Britannia Radio

We are still in deep trouble but at least and at last we are getting  
some clear thinking away from the consensus that has ruined us!    
Earlier I forwarded John Redwood’s ‘Are some banks too big to  
fail’ (my posting 13/3/09 was entitled “Positive Thinking”)  and now  
Andrew Lilico for the Centre for Policy Studies goes into more detail  
and shatters the illusion that Brown is doing the right things when  
in fact he’s making it much worse.

Take these and Liam Halligan in my posting yesterday  (“ The  
'experts' don't have a clue”) and you can see that sense IS there -  
it’s just being stifled.

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TELEGRAPH        16.3.09
We need more risk and less regulation of the financial sector
The politicians' answer to the banking crisis – if it fails, bail it  
out – will get us nowhere, says Andrew Lilico.

    Andrew Lilico

The Government bail-out of the banks is a disaster on two grounds.  
First, it is based on a false diagnosis of the financial crisis.  
Second, it will be enormously destructive of our country's  
prosperity. The continuing attempt by politicians – of all parties –  
to put forward clever political solutions to the problems of the  
financial sector are only making things worse. And it shows how  
little they understand of what has really happened.

Capitalism is based on innovation. But innovations are not always  
well understood when they first turn up. People buy too many of them  
and pay too much for them. That happened with the railways, with the  
light bulb, with radio and with dotcom companies. Most recently it  
has happened with complex financial products. That's how it goes: if  
you don't like it, then you don't want the innovations that are its  
cause.

That is what happened in this crisis. People paid too much for  
financial products that they didn't understand. Partly, that was a  
reflection of their novelty; but also of the financial regulation of  
the past 25 years, which sought to replace personal responsibility  
for assessing financial products and companies with the opinions of  
regulators and ratings agencies.

Inevitably, when these regulators and ratings agencies made mistakes,  
they made mistakes for the whole market since everyone depended on  
the same few assessments.

As a result of this regulatory strategy and other flaws in the system  
(such as the annual inflation targeting regime) there was over- 
investment in the new products. Things got completely out of control,  
resulting in huge losses and a need for the financial sector to be  
restructured and shrink.

Left to function alone, the market would have punished those that had  
invested in the companies that lost. Companies going bust and  
investors losing their money are not a "failure of capitalism". It is  
capitalism; and if you don't like it, then you don't like the system.

The people who ought to have lost are the bondholders who lent money  
to banks when banks already paid out high dividends while borrowing  
extra money, thereby increasing their dependence on debt as opposed  
to equity. This was a risk, and when it went bad the market should  
have punished it.

Instead, governments have turned that into a good decision. People  
lent money to banks thinking they were low-risk. And government  
action has made that true. Even when the bank effectively fails,  
government action has meant that the bondholders have been spared.

There was no need for the British government to bail out the banks  
last autumn. Depositors should have been given claims on bank assets  
that ranked above those of the bondholders, so that when the banks  
went into administration it would be the bondholders that lost, not  
the depositors. In other words, mistakes should have been punished.  
The wrong policy response – the one adopted – was to reward investor  
error. It saved the capitalists made rich at the expense of private  
capitalism.

Calls for heavy-handed regulation to restrict the actions of banks  
are the flip-side of acting so as to undermine the market's means to  
punish poor decision-making. Unless there is a penalty for risky  
decisions that go bad, there is no room for the risky decisions that  
might go well. This means there will be less risk-taking in the  
economy as a whole – less innovation and experimentation, less  
diversity and dynamism. We will have an economy that grows more  
slowly and a society that is less tolerant, offering fewer  
opportunities for those who have no money but good ideas to get ahead.

Financial regulation should increase personal responsibility for  
investment decisions, not reduce it. That would simply take the  
weakness in the current system even farther. The motto should be, as  
it once was: "Caveat emptor" . It has been replaced with: "Does the  
regulator say it's all going to be OK?"

Governments may yet be forced to make bondholders take their losses.  
The financial sector is unlikely to be able to return to sustained  
profitability without significant restructuring of a much more  
radical nature than the current favourites of creating "boring banks"  
and "bad banks". Governments are now the major shareholders in these  
institutions, and they should insist upon their restructuring. If  
that fails to restore profitability, bondholders should be made to  
accept losses.

In the meantime, estimates of the total final losses from the bail- 
out policy escalate all the time – £100 billion, £200 billion,  
perhaps £400 billion. Imagine if, instead of all that, we had used  
£100 billion or £200 billion for tax cuts to stimulate the real  
economy. How much better off we would all have been then. Instead, we  
have a Labour government that has gambled huge sums of money to keep  
rich people rich.

Ironically and tragically, that will be Gordon Brown's legacy.
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Andrew Lilico is the author of 'What Killed Capitalism? The Crisis –  
What Caused it and How to Respond', published today by the Centre for  
Policy Studies www.cps.org.uk
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[SEE expanded article ---
Andrew Lilico: What killed private capitalism?
  http://conservativehome.blogs.com/platform/’
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THE SCOTSMAN        16.3.09
Scrutineer: Why we should have let RBS and HBOS fail

    By Bill Jamieson

TAXPAYER rescue of Royal Bank of Scotland and HBOS may prove to have  
been the worst solution: "zombie" banks, a prolongation of the crisis  
and a recession deeper and longer than would otherwise have been the  
case.

The £200 billion that the IMF estimates to be the cost of the UK bank  
"rescues" would have been better spent on massive tax cuts. This  
would have spared us the worst of the recession and secured recovery  
earlier and more robust than the years of sturm und drang that now  
lie ahead. This constraint on growth will cause the failure of many  
thousands of businesses that might otherwise have had a reasonable  
prospect of survival.

So argues Andrew Lilico, a leading specialist in financial sector  
regulation, in a provocative paper, What Killed Capitalism published  
today. He argues the emergency responses have made a devastating  
crisis worse and we should stop trying to save failed banks.

Nationalisation of most of the UK's banking sector marks the end of  
300 years of private capitalism – "a disaster of the first order".  
Bailing out failed banks, he says, has let bondholders off the hook  
and marked a catastrophic abandonment of the principle of "caveat  
emptor".

So what killed capitalism? Lilico cites five main factors: genuinely  
valuable innovation, over-confidence in regulatory banging; the use  
of novel products to bypass regulatory requirements; extreme moral  
hazard in respect of housing and over dependence on annual inflation  
targets which did not contain any measure reflecting the rise in  
housing costs. What did not cause the credit crunch was greed or  
bonuses.

Nationalisation of a huge swathe of the banking sector – and indeed  
the lion's share of the banking system in Scotland – only validated  
the poor decisions that led to the crisis. "The banks took on too  
much bond-based debt at the expense of equity on the premise that  
debt was low risk. By sparing bondholders, the government has made  
this judgment right … this rewards the behaviour that led to the  
failure of these institutions."

Instead, says Lilico, the correct policy should have focused on  
employing market mechanisms so as to punish the bondholders and force  
the required restructuring. "Formulaic" prudential capital  
requirements made it worse once the crisis was here and should have  
been suspended.

The Bank of England should have been made the prudential supervisor  
and placed failing institutions into a special administration regime.  
Retail depositors should have been made into preferred creditors,  
ranking above secured creditors and the real economy supported with  
tax cuts.

"How much less bad would things have been if, instead of spending  
£200bn on the financial sector, the government had made £200bn of tax  
cuts?"

The hidden cost of the bail-outs is loss of growth. Private  
capitalist economies, because they promote innovation, grow on  
average rather fast. A state capitalist economy must grow more  
slowly. He describes the government's insistence that the sustainable  
growth rate of 2.75 per cent had been unaffected by the credit crisis  
as "preposterous". A more plausible figure would be 2.2 per cent.

If that seems insignificant, an economy growing at 2.2 per cent over  
the next two decades would be about 10 per cent smaller. That's less  
job creation, less investment, less tax revenues – and a large swathe  
of investment and long-term deals entered into in 2005 and 2006  
predicated on that higher growth will now go bad, inducing an  
additional GDP loss of between 5 and 6 per cent.

Of particular interest in helping to prevent a return to the crazed  
lending in the mortgage market is a broad recommendation for the  
return of the principle of "caveat emptor". One of the changes Lilico  
advocates is for a clearer definition of the role of genuine  
independent financial advisers (rewarded by fees) and salesmen, paid  
by commission. A disturbingly large number of mortgages advanced in  
recent years have turned out to be poorly or inadequately researched  
and documented where not fraudulent – the tell-tale signs of a system  
driven by the thirst for commission income.

His analysis of what caused the crisis – and what should now be done  
– is a major break from the fragile consensus. What makes this  
clearly written and compelling analysis particularly resonant is his  
warning of an impaired recovery as new government agencies struggle  
to establish and assert oversight and control over the banking system.

Only now is the Treasury embarking on the recruitment of dozens of  
risk specialists who will take control over the £600bn of toxic  
assets acquired from the banks under the Asset Protection Scheme.  
These problematic portfolios will take years to unwind. This is not  
the end, or the beginning of the end, but a new and worrisome beginning.
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