Britannia Radio

JOHN REDWOOD Blog            13.3.09
Are some banks too big to fail?
Published by John Redwood at 7:30 am

I have always been careful to go along with the conventional wisdom  
and with the government spin that there are banks that are too large  
to be allowed to fail. I have done so knowing how powerful the spin  
against me would be if I ever suggested otherwise.

To concede that does not mean, however, that I have to support the  
huge sums of money the government has made available to bail out bad  
banks, and certainly does not mean I agree with buying shares in them  
which delays sorting them out. If the authorities are stupid enough  
to get themselves into the position where some banks are too big to  
fail, it is even more important they take prompt action to break them  
up so they cease to be too big to fail.

The correct strategy with an unwieldy conglomerate like RBS is to  
break it up into its constituent parts and find answers for each of  
them. Some could be sold immediately. Some will need managing to  
health and some like the Investment bank can be closed down after the  
bits of value have been sold. You should also keep RBS short of  
capital and cash to force it to raise more of its own, and to prevent  
it from paying the absurdly high salaries and bonuses it is still  
paying when it is no longer making profits and raising private money  
to do so.

This is a good policy for the taxpayer, cutting the taxpayers risk  
and getting some cash back. It is a good policy for the banks’  
customers, leading to more banks and therefore more choice in the  
marketplace. It is good policy for the regulators, making it easier  
to see what is going on with each business having its own balance  
sheet and its own more visible and accountable management team.

The Competition authorities were asleep on the watch in recent years.  
They should not have allowed the Lloyds/HBOS merger, nor some of the  
constituent mergers that created RBS. Allowing banks to come that big  
does damage the market, putting too much banking under common  
decision making and ownership.

I read yesterday that the FSA is now going to hire 280 extra staff  
and is going to make life frightening for banks. I don’t think that  
is the right response. The regulatory failure in the UK occurred  
thanks to the former Chancellor.

He was the man who split responsibility for banks capital and  
solvency by making the Bank of England responsible for the banking  
system and making the FSA responsible for individual banks. He became  
the chief Regulator himself, as the Head of the tripartite system. He  
must take the ultimate responsibility for what went wrong.

What he failed to see was obvious. Banks were allowed to expand their  
balance sheets far too much. It does not take 280 people to work that  
out. Just one person who knew what they were doing could have seen  
that the top four banks were all expanding too quickly and had too  
little capital in relation to the amount of business they were  
writing. If I could see that from the sidelines, surely the  
Chancellor could see it aided by all the advisers he enjoys at the  
Treasury, Bank and FSA. They had the powers to make them have more  
capital for any given volume of business and should have used them.

When I wrote the Conservative Economic Policy review Foreword I read  
the banks balance sheets and described how the fast growth of the  
previous few years rested upon the weird and wonderful expansion of  
financial instruments in the banking and shadow banking system. I  
explained how this would now come to a stop and how times would get  
tougher. This has been selectively quoted by the Guardian website to  
suggest I thought the expansion was a good idea! They just refuse to  
quote the crucial following passages and the recommendation that the  
Bank of England needed to be given back its powers to control banks  
cash and capital.

For those who have read the quote about how the easy credit created  
good times, misinterpreted on the Guardian site, here is the  
following quote in the same Foreword about what could happen next,  
written in June 2007 well before the run on the Rock and the events  
which followed:

“As we write, there is considerable uncertainty about how far the  
Fed, the ECB and the Bank of England may go in raising rates to  
squeeze inflation out of the system. They must know there are huge  
pyramids of debt throughout the system, and inflation will not be  
killed unless the appetite for more debt is blunted. They also know  
(perhaps they didn’t!) that if they push interest rates too high for  
too long they could bring the debt structures crashing down, as we  
have seen with the sub prime mortgage collapse in the USA, leading to  
falling asset prices, rising unemployment and even recession. “

I rest my case.