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However, I am not so confident that the FSA will fix a much bigger defect in the scheme which has been referred to in the debate—that is, the problem of the £50,000 compensation limit applying not per brand but per authorised institution. A few weeks ago, Hector Sants spoke at an all-party meeting downstairs and suggested that it would be solved, but I think that the omens since have suggested a backing-away. Perhaps I may describe the problem, taking HBOS as an example. Let us suppose that you have £50,000 in an account with H and another £50,000 in an account with BOS. You think that you are covered by the compensation limit but if HBOS goes down, other than if the Government take special action, under the scheme you will get back only one lot of £50,000 and will be £50,000 down.

At present, the approach seems to be that information will be brought to bear on consumers so that they understand that HBOS is only one authorised institution and that two separate accounts will not be protected. However, I think that that expects an awful lot of consumers. When you open an account, there is enough small print without trying to find out what other banks are linked with the bank into which you are putting your money. So I believe that, if there is to be a limit—I shall come back to that in a minute—it should be per brand and not per authorised institution. I know that there are problems of legal definition in dealing with that, but I cannot believe that, with all the resources of the FSA’s legal department, those problems cannot be resolved if there is a genuine will to do so, and the FSA would alleviate much concern among investors if it did so.

I come to the kernel of what I want to say tonight. I referred to a limit on compensation for depositors, but why should there be a limit on retail depositors? I do not necessarily go as far as the noble Lord, Lord Blackwell, in wanting all depositors to have 100 per cent protection but I think that all retail depositors should be 100 per cent protected. I have puzzled over this question but I am afraid that it involves a journey into a very strange world—that of bank regulators.

I have known bank regulators for a while, including as an economic journalist. Those who do not know them can be assured that they are not like other people. There are many stories to illustrate this but I can do it most quickly by quoting one magnificent sentence from the regulators’ regulator, Alan Greenspan:

“If I have made myself clear, you must have misunderstood me”.

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Banking regulators embrace paradox, ambiguity and contradiction. They persuade themselves that in this they have a higher wisdom and that, if it escapes the rest of humanity, that is not surprising. The argument against unlimited compensation that banking regulators come out with is that it would create moral hazard. Those two words in themselves do not mean very much, but never mind—noble Lords will know what they mean. In normal language, they mean that ordinary people must be at risk with their deposits if they put a lot of money into one bank, otherwise they would not have any incentive to check whether the bank was sound or unsound.

I find that a very bizarre argument, even coming from bank regulators. The truth is that there is a lot of moral hazard in banking, and there are two lots of people to whom it should apply. One is those who manage the banks because, if a bank collapses, they lose their jobs. I should not say that I am delighted but I cannot help but observe with a certain wry humour that a lot of them are losing their jobs now. They are paying the price of the moral hazard.

The second lot of people who suffer, for whom I have more sympathy, are shareholders, who will lose many, most or all of their investments. They are supposed to know what goes on in their banks; if they do not and things go wrong, it is right that they suffer. You have to feel sorry for small shareholders but, if you go into the stock exchange business, you have to be prepared to run the moral hazard of investing in bad companies and, if you get it wrong, losing money. However, the information that shareholders have is vastly better than that available to consumers, and their moral hazard is quite enough to protect against insanity, if indeed it does so. It was not a lack of moral hazard that caused the banks to collapse; as the noble Lord just said, it was a sort of collective insanity that came over the industry.

Furthermore, the other main protection against these kind of events is supposed to be the action of regulators. It seems tough to allow regulators to make the appalling mess that has allowed the collapse that is going on at the moment, and then say that depositors should know that bank A is safe and bank B is not safe and, in theory, lose money if they fail to distinguish between the two. It is most unfair on your average punter.

However, there is a further twist as we go through this fantasy world of banking regulation. The theory is that you only get £50,000 back, but, in practice, nothing of the kind applies. In practice, the Government have paid out in full for all depositors who lose their money. They have even paid out in full on people who put their money into Icelandic banks, which is pretty extraordinary. To call it generous understates it. When London Scottish went down only a few weeks ago, there was no question of any depositors losing their money. They all got the whole amount back from the Government.

So we are here in Alice in Wonderland territory. On one hand, Ministers insist—the Prime Minister himself has done it—that depositors will be compensated in full and simultaneously insist that they are only entitled to £50,000 per authorised institution. Jimmy Thomas,

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a working-class Minister in the MacDonald Government, once said that if you cannot ride two horses at once, you should not be in the circus. The Chancellor’s position on this is a bit like riding two horses galloping in different directions and this is a trifle demanding, even for a politician.

This strange world has practical consequences. Suppose you hear that a bank is rumoured to be in trouble. Maybe you have a deposit there. You start to wonder if you should go down and get your money out before everybody else does. If you believe the Alistair Darling who is riding one horse, there is no reason at all. You will be compensated in full if it does go under, so leave your money there. If you believe the Alistair Darling who is riding the other horse, you had better get down there fast if you have more than £50,000. I will just deal with one counterargument which is used. It is perfectly true that only 2 per cent of depositors have more than £50,000 in a bank, but it is also true that they account for one-third of the total deposits; that is to say that they have quite enough capacity to bring down any bank that may exist.

Different European countries have different compensation arrangements, from 100 per cent in Ireland on down. It would be much the best if there were one rule for the whole of Europe, so that deposits and depositors did not become the itinerants of our day, chasing hither and thither in pursuit of maximum safety. However, it would be better still if the one rule across Europe was 100 per cent compensation for all retail depositors. At a stroke, one possible source of instability, in these all too unstable days, would be eliminated.

7.03 pm

Lord Selsdon: My Lords, I have stood from these Baron Benches, as they are called, for many years and spoken on similar subjects. It always gives me really great pleasure when the professors and economists buzz off. If the accountants could only go as well, life would be much easier. Banking problems only began when economists arrived within government departments—237 within one year, over half from eastern Europe. It was only when people relied upon accountants that things began to go wrong. These Benches are where the Barons sit. Noble Viscounts such as my noble friend on my left should normally sit a bit nearer the front, and the Earls sit on the very front.

I am rather pleased that I have two speeches today. I was always told that I should have three.

The bankers are now here. There is the noble Lord, Lord James—Lloyds from 1959 to 1964—and the noble Lord, Lord Stewartby, then Ian Stewart, working for my cousin Giles Guthrie at Brown Shipley, a really great name. The noble Lord, Lord Oakeshott, was in Warburg Investment Management, known for being able to take a risk on absolutely anything and to give odds on any financial subject in the world. These were great people.

Me, my Lords? I was in industry—asbestos. I then went into economic forecasting. I was the only non-economist to be employed because I was meant to know about industry. Thereafter, I thought that everything

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I did went well, but it steadily collapsed. I joined Singer and Friedlander and yesterday the legislation came in effectively to abolish it. It was a great entrepreneurial bank set up by two arbitragists, Mr Singer and Mr Friedlander—one Austrian and one South African—at the start of the war. That was arbitrage, which gradually became acceptable. When it merged with the Bowring Group, it became an accepting house. The reason I felt confident to join was that CT Bowring was the only person to pay out in the San Francisco earthquake disaster, as a fund. You knew, therefore, that you were with someone who was undoubted. From there, I moved to Samuel Montagu, which was owned by Midland Bank.

I want to try and explain how a bank works. It does not need all these outside regulators. It needs supervision. When you really have a fear of the chief inspector coming to look in your fridge to make sure whether you have any wine illegally on the bank, you then start to get nervous. Midland Bank, for which I worked, was the biggest bank in the world. It was known as the farmer’s bank and was an industrial bank, but gradually it fell and fell. It trained every bank in the world and every banker. You could recognise one, because if he crossed his hand over his chest and seemed a bit deferential, you could ask if he was trained in the Midland Bank and if it was Sheffield or Haslemere and they would say yes.

Every single head of finance in the country had been trained in the Midland Bank. Unfortunately, things gradually went wrong. When we had a credit committee it was a nightmare. First, I was a director of international banking at Samuel Montagu. We wanted to get use of our parent company’s balance sheet and that needed craftiness beyond belief. We knew that if we worked with Warburg, it had that amazing ability to unlock money from any bank in the world—it was called placing power. It never put any of its own money in; it just wanted to use other people’s balance sheets, and it was clever. In Morgan Grenfell, where the noble Lord, Lord Smith of Kelvin, was, there was a wonderful man, probably the best investment merchant banker in the world, Bill Mackworth-Young. When he spoke to Luke Meinertzhagen at Cazenove’s—Luke was called the man with the golden telephone—they could place anything in the world and anything they placed never went wrong.

On the other hand, at Midland—if you were in Samuel Montagu—you had to go across the road to the international credit committee and present yourself, as a director, in front of 20 people, with someone standing with a brown telephone in the corner to say what the committee had done direct. It would go out by texted telex, wherever it was. I was quite nervous because I did not understand this. They were all slightly bureaucratic. In the merchant banking side you could be called an “esq”—I was known as “Lord Esq”—but you had to be a “mister” in the bank; you could not be an esquire because you were not landed. These people knew their job. You would be asked, “Have you been there?”. That meant that you could not lend to anybody unless you had been to the country in the last 90 days, or unless you or the manager had visited the client in the last day. You had to know thy customer. Then, if they were not sure

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about it, they would introduce a strange phrase. I thought I should know all these initials like SIVs, but they did not turn up. “Committee, I think we are not sure enough. I think it should be an FFW”. I did not know what an FFW was and I did not dare go and ask other people. Quietly, I asked how long we had been using the term “FFW”. “Oh, before my time, my dear chap, way before my time”.

I then found out that only Midland had it. It was a “fair following wind”. It meant that, if the project stacked up, the agreement, in principle, would follow. That FFW would read as Project MJ223B and so on, FFW-ed. The governor of the central bank of wherever it was in the world knew that he had got Midland on side. That was almost like the traditional handshake.

That was not the end of it. The proposals then had to go back to head office in Poultry, to the fourth floor where the gold was actually gilt, not gold paint as on the other floors. If you ever went before the Midland board—some of my noble friends have been directors—you were told to go into the office, wait and then take three steps before the board, and you had to describe the project, as a director.

Only once did I beat the system. The noble Lord, Lord Whitty, who is not here, would enjoy this. I dealt with the more difficult countries because I was not important enough to deal with the easy countries. I was asked to help Bhutan. Bhutan wanted a new aircraft. As our esteemed customer was Hawker Siddeley, where the noble Lord, Lord Whitty, worked, I suggested that it should have an HS125. When I put forward the proposal to the credit committee, I was asked whether we had been to Bhutan. We had not, but by chance, the night before I had met the Queen of Bhutan in Fulham and helped to push-start her MG. So I said, “I have met the Queen of Bhutan”. The committee said, “Hmm. Perhaps. FFW-ed”, and Bhutan got the plane.

The supervision was from within and you were so frightened of letting down your own colleagues that you did not need outsiders, but of course you constantly had to walk across the road to the Bank of England, particularly when you handled the exchange control.

Sadly, Midland Bank, with 333 branches, employing 33,000 people and getting 330 applications for charity, one from each branch, every day, thought it could expand. It owned Northern Bank and Clydesdale Bank and had a 20 per cent stake in Standard Chartered Bank and lots of joint ventures. It then decided it must move with the new world, open up another time zone and get involved in America. It bought a company called Crocker which was in the sub-prime mortgage market—all that time ago—and it was accused of red-lining. That cost Midland Bank $800 million, the same amount as the total budget of Afghanistan today.

I learnt very quickly that if an investment bank or any bank does not have a balance sheet, it is not allowed to lend more than 17 or 20 times the share capital in reserves. I thought, “How much can you lend?”. I did not think about what would happen if you lost $20 million and that you would have to reduce your lending by that much. Nor did I realise the pain

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when inflation came in. With interest rates so high, we found that big companies would not pay early and suppliers would pay late; you then found that the pressure was on lending.

That is the present situation. Every one of us needs Joe the plumber. I have lots of “Joe the plumber”s. This morning it was Steve the laundryman. He is a really good, right-wing chap who believes in his children being properly educated. He works his heart out and does the best shirts in London at the cheapest price. This morning, I said to Steve, “What shall I tell them today?”. He said, “Tell them to take over the banks, nationalise them all, and give us the money without interest until they bring down the amount of interest they are getting in from everyone else. It’s not fair. They’re coining it in”. I said, “They made a mistake. Do you need any money?”. He said, “No, except that you are not doing as many shirts”. For economic reasons, I thought I might wear one shirt for two days; for noble Lords sitting close to me, I should say that this is actually a new shirt today. Steve pointed out that many people are thinking of economising.

The banks and the Bank of England are the best people to supervise their business, provided they know what they are doing. Now we come to the problem: no one doubted the four clearing banks, but we have too many banks. I shall not bang on too long about the rating industry, but maybe we should introduce our own rating system. Let the Bank of England introduce a rating system for banks. There would be no triple A-rated banks at the moment; there may not be many double-A banks, but we could devise our own rating system which would give people confidence in banks. If the rating was sufficiently good, people would stand behind it.

I end on a slightly sad note. Everything is about trade and I was in trade. Lombard Street was about trade. Our worry today is that we are misrepresenting things. The noble Lord, Lord Myners, has heard me bang on about the balance of payments. We will have a balance of payments deficit of £100 billion on visibles this year. The surplus on invisibles will fall away naturally because the financial services market is down a bit. We have only 11 countries in the world where we have a surplus in trade. As our currency has gone down by 20 per cent, so the cost of our imports, which are many times more than our exports, will go up. We may have a currency crisis and we may, one day, think back to exchange control.

I am optimistic because we are still one of the most international countries in the world and the Bank of England is one of the most respected banks. We should not just count our blessings, but when there is a problem we should look at our future trading strategy and the advice we give to help it to trade out of it. We have some problems and the only way we can get out of them is to trade out of them.

7.15 pm

Lord Williams of Elvel: My Lords, it is always a great pleasure to follow the noble Lord, Lord Selsdon, who introduces a personal note into our debates which is genuine and pleasant.

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The noble Lord, Lord Stewartby, asked why we are here. This Bill has been pored over, as the Minister said, in consultation, in papers, in studies and in extensive debates in another place. That does not mean that the Bill is perfect. When dealing with the Financial Services Bill, which my noble friend Lord Peston will remember very well, I sat where the noble Baroness, Lady Noakes, sits now; it too had been studied endlessly, but it got a lot of things wrong, as I shall explain.

A further complication is the timetable. I understand that the Bill has to become an Act before the original Act lapses. That means that a 255-clause Bill will be debated in your Lordships’ House at a machine-gun pace in the first week after the recess. I will argue, and I hope that the Minister will accept, that in the light of that and all my other arguments, a review of the legislation after a period would be right, as the noble Baroness and the noble Lord, Lord Newby, have claimed. We cannot just let it go by without reviewing the legislation.

The noble Lord, Lord Stewartby, asked why we were here in the first place. It is commonly said that today’s bankers have forgotten how to be bankers. We have had a series of catastrophic misjudgments. One was revealed yesterday: the Royal Bank of Scotland and HSBC were involved in a fraudulent arrangement in New York. The Government have had to intervene on a massive scale. Bankers are very unpopular, as mentioned by my noble friends Lord Peston, Lord Lipsey and Lord Barnett. I have a slight caveat to that. Auditors, as my noble friend Lord Barnett said, seem to have escaped criticism. It is important to look at history to explain, in the words of the noble Lord, Lord Stewartby, what has happened and why we are here.

In 1890, Barings Bank, for which I had the privilege to work for a number of years, had to be bailed out by the Bank of England and a consortium of friendly banks because it was left holding a baggage of Argentine defaulted securities and had no liquidity. No lessons were learnt as in 1995 Barings collapsed completely, beyond salvation, because one of its traders in securities was arbitraging between the Singapore and Tokyo stock markets with such enthusiasm that he engaged the whole net worth of the parent bank. Directors in London were prepared to transfer the whole of the net worth of the parent bank to Singapore to support his position. The result was that Barings went bust. The Barings directors did not have a true understanding of the business being conducted in Singapore, because if they had they would not have allowed the entire net worth of an old merchant bank to be squandered away on some trader’s say-so. I remind noble Lords that the same thing happened in 1931 at the Creditanstalt bank in Vienna. It went bankrupt because it was left holding a lot of securities and had no idea that they were worthless. The failure of the Vienna bank led to the collapse of the entire financial system in 1931, which in turn resulted in legislation that I will come to in a moment.

All these banks—Lehman Brothers is another case—had securitised instruments which they did not understand. The collapse in 1931 led to what in my view was a very

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sensible development. It ended with the Glass-Steagall Act in the United States and a distinction being made between commercial banks and banks that traded in securities. All that broke down here in the 1980s and in the US, with the final repeal of the Glass-Steagall Act in 1999. In our case, the breakdown led to the infamous Big Bang in the City, when banks paid stockbrokers and jobbers ludicrous sums of money on the grounds that that was the way forward. They had no idea what they were buying, but they rushed into buying things because that was the fashion of the period. As a result, serious bankers forgot to be bankers and became, as they saw it, dealers. However, the business cultures of dealers and bankers are quite different. I am sure that I do not need to overemphasise the fact that a banker is someone who looks at a balance sheet and says, “I am a taker of deposits, I will lend them out on overdraft over a relatively short term, and I will not get involved in buying securities, let alone when I have no idea of their value”.

That was not the case with Northern Rock and Bradford & Bingley, which involved a different clash of business cultures. I am afraid I was also Jeremiah on the opposition Front Bench during the passage of the 1986 Building Societies Bill. I said that it would be a disaster. It seems to me now, just as it did then, that a building society, whose business is lending on mortgage at long term on the back of a relatively stable retail deposit base, is asking for trouble if it develops ambitions as a bank to finance those long-term assets in the wholesale money market, particularly the interbank market. The danger is compounded if the building society in question loses its sense of social lending and goes recklessly in pursuit of profit maximisation. That is precisely what happened in the cases of both Northern Rock and Bradford & Bingley. The cultures of building societies and banks do not mix.

Although the Big Bang and the building societies legislation were under a Conservative Government and in my view underlie our present problems, I have to agree with noble Lords opposite in their criticism of the move some years ago by this Government to remove the regulation of banks from the Bank of England and place it under something called a tripartite framework of the Treasury, the Bank and the Financial Services Authority, a development also referred to by my noble friend Lord Eatwell. I could not understand then and I cannot understand now how the Bank can satisfactorily play the role of lender of last resort unless it also has a regulatory function—not, I hasten to add, that when I was a banker myself I was particularly happy with the banking supervision department of the Bank of England as it was then constituted. The department head had spent most of his career in public relations, which would mean beefing it up.

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