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I wish I could give him similar credit for fiscal policy, but I cannot. This has been a disaster area. He gave the Treasury a golden rule, which was to balance its current expenditure by taxes over the business cycle, so why, after six years of boom, are we entering this present crisis with a projected deficit of £60 billion, which the automatic stabilisers will bring to £100 billion? It is not the deficit as a percentage of GDP that is the issue, but the confidence factor. With this kind of fiscal background, people will lack confidence in government finances.
As to the global imbalances, we need to reduce the incentives for countries to accumulate such huge reserves. One suggestion that I am quite attracted to is some pooling of those reserves in an international body such as the IMF so that they might be redistributed to countries in deficit.
My final point is more abstract. It is about economic theory. The heart of the issue is whether what we are experiencing is a once-or-twice-in-a century chance or an ever present possibility. If this kind of financial tsunami is a once-in-a-century chance, we do not need to base our lives on the possibility that it is going to happen. We can have a theory that assumes that such tsunamis are outside any normal distribution, and that is fine. However, if they are an ever present possibility, we need to guard against them. If we regard them as simply outliers, we keep Keynes in his cupboard, bring him out occasionally to be dusted down and, once he has done his rescue work, we put him back in again and everything goes on as before. However, Keynes believed that an unregulated and unmanaged market was always prone to such huge swings because the future is uncertain—the point made by the noble Lord, Lord Peston—and although we can insure against risk, there is no insurance against uncertainty, so these phenomena, with their accompanying swings of opinion, herd behaviour and so on, are built into the operation of a market.
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How seriously do we treat this volatility? Do we say that it is a price that we should pay for the greater efficiency of a deregulated market or is it a price too high? I shall end with a quotation from Keynes, who is endlessly quotable and whose quotations shed great illumination. He described economics as,
- “one of these pretty, polite techniques which tries to deal with the present by abstracting from the fact that we know very little about the future”.
We try to disguise this ignorance by assuming that the future will be like the past, that existing opinion correctly sums up current prospects, and by copying what everyone else is doing. However, any view of the future,
- “based on so flimsy a foundation ... is subject to sudden and violent changes. The practice of calmness and immobility, of certainty and security, suddenly breaks down. New fears and hopes will, without warning, take charge of human conduct ... the market will be subject to waves of optimistic and pessimistic sentiment”.
I do not think anyone has bettered that as a description of where we are now.
6.27 pm
Baroness O'Cathain: My Lords, I welcome this debate and hope that, following the Minister’s opening speech with its long catalogue of information on how wonderful the Government have been, all of which has been in the public domain for some time, in her closing speech the noble Baroness, Lady Vadera, will be able to indicate the current thinking of the Government in this serious situation and give us and a worried country some crumbs of comfort. I worry about the current economic situation and how it will impact on the future performance of the economy, not least on our competitive position in the global market but, most of all, I am concerned about the huge uncertainty, grave concerns and serious feeling of insecurity among the population of this country.
The headlines in the press and the pundits on the air—I cannot comment on TV, but I am sure the broadcasts there are no less scary than the others—are having a dreadful effect on those who were once famously described by a Cabinet Minister in a new Labour Government as “the ordinary people”. We need a rational analysis described in understandable terms. We want honesty from the Minister and an indication of the Government’s future policy. We are too frequently fed a diet that reiterates the measures already announced. Openness and honesty are necessary to calm the country as a whole, families that are so worried about their housing situation, employees worried about their jobs and small businesses, which employ some 13 million. People are being badly wounded by the behaviour of the banks and by the effects of the policies so succinctly stated by the noble Lord, Lord Bilimoria.
Most of us agree that the first few years of this Government were successful. The economic and spending policies of our Government were followed. The independence of the Bank of England, despite initial worries expressed by this side of the House, was a very good policy. However, despite many objections by the MPC committee of this House, voiced strongly by the noble Lords, Lord Peston and Lord Barnett, and by
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Of course, we all have PhDs in hindsight, but that determination not to listen was one fact that, long term, has had a deleterious impact on our economy. Another fact, again debated in the MPC committee so ably chaired by the noble Lord, Lord Peston, was the determination of the head of the newly setup FSA to combine the roles of chairman and chief executive. That flew in the face of all the tenets of corporate governance that had recently been accepted by business but ignored by government. That is no longer the case, but starting off such an important regulatory organisation with defiance in the face of rules imposed on others must have had an effect on the whole organisation. It almost certainly felt that it was bomb-proof.
There has also been the lacklustre performance of the FSA, notably over Northern Rock, which has already been mentioned several times, but also in attention to issues that seem of a second order compared with the mess that the regulatory authorities have got us into now. I wonder how many of your Lordships have had the most irritating demands from the FSA requiring passports, utility bills and so on when making small investments. Surely close attention to the activities of banks and hedge funds would have been much more appropriate.
After a few good years, complacency and arrogance have taken over and now hubris has been followed by nemesis. The eye was definitely taken off the ball. Above all, the idea of saving did not feature, despite the constant reference to prudence. Many people were fooled into believing that, in having a huge mortgage, they were in fact saving. Memories are very short. The negative equity situation of relatively recent years was never discussed. After all, we would no longer have boom and bust.
On several occasions, I have spoken of my anxiety concerning the erosion of the savings ratio, most recently in a debate led by the most reverend Primate the Archbishop of Canterbury on 25 April this year, at Hansard col. 1776. I pointed out that in 1997, the savings ratio was 9.5 per cent, but it declined to 5.3 per cent in 2005. The most recent figure—I have to correct two previous speakers—is now minus 1 per cent. My noble friends Lady Noakes and Lord Lawson have also mentioned that.
We are where we are, but what is likely to happen in future? Last week, I received a pre-publication document written by my close friend Howard Flight, the former MP. It will be published tomorrow, but I have his permission to quote from it. It states:
“The UK outlook is for vicious house price deflation; a severe recession, a falling stock market and a large sterling devaluation”.
He further draws attention to the fact that it was,
I say amen to that. Reading his document, I am convinced that the three major priorities must be, first, to restore liquidity to the inter-bank market; secondly,
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Does the noble Baroness recognise that the measures taken by the Government in the bail-out exercise are more draconian in how they treat preference shares than the Dutch Government’s action to assist ING? Preference shares in the UK case have a charge of 12 per cent; in the case of IMG, it is 8.5 per cent. Why is that?
Secondly, is the noble Baroness prepared to attempt to address the major concerns of pensioners, who think, with reason, that their pensions will be badly affected by the current situation, on top of the heinous crime of the then Chancellor in looting the pension funds in 1997—amounting now, as my noble friend Lord Blyth said, to a total damage to the pensions of this country of £200 billion?
We must give a clear steer to the world that we are determined to ride this one out, to protect our citizens from the worst effects of utter dereliction of moral duty by the financial sector and the regulators. Perhaps the Government should also remember that not all the best brains work for new Labour, and that now is the time to get on with listening to wise people, repairing the damage and putting in place firm, transparent and fair policies for the economy.
6.35 pm
Lord Burns: My Lords, I thank the noble Lord, Lord Myners, for introducing the debate and join other noble Lords in welcoming him to the House. We are former board colleagues at a well-known retailer, and I warmly welcome him to his position as Minister for the City. I am sure that he will enjoy the Treasury a great deal and I wish him well in that role.
Given the nature of the debate, I should remind the House that, as set out in the Register of Members’ Interests, I am a non-executive director of Banco Santander and chairman of its two UK banking subsidiaries, Abbey National and, now, Alliance and Leicester.
My first comments are about the current economic cycle. I understand the temptation to make the case that this is not just a normal boom and bust for which the Government are responsible, but a boom and bust made elsewhere for which the authorities cannot be blamed. There is something in that assertion, but surely the Government overstate their case. The key feature of any bust is the boom that precedes it, and the run-up to this bust has many of the characteristics of other booms. We have seen over-optimism about the underlying growth of output; we have watched a house price and equity boom go without any response in interest rates; we have had a commodity and oil price boom that was put down to long-term resource problems rather than the cycle; a boom in financial activity and rising levels of leverage; and, of course, the boom in consumer lending. In this case, more of the unsustainable increase in world output came from activities outside the advanced industrial countries than was the case in many other cycles, but we have clearly played our part and should not exaggerate the position.
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To me, the difference in this cycle is less about how the boom happened and more about the way that it came to an end. Here, there is of course a big difference. Normally, an upswing comes to an end with rising inflation and interest rates whereas, on this occasion, the boom was brought to an end by the emergence of bad debt, an abrupt freezing of the inter-bank market and huge losses on asset-backed securities that far exceed the impairment of the underlying assets. These losses have inflicted severe damage on the capital resources of many of the banks, noticeably the British banks. Not surprisingly, the banks are now cutting back lending and trying to avoid being too dependent on wholesale financial markets. Instead of interest rates rising to choke off the pressure, declining availability has done the job for us.
Along with others, I still have a lot of uncertainty as to the severity and length of the recession. The outcome still depends a lot on what happens in the financial part of the crisis. The noble Lord, Lord Griffiths, is surely right to say that we are not facing a 1930s-style meltdown, but everything that I have seen from the perspective of the banking industry tells me that we face a very painful period. How the UK economy performs relative to other advanced industrial countries is also uncertain. Along with many other noble Lords, I would hesitate to argue that we are better positioned than they are.
We still face a painful time. Resolving the crisis will take time. In my view, it is right that the Government's attention should be focused on doing what they can to maintain levels of lending within the economy. Along with others, I welcome many of the actions that they have taken. As the noble Lord, Lord Lawson, pointed out, there are lessons for the future for regulation and supervision but, to my mind, that is for the future. As a regulated person, I hesitate to criticise my regulators at this moment.
The noble Lord, Lord MacGregor, asked me about Spanish regulation. I am sure that we will hear a lot more about the future of supervision in later debates. In response to his question, I shall make a couple of points. First, the Bank of Spain has done what we have all been told not to do throughout our lives; that is, fight the last war. Its actions were the response to the banking collapses in Spain in the early 1980s from which it learnt a lot. We live under three aspects of the regime in Spain. It has had a regime of insisting that banks hold capital against off-balance-sheet vehicles, which meant that none of the Spanish banks had any off-balance-sheet vehicles. Therefore, they had no toxic assets and largely escaped from this first round of problems. Secondly, banks were required to hold general provisions against all loans and not only against specific bad debts when they occur. Thirdly—I hesitate to say this—it is a long way from light-touch regulation. The Bank of Spain has 27 permanently resident people going through the books in Banco Santander, which is a rather different regime from ours—thank God.
The result of our financial crisis is that the banks are now in a difficult position. Given their capital position and the present dangers of relying on wholesale lending, they are all being forced to deleverage their balance sheets, which means a combination of lower
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The banks need access to liquidity. Again, it is important for the authorities to continue to play the part that they have in underwriting wholesale borrowing by the banks, and being an intermediary and recycling cash between banks. It is to the credit of the Government that they have taken action on each of those fronts, as well as working to find solutions for banks that have been in serious difficulty. Only time will tell whether that is enough. The Government have to stand by ready to do more if they are to help to unwind the blockages that I fear still remain in the financial system for inter-bank lending and wholesale lending generally.
As other noble Lords have argued, these actions need to be buttressed by an aggressive cut in interest rates. Monetary policy has to be the main lever to support the economy. Effective market interest rates have risen sharply relative to bank rate and it is my judgment, along with many others, that the bank rate needs to adjust to compensate. As my noble friend Lord Skidelsky reminds us, we cannot be sure that market rates will decline in line with the official intervention rate, but, in time, it will make a significant difference. We will also get some easing from the decline in sterling.
I have some particular concerns about fiscal policy. If I read the newspapers correctly, we seem to be being briefed that the budget deficit could be as bad as in the early 1990s. I no longer make forecasts, but I would simply observe that at this stage in the cycle the tendency of all forecasts is towards over-optimism. It is generally accepted outside Whitehall that the fiscal rules, although worthy in their intention, have not in practice been a success. The extent to which they seem to be more influenced by the re-writing of the past than a judgment about the present or the future has been a problem, particularly taking the view that the cycle has been as long as it has.
With the prospect of a period of falling output and a relatively slow recovery, the budget deficit will grow rapidly. To the extent that it is because of the cycle and what we know as the automatic stabilisers coming into effect, that is not a matter of great concern, as many have argued. As output returns, some of that deficit will decline automatically. I belong to the same group as many noble Lords who have spoken today who say that to go beyond that would be very dangerous at this point. We begin from a position of a structural budget deficit. Adding to that structural budget deficit can only increase the problems subsequently.
Each of the three serious downturns that I have observed at close quarters—1974-75, 1980-81 and 1991-92—have had two striking characteristics; namely, the emergence of a budget deficit that increased to a point where the restoration of structural balance was a long and painful process, and at some point a depreciation of sterling that moved from just about being welcome to becoming very painful. Let us hope that we are not forced to repeat those experiences.
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6.44 pm
Lord Saatchi: My Lords, many noble Lords want to know what went wrong. Perhaps your Lordships would allow me to take them to the committee room in the US Congress a few days ago where the former chairman of the Federal Reserve was giving prepared testimony. He was asked how this economic debacle had started on his watch. His answer was that he had been following orders. As he put it:
“I’m here to uphold the laws of the land passed by Congress, not my own predilections”.
In other words, the fault lay with the legislation which gave him his instructions.
The same might be said of the Bank of England Act 1998—the iconic Act of Parliament which gave the Bank of England its independence—which is why I was grateful to the usual channels of your Lordships' House for allowing me to introduce last week the Bank of England (Amendment) Bill. The Bank of England Act 1998 has a fatal flaw: it has three words too many, which this Bill aims to delete. Section 11 in Part II of the Act mis-defined the role of the bank in relation to monetary policy. It states:
“In relation to monetary policy, the objectives of the Bank of England shall be—
a) to maintain price stability, andb) subject to that, to support the economic policy of Her Majesty’s Government, including its objectives for growth and employment”.During the Committee stage of the Bill in your Lordships’ House—I am most indebted to the noble Lord, Lord Barnett, for first drawing my attention to these debates many years ago—there was much discussion about the three words, “subject to that”. Why could it not say, “having regard to” or “taking account of”? Why were all other considerations to be subordinate to controlling inflation?
As distinguished LSE alumni in the Chamber are aware, the economic orthodoxy which underpinned the Act was based on the seminal work of Professor Paish at LSE. The Paish curve showed that high inflation was incompatible with high employment and high growth. The mechanism of the causal relationship between them was “wage push”. Noting the expectation of higher prices, unions would press—
Lord Peston: My Lords, does the noble Lord mean Frank Paish or does he mean Bill Phillips?
Lord Saatchi: My Lords, I am not sure. Noting the expectation of higher prices, unions would press for higher wages and employers would lay off workers to compensate. That was the dreaded wage/price spiral of the 1970s. Policy-makers concluded, and legislators concurred, that inflation must be curbed at all costs. At the time of the Bank of England Act, the winning argument was that the relegation of the Government’s “growth and employment objectives” would prevent the manipulation of economic activity by unscrupulous politicians in search of votes. In any case, the control of inflation was said to be the best guarantor of growth and employment.
In October 2008, that fine theory met its Waterloo when we discovered that you could have, according to the deputy governor of the Bank of England,
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during a period of low inflation. By focusing only on inflation, as Section 11 directed them to do, Bank of England officials were blindfolded to the disaster that could occur in a low-inflation environment. That error was compounded by obliging the Bank to monitor the wrong kind of inflation. Whereas the Bank’s consumer price index—the CPI—keeps a close eye on the price of a packet of peas and a loaf of bread, it overlooks the very aspects of inflation which led to the current crisis.
For the past five years, “debt inflation” was 9.5 per cent a year, which is almost five times the Bank of England’s CPI inflation target. But where is debt inflation in the CPI? It is not included. During the same period, the inflation rate of one asset class—residential property—was 13 per cent per annum. Where is that in the CPI? It is not included. What about the cost of acquiring and holding these property assets; that is, mortgage interest? It is not included.
The Bank’s measure of inflation was irrelevant and out of touch because the world had changed. The era of hand signals from Threadneedle Street to discourage troublesome unions was over. Millions of people had become investors in a new asset class: they were home owners. They adopted a simple model. I borrow money and I buy an asset. The price goes up, I exit the asset, I repay the loan and I keep the profit. This was the joy of debt as taught by the masters of private equity, and why should not private individuals do the same? So they did, in their millions. By creating the false impression that low inflation meant economic stability, the Bank of England Act 1998 encouraged the view that it was safe to borrow and safe to invest. As many noble Lords have said, UK average household debt has more than doubled in 10 years, and British households have taken on more than twice as much debt as their EU counterparts. Yet the rate of inflation as monitored by the Bank of England in accordance with the Act excluded debt inflation, asset class inflation and mortgage interest inflation, the very causes of the current crisis.
Nor did the Act consider how a change in the inflation rate of a certain asset class could bring about a dramatic collapse in the economy, notwithstanding low inflation. As the current chairman of the Federal Reserve, Ben Bernanke, put it, there is no one correct method for valuing an asset class. There are two methods. The first is the price a normal seller would receive from a normal buyer who looks to the value of the asset at maturity. The second is the price a distressed seller would accept from a reluctant buyer who thinks only of short-term risk. That change in valuation method, completely unforeseen in Section 11 of the Bank of England Act, created this crisis.
Experts tell us that the UK will have the worst of this crash because, in conformity with its exclusive brief to control inflation, the Bank of England kept UK interest rates at 5 per cent, the highest level among the G7 countries, until this October, while the US, for example, cut interest rates by more than half from 5.25 per cent to 2 per cent in April. The record seems to show that the top officials at the Bank were like top generals given the wrong orders. All noble Lords know the importance of language. We are often mocked for endlessly debating minute amendments to legislation
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