THERE was lots of good stuff in yesterday’s report on the demise of RBS and the idiocy, stupidity and incompetence of the top executives – including Sir Fred Goodwin – advisers, politicians and regulators in charge, including Gordon Brown and Ed Balls. RBS’s rise, fall and slow-motion crash is an astonishing tale of hubris: human beings who think they can defy the laws of gravity, as well as the reality of economics and finance, always end up destroying themselves and those around them.
But in other ways the report is flawed; here are some reasons why. There was no proper attempt at justifying RBS’s bailout. A disorderly collapse would have been horrid but it might have been possible to forcibly convert at least some debt into equity, thus protecting taxpayers. Those decisions were just as important as errors in the run-up to RBS’s failure. We need an inquiry into them too.
There was no proper plan to deal with a major bank going bust – no resolution mechanism to protect taxpayers and allow an orderly wind-down. Why did regulators not think of this during the boom? The fact that no such plan B existed was tantamount to an implicit guarantee that an institution could do anything, safe in the knowledge that it would be rescued. Yet the report doesn’t go into this.
Another much misunderstood issue is “light-touch” regulation, blamed for allowing RBS to happen. Supporters of a free-market economy believe human action needs to be governed by a complex web of rules and restrictions, based around private property, profit and loss, freely functioning price signals, the rule of law, liability and contracts. Under this system, resources are allocated reasonably efficiently, with greed tamed by fear. Bad decisions are penalised by losses; good ones rewarded by profits. Behaviour is “regulated” by market mechanisms: if you lend money to a bank, and know you will lose it if it takes silly decisions, you will pay close attention.
Real capitalists don’t believe behaviour should be unconstrained or “unregulated” – they do not think that people should be able to do whatever they want, with no consequences. What they do believe is that it is best if the constraints and consequences are market-based, harnessing the power of self-interest, rather than imposed by supposedly selfless or omniscient regulators. A few decades ago, before the Basel Accords, capital ratios were often higher than they are today – investors and depositors demanded the protection and extra prudence.
A real free-market is not the rule of the jungle – a system with no private property, no contracts and violence – but neither is it the pre-2008 model. That crazy system, perfected in Brown’s Britain, saw the authorities repeal many traditional market-based constraints on CEOs – because liabilities were guaranteed, private creditors relaxed and ceased to exercise proper supervision – and replaced them with an ineffectual regulatory system. This was the worst of all worlds: private investors no longer cared, consumers thought they were safe – and the regulators were useless. There was also intervention in other ways, with excessive liquidity from central banks corrupting the price of credit.
What is wrongly called “light-touch” regulation was in fact a corporatist system that insulated creditors, promoted moral hazard and encouraged the likes of Sir Fred Goodwin. It’s a shame the disease has been so misdiagnosed.
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