financial system. Thirdly, we must protect the world’s poor, rejecting trade protectionism in any form.
5.38 pm
Mr. Peter Lilley (Hitchin and Harpenden) (Con): It is always a privilege to follow the right hon. Member for Bolton, West (Ruth Kelly) since she returned to the Back Benches. She has consistently given the House thoughtful and well-informed speeches on economic matters, even though in this case I profoundly disagree with her, on both her analysis and her prescription.
Unless we establish the cause of the current economic crisis, we will not be able to find a cure or a way of preventing a repetition of the problem. Unfortunately, so far analysis has focused not on establishing the ultimate cause, but largely on allocating blame to greedy bankers, impotent regulators and incompetent Americans.
Incidentally, following the point that the right hon. Lady made, the Prime Minister cannot say, as he does when he is trying to escape any share of the blame himself, that the problem arose solely in the US, and simultaneously blame the British bankers. Either the problem was caused exclusively in the US, in which case
not only is the Prime Minister innocent, but so are the British banks, or the British banks contributed to their own downfall and aggravated our economic problems, in which case not only are they guilty—I believe they do share in the guilt—but given that he was responsible for regulating the banking system over the past 12 years, so was the Prime Minister, the former Chancellor, guilty of his share of aggravating our problems.
I am sure that all the alleged guilty parties deserve some of the blame, but I will argue that their behaviour was essentially a symptom of a much more fundamental underlying cause of our woes. Take greedy bankers. I am sure that bankers were greedy, but bankers have always been greedy—I cannot remember a time when they were not accused of being so. It is a fundamental axiom of logic that we cannot explain a change by a constant. If bankers have constantly been greedy, why has that only now resulted in this change in our economic fortunes?
The interesting thing is that, in the past bankers, were accused of being greedy because they would lend only to the rich, who had ample collateral, and to low-risk projects at high interest rates. This time they are accused of greed because they have lent to poor people at low interest rates with inadequate and inflated collateral and a risky repayment profile. Bankers’ greed has been a constant feature; it is the form that it has taken that has changed and needs explaining. I shall come in a moment to a more fundamental explanation of that change.
The second alleged culprits are impotent regulators. The common accusation is that deregulation stripped the regulators of the power that they needed to prevent the excesses of the past decade. In fact, under the regime that the Prime Minister introduced in one of his first acts as Chancellor, the regulators whose duty was to supervise the banking system in the UK had every bit as much power as they had ever had.
The other day, my right hon. and learned Friend the Member for Folkestone and Hythe (Mr. Howard) reminded the House—and, indeed, me—that I was the shadow Chancellor when the Bill that became the Bank of England Act 1998 was introduced. In the debate on that Bill, I warned the House:
“With the removal of banking control to the Financial Services Authority...it is difficult to see how...the Bank remains, as it surely must, responsible for ensuring the liquidity of the banking system and preventing systemic collapse.”
“The coverage of the FSA will be huge; its objectives will be many, and potentially in conflict with one another. The range of its activities will be so diverse that no one person in it will understand them all”—
and so it turned out. I added that I feared that
“the Government may, almost casually, have bitten off more than they can chew. The process of setting up the FSA may cause regulators to take their eye off the ball, while spivs and crooks have a field day.”—[ Official Report, 11 November 1997; Vol. 300, c. 731-32.]
I could foresee that then, because the problem was not deregulation but the regulatory confusion and proliferation introduced by the former Chancellor. The regulators have never had more power, employed more people or spent a bigger budget than now, but they have failed. The problem with the regulators worldwide was not lack of power, but lack of foresight and insight; until
the eleventh hour, they were as convinced as the bankers that everything was going swimmingly. In its global financial stability report in April 2006, a year before the crisis erupted, the International Monetary Fund no less, referring to securitisation and other complex derivatives, said:
“There is growing recognition that the dispersion of credit risk by banks to a broader and more diverse group of investors, rather than warehousing such risk on their balance sheets, has helped make the banking and overall financial system more resilient...The improved resilience may be seen in fewer bank failures and more consistent credit provision. Consequently the commercial banks...may be less vulnerable today to credit or economic shocks.”
That is what the pinnacle of the regulatory system worldwide was saying a year before the crash. The truth is that the behaviour of bankers and regulators was not so much the fundamental cause of the crash as a symptom of a long period of easy money and irrational exuberance fuelled by excessive credit.
Mr. Redwood: Does my right hon. Friend remember that the Government introduced a lot of mortgage regulation relating to process? When we criticised them and said that they needed to regulate the institution, which was where the damage was being done, they said that we were wrong. Do they not now see that we were right and that the institution, rather than the individual transactions, had to be regulated?
Mr. Lilley: My right hon. Friend is absolutely right. The bulk of regulation was focused on consumer protection rather than systemic stability. There was not enough prudential supervision; if anything, there was too much detailed regulation of the consumer-lender interface.
John Reid: The right hon. Gentleman has succinctly described the causes of this situation, and I do not want him to go off that point. Basically, he is saying that people were lending money they did not have to those who should not get it, in a form that neither side understood, for returns that were too high and with a risk that was too high, and then persuading themselves that if they spread-bet all that across the world, everything would be fine. If they had gone to Ladbrokes, they would have been told by any spread betting expert that if a bookmaker is accepting all the money on a hot favourite and all the other horses in the race have only three legs, they can reinsure all they like, but ultimately they just lose a fortune.
Mr. Lilley: The right hon. Gentleman puts it extremely eloquently. He demonstrates why he should have been Chancellor during the past few years instead of the person who has occupied that place on the Front Bench—a point on which I am sure we are similarly agreed.
The monetary authorities allowed lending and borrowing to outstrip personal incomes. They ignored bubbles in dotcoms and house prices, and promised to limit the downside risk by what became known as the “Greenspan put”—the promise to cut interest rates and pump in money if ever the economy faltered. However, it was not just down to Alan Greenspan in America—the monetary authorities on both sides of the Atlantic pursued almost identical policies. Indeed, it is a bit rich for our Prime Minister to blame the United States and,
by implication, Alan Greenspan, when he slavishly copied Greenspan’s policies, appointed him as his adviser and awarded him a knighthood for, let it not be forgotten, services to financial stability. Of course, he went on to give knighthoods to most of the bankers he is now vilifying—for services to banking.
Underlying that “easy money” policy was the willingness of half the world to run savings and balance of payments surpluses, tempting the other half—the Anglo-Saxon and “Club Med” countries—to run deficits fuelled by borrowing. It was lovely while it lasted, but it could not go on for ever. Our banks had to find people to lend their surplus savings to, and as they ran out of rich people with good collateral and low risk of default, they started lending increasingly to poor people with inadequate and inflated collateral and a high risk of default. The ultimate cause of our problems, which we must recognise if we are to come up with the correct solution, is that we took advantage of the cheap savings from the surplus countries until we were so over-borrowed and inflated that the system was ripe for collapse.
We now face a huge dilemma. The cure for too much borrowing cannot be yet more borrowing—least of all for the UK, which as well as having incurred excessive private debts is running an unprecedented public sector deficit and, unlike the US, does not enjoy what General de Gaulle called the “exorbitant privilege” of having the world’s reserve currency. The deficit in this country is expected to exceed the entire defence budget, the entire children, schools and families budget, the yield from doubling corporation tax and the yield that would come from increasing VAT to 25 per cent. If we are contemplating any further discretionary borrowing on top of that, we must be mad, and we would destroy confidence in the markets.
Ruth Kelly: Does the right hon. Gentleman accept that by far the main cause of those high deficits is the operation of the automatic stabilisers?
Mr. Lilley: Well, let us not add to that problem by some un-automatic excessive borrowing.
The other half of the dilemma is that if the whole world tries to save less than it is producing, output and/or prices will fall in a deflationary spiral—the point that the right hon. Lady was making. The only way in which we can reconcile those two truths—that we cannot solve too much borrowing by more borrowing, and that we cannot simultaneously, across the world, all try to spend less than is being produced—is that the countries that have borrowed too much must, sooner or later, start saving, and those that have been running prudent surpluses should start spending more. The Prime Minister is misguided in trying—to offer himself cover—to persuade everyone to do the same thing: to run discretionary deficits simultaneously. Equally, the German Chancellor is mistaken if she is correctly reported as telling everyone to do the same thing: to strive to reduce their deficits simultaneously. The spenders need to start saving and the savers need to start spending. It will not be easy to co-ordinate that, but if the Prime Minister, as chairman of the G20, does not realise that we need such a bifurcated approach, it will not happen. That should be the agenda for the G20. It is sad that he has mistaken the recipe that he is trying to cook up at that meeting.
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