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5.22 pm

Lord Lamont of Lerwick: My Lords, I join others in congratulating the noble Lord, Lord Myners, on his post and his arrival in this House. He and I were colleagues many years ago. He has a most distinguished career in business. I hope that I will not be giving away any secrets—I am sure I am not—if I disclose that he regards himself as old Labour. However, as a very successful businessman, we none the less entrust him and trust him with the policy towards the banking sector, and we look forward to hearing him again.

This is a very different recession from others we have experienced since the war. It is different in two particular ways. First, previous recessions have, to some extent, related to policy. They have been slowdowns that have often happened when Governments have felt it necessary to regain control of inflation. This recession is more of a market-driven recession. It is, pace the Prime Minister, an old-fashioned boom and bust recession. The fact that it is a cyclical recession does not mean, though, that it will be any easier to deal with or that recovery will be quicker.

The second way this recession is perhaps different from other recessions since the war is that it has been accompanied by a very serious banking crisis indeed; more serious than the previous secondary banking crisis and probably the most serious since the 1920s and the 1930s.

The banking crisis has caused many people to talk about a return to the 1920s, the 1930s and a depression. I do not believe that the crisis will go that far. Policy is more accommodating than in that period; the banks have rightly been rescued; and I do not believe that we are heading for 20 per cent unemployment or a 15 per cent fall in GDP.

I want to concentrate today on the Government’s relationship with the banks. I want to talk about three issues—transparency, lending and pay, although in a rather different tone from the noble Lord, Lord Smith. The Government find themselves likely to be the major shareholder in the Royal Bank of Scotland, a significant minority shareholder in Lloyds TSB and HBOS, and the only shareholder in Northern Rock and Bradford & Bingley. I am not an admirer—surprise, surprise—of state involvement or stakes in banks. As far as I am concerned, the sooner the Government can get out of their holding in the banking sector, the better. I am encouraged by what the Chancellor of the Exchequer has said about that.

It is interesting that Barclays Bank, with its injection of capital from Middle-Eastern investors, has been prepared to pay no less than a 16 per cent coupon in order to be out of the Government’s clutches. Some regard this as something to be criticised. I do not regard it as such in any way. It is a commercial judgment for the shareholders of Barclays.

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I say as forcefully as I can that I hope that the Government, in their new position as shareholder in these banks, will use their influence towards the maximum, earliest disclosure of losses on complex derivatives, sub-prime securities and all the other types of assets that have caused such problems. It was the failure to disclose early on that made the Japanese banking crisis much worse. For all the Government’s helpful and correct intervention in the inter-bank market, we will not get banks lending their own money to each other—as opposed to the Government’s money, or with the Government’s guarantee—until there is a full understanding of what must be disclosed and what losses have been made.

That is linked to International Accounting Standard 39 and “marked to market”, as opposed to holding securities to maturity or as available for sale, thus influencing whether losses go through the PNL or just remain on the balance sheet. The accounting standards authority has allowed some new flexibility in this. Deutsche Bank has recently been the first to avail itself of this new flexibility, and has consequently been able to make a €180 million saving, thus turning a loss into a profit. I read that the Royal Bank of Scotland—RBS—in which the Government have the majority shareholding, will do the same.

I am not saying that that is wrong; it is not an issue on which I feel competent to make a judgment. However, I urge the Government to ensure that the basis on which these losses are disclosed is crystal clear, and that the maximum pressure is put on the banks to reveal the maximum losses as quickly as possible. Whether an asset is valued at $100 or $600 does not alter the cash a bank has, or how much it owes and has to repay. Maximum transparency is extremely important.

Secondly, my noble friend Lord Blyth referred to lending policy and government influence on lending. We do not want political lending from the banks. It was not encouraging to read that, within a short time of the stakes being taken in banks, pressure was being put on them to participate in the Government’s shared equity scheme to a larger extent that the banks had wanted. As my noble friend forcefully and rightly pointed out, it is easy to say that lending should be maintained at 2007 levels. Actually, the Government’s wording is very precise: the “availability”—not “lending”—of lending will be at 2007 levels.

While bearing in mind the needs of small businesses—which I understand well; I experienced them at first hand—we have a serious need to repair banks’ balance sheets. We must not have the banks being forced into a new series of problems thanks to political problems. RBS had its whole profit of £5 billion wiped out in the first half of this year because of the impairment losses. It is extremely important that the balance sheets should be rebuilt.

Lastly, it may be surprising for a Conservative to mention pay. I do not think that the level of pay is the issue; it is the structure of remuneration packages and the alignment of pay and risk which has sometimes been wrong. Too many bonuses have been paid on a short-term basis, whereby people have been encouraged to take large bets. Sometimes, they have been given

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extremely large rewards and have walked away leaving chaos behind them. There has to be a closer alignment between remuneration and risk management. There has not been a close alignment and that has contributed to the present situation.

I agree with many of the points that have been made more generally. I do not think that we are better positioned at the beginning of this recession than we were in the previous one. We go in with a weaker position in terms of the current deficit in the public accounts. We should have put more aside in the good years. There has been a failure of regulation. The Government’s own fiscal rules are in tatters. The distinction between capital and current was always dubious and the rules were always open to criticism because the Government were able to define the length of cycle themselves. We face a very painful period, but I am sure that we will get through it. If there is any consolation, it is that which Joseph Schumpeter used to offer; namely, “It is in recessions that economies recreate and reinvent themselves”. I am sure that we will come through it stronger in the long run.

5.31 pm

Lord McIntosh of Haringey: My Lords, I have two disqualifications for intervening in this debate. First, my great-grandfather was a blacksmith in Blairgowrie. As the Scots know, the Carse of Gowrie has a very clement climate and provides a lot of the soft fruit which is sent down to Dundee to make jam. My grandfather, like many others who were not involved, used to speculate on the raspberry crop. If the raspberry crop was good, he used to buy it up in advance, and he and his family did very nicely over the winter. If it did not do well, I suppose noble Lords on the Conservative Benches would say that it was all Gordon Brown’s fault, given a century or two of décollage.

My second disqualification is that I was chairman of the Select Committee on Regulators, and we got it all wrong—it is no consolation to me that nobody else got it right either—because we pursued almost trivial objectives rather than realising the real crisis in regulation which is now upon us. Noble Lords have referred to the Royal Bank of Scotland. I remember that bank saying to us that the problem was that regulation in Britain was one of the most onerous in the world and that that threatened competitiveness. We finished our report before Northern Rock’s situation came about. Since then, it has not needed me to criticise the FSA; it did it very thoroughly itself in its internal audit in February this year, and in Hector Sants’s response to that. John Tiner, the chief executive of the FSA, said in evidence to us that our regulation contrasted very favourably with the USA’s very severe rules-based and inspection-based approach. That did not work very well either, but I do not think that it was much of a defence of the FSA.

So what went wrong not just in this country but with capitalism anywhere in the world? There was a fundamental misunderstanding of the nature of risk. Alan Greenspan said in 2005 that the increasingly complex financial arrangements meant that the markets were more flexible, more efficient and hence more resilient than those which existed just a quarter of a

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century ago. I remember Alan Greenspan dining in the Treasury five or six years ago and making, as usual, a very opaque speech. Like most people, I did not understand it, but I thought I saw in that speech a defence of hedge funds, and I thought at that time that was wrong. Some people got it right, or came close to understanding. Oddly enough, the financial stability report of April 07 was perceptive. Members of the Select Committee did not read it, but we ought to have done. It stated that,

However, it went on to say that those who assess risks are,

That backs up the point that the noble Lord, Lord Lamont, made that transparency is a prime requisite. The problem with transparency is that even if those responsible wish to be transparent, they do not really understand the risks themselves.

What will be done about better regulation? I hope I do not need to say that as regards the wider field of macroeconomic policy I agree with the Prime Minister, and so does everybody else in the world except those on the Conservative Benches. However, that is not an issue with which I shall concern myself today. Certainly what the financial services report now calls “macroprudential”—a word I did not know—means that, contrary to everything that people were saying to us only 18 months ago, we must have much more regulation and much more intrusive regulation, which must be undertaken globally.

The financial services report of October this year reaches the very valid and very discouraging conclusion that the remedies which are necessary in the short term for the banking system will be severely detrimental to the real economy. The financial services report says that in the seven years 2001-08, there was £700 billion more bank lending than saving. That bank lending was financed with securitised assets, which were insured by credit default swaps. The point about that is not the deliberately obscure language but the fact that these figures are very much greater than anything which Government can put in to deal with the problem. If there was an undesirable increase in balance sheets—and there was—shrinking balance sheets will be a very painful process because banks are different from the real economy, although they very much affect it. Financial markets are inherently unstable. They involve speculation which is sometimes skilful, like, for example, studying racing form, or may sometimes be based on a real misunderstanding of probability, like gaming. You cannot pick them apart in the way bankers think. They do not understand the difference between skill and luck, and we are all suffering as a result.

Therefore, I am afraid that we are only at the beginning of being able to decide what should be the future of regulation. Matthew Parris said:

“The market must be the engine of our economics and therefore our politics. That argument is over. But now another starts. What about the accelerator, the brakes, the gearing, the emissions control?”.

That is a big challenge for us.

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5.38 pm

Lord Forsyth of Drumlean: My Lords, I say to the noble Lord, Lord McIntosh, that it is possible for regulation to be onerous and useless, and that is what we have experienced to date. I am delighted that we have the opportunity to have this debate. However, it is a great failure of Parliament that the House of Commons has not had such a debate. I thought that Parliament was about controlling supply. I thought that Parliament was about holding the Executive to account for the resources they spend. Here we have a Government committing £500 billion—is that right?—of taxpayers’ resources and there has not been a debate in the other place, which is so jealous of us discussing means of supply and taxation.

I welcome the Minister to his new role, and I am in no way criticising him, because he is new to his role. But what on earth is going on in his department when it sends him here with a speech that does not actually deal with how that £500 billion is being spent, or its conditions? Instead, we had a somewhat biased view of what the former Government did, what the rest of the world is doing and what is happening on the international stage. I want to know what is being done with that £500 billion of our money. If I may, I shall ask some specific questions.

First, I very much welcomed the Minister’s promise to this House that there would be a full inquiry into all of this, including the conduct of the Government, the banks and the regulators. We need to know about that so that we can learn from that experience. I want to take up the Minister on the point that the persistent leaks from the Government are a matter for inquiry by the FSA. I shall not name the person, but I spoke to a non-executive of a financial institution, who told me that he could find out better what was going on from reading Robert Peston’s blog on the BBC website than from what he was being told by the Treasury. I see the noble Lord, Lord Peston, nodding in agreement, and I make no criticism of his offspring, who shares his undoubted abilities.

Lord Peston: My Lords, I want merely to point out, in reference to a first-class journalist who gets his stories perfectly legitimately, that we do not need an inquiry. We just need to have excellent journalists doing their job properly.

Lord Forsyth of Drumlean: My Lords, I do not need an inquiry into the conduct of Mr Peston, but I should like an inquiry into the conduct of those people who gave him and others information that was market sensitive. Because it was leaked into the public domain, it did enormous damage to the savings and investments of people in this country.

I find it absolutely extraordinary that the Prime Minister can call from the Dispatch Box for an inquiry into my right honourable friend visiting a boat on his holiday, but he does not see any need to have an inquiry into the leaks that we have seen not just with respect to the bail-out but also in respect of the Bradford & Bingley and Northern Rock. The run on Northern Rock was started because the BBC told us

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that Northern Rock was in discussions with the Bank of England about getting financial support. The Government are not only incompetent but incontinent.

Secondly, on dividend policy, it seems to me that one of the things that we should be doing is encouraging people to save. We have already heard that the savings ratio has fallen close to zero. What message are we sending to those people who have done the right thing and who bought shares in the banks, believing that they were regulated and that they were safe and that the banks were a source of income because of their dividend policy, when the Government come along and use that taxpayers’ money to bail out the banks and insist that the banks pay no dividends for five years? The Minister is shaking his head. That is what the Government said in the beginning, and then they changed their mind. Then they said, “Perhaps after one year there might be a change”. Now, they are saying, “Actually, if you pay back the preference shares you will be allowed to pay dividends”.

The effect of that is to make those shares less attractive to investors and less attractive to those savers. That will mean that the taxpayers will end up with a bigger slice of Lloyds TSB and a bigger slice of Royal Bank of Scotland. What is going on here? I understand why the Government might not want taxpayers’ money to be put into the banks and then paid out as dividends but, as the Minister will no doubt confirm in her reply, the FSA already has the power to stop the banks paying dividends if it is not prudent to do so. So why the spiteful requirement in respect of dividend policy, which damages the interests of savers in this country and makes it less likely that the banks will have a larger share of ownership from the private sector as opposed to the state?

The third issue that I shall pick up on—political interference—has been mentioned by my noble friends Lady Shephard and Lord Lamont and the noble Lord, Lord Powell. We have already seen it. What assurances are we going to have? Can we have an assurance that the members of the boards of the banks where the state has taken a substantial shareholding will be appointed by the banks and not by Ministers? We do not want to see any more Labour donors appearing on the boards of those banks. We want the people on the boards of those banks to be appointed by the banks, subject to approval by the Government.

Equally, we are getting mixed messages. We have heard from the Liberal Benches how the Government ought to use their position to do this or do that. If the Government are going to interfere in the banks, it will make them less competitive. I have a question about the FSA and capital requirements. Why was Lloyds TSB asked to have a capital requirement, as were the other banks, which was set by the FSA and which was different from that for Northern Rock or for the Bradford & Bingley? How can our banks be competitive if they have a core tier 1 capital requirement that is higher than those of their international competitors? On the subject of the preference shares, why are our banks being charged 12 per cent on the preference shares, whereas France and Holland are being charged 8 per cent and 8.5 per cent respectively? Does that not make it harder for them to compete? Does that not

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make it harder for them to provide the money that we have been hearing that small businesses and mortgage-holders want?

On spend, spend, spend, I say to the Government that it is obvious that tax revenues are going to fall off a cliff. We now need growth in revenues. How can we get that? What is the biggest source of possible income for the Government? It is PAYE. We need to stimulate the private sector. We need to encourage the private sector and give it some support. That means not going ahead with the increase in corporation tax on small businesses, to which the noble Lord, Lord Bilimoria, referred. The Government need to cut their own spending and cut their own cloth in the same way as every family and business in the country is doing.

My right honourable friend the shadow Chancellor has talked about sharing the proceeds of growth. Now there is no growth. There is only negative growth. So why are the Government not taking their share of pain and giving some of the money back that they have taken from people in the good times, to cut taxes, to encourage growth, to encourage free enterprise and to reverse the terrible damage that has been done by the Government through their policy of spending more than they had in tax revenues and borrowing the rest?

5.47 pm

Lord Taverne: My Lords, I believe that one lesson of the credit crunch is that we should look again at the case for joining the eurozone. It is not an issue that has been raised in this debate, although it was raised in today’s Financial Times. The arguments today are different from those of 10 years ago, because circumstances have changed, but they are very relevant to our present condition.

First, we now face a crisis of stability and credibility. To avoid heavy unemployment, we need low interest rates and higher government borrowing, whether by way of tax cuts or further spending. Both of those will threaten sterling, which is now a highly vulnerable currency. If there were a collapse of sterling, with the threat of high inflation, it would cause the mother and father of all economic crises, especially since we have such a very high level of personal indebtedness; 53 per cent of all credit card debt in the European Union is in Britain. Membership of the eurozone would give us a certain security.

The second argument concerns the future of the City as a world financial centre. That is mainly what I want to speak about. The question that we have to face is whether we can today successfully maintain the City’s role as a world financial centre if we are not part of a major reserve currency area and do not have a central bank that can act as a lender or market-maker of last resort. The issue has been the subject of a fascinating dispute between two economists who I greatly admire; Martin Wolf and Willem Buiter. I find Buiter’s arguments impressive and persuasive.

Why did Iceland’s banks collapse? They collapsed not necessarily because they were insolvent or badly managed, but because, like so many banks, they were overwhelmed by the unexpected liquidity crisis in all the world’s wholesale financial markets. Iceland is a very small country that has a very large financial

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sector; it is huge in relation to its GDP. It is internationally active and internationally exposed. That need not have proved fatal, except that Iceland has its own currency.

All banks are, in a sense, risky businesses, because they borrow short and lend or invest long. If all their depositors suddenly want their money back, they cannot pay, even if they are not fundamentally insolvent, since their long term assets normally exceed their liabilities. In the case of domestic banks, the central bank can act as a lender of last resort to tide them over, since it has the security of the value of their long-term assets. The central bank can rescue a perfectly sound domestic bank if there is, as at present, a crisis of liquidity. If necessary, it can print more money.

However, a central bank can intervene as saviour only if it can lend in the currency in which liabilities have to be met. It cannot print foreign money. Iceland’s banks borrowed and invested abroad in foreign currencies and incurred foreign liabilities on a massive scale, amounting to about 800 per cent of Iceland’s GDP. Its central bank could not act as a lender of last resort in foreign currencies. The story would have been different if that country had been a part of the eurozone. The case of Iceland was not altogether unique. It is very likely that Ireland would have gone the way of Iceland if it had not been part of the eurozone.

What about the UK? Financial services also form an important part of our economy, although not on anything like the scale in Iceland. Our financial institutions, too, have borrowed and lent or invested in foreign currencies on a massive scale, amounting to well over 400 per cent of our GDP. That compares with a figure of some 100 per cent in the United States and some 30 per cent in the eurozone. The Bank of England is not able to act as lender or market maker of last resort if UK banks cannot sell their foreign currency-denominated assets to meet their short-term foreign currency-denominated liabilities. They may not be able to do that because they cannot roll over their liabilities or because of the shortage of liquidity in international wholesale markets.

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