FINANCIAL regulation is often defended on the grounds that financial products are complex and consumers do not understand them properly. But that is nothing special in itself. I know little about car repair. When I take my car to the garage, the mechanics start talking Esperanto to me about their plans, followed by “OK?” We have been reminded recently that almost none of us knows anything material about how processed meat gets to be in our pies.
Where products create safety concerns, some regulation can be justified to protect consumers from scoundrels. If your pie poisons you, or your car wheel falls off, regulators (perhaps even the police) will search out those responsible. Fraud is also illegal – if your pie says it’s chicken, it oughtn’t to be pork.
But we don’t think it’s the job of regulation to insist that, absent deception, pie-sellers or car workshops give us what is in our best interests. At the supermarket checkout, they aren’t required to ask “Do you really need a pie, sir? Mightn’t a lasagne be better?”
Yet in financial services regulation, the notion of consumer protection has gone so far that the government requires banks to only sell products to consumers that are in their best interests. The government not only takes responsibility for customers purchasing products from banks, but also for the main capital-providers – the depositors. Government involvement is not simply information provision or fraud prevention, but active protection.
Because governments protect (even nationalise) financial services companies, they enormously distort the internal workings of those companies. In an ordinary business a scandal could seriously undermine confidence, meaning customers would go elsewhere. But half the time it seems bank “scandals” are not scandals at all – simply governments ensuring customers against downside risk (like with endowment policies), so customers are unmoved. Many other scandals, such as Libor rigging, though they badly damage international confidence in the City, are seen by retail customers as part of the internal workings of the bank – without real consequence because of government protection, and so irrelevant. The more governments have involved themselves, the more they have destroyed the web of incentives that motivates ethical conduct in other businesses.
This has other consequences. In any normal business, creditors – the bank or the bondholders – would take a dim view of excessive risk-taking or risk-based remuneration for executives. But from the mid-1980s on, governments promised to bail out bondholders, so such disciplines disappeared.
With retail customers unconcerned about scandal, and creditors (depositors and bondholders) guaranteed by the state, almost all natural market control mechanisms on the activities of banks vanished. The game was then played out between the bankers and the regulators – who could catch whom out? If the regulators didn’t say they bothered about it, and no customer or creditor would be hurt by it, and the shareholders gained from it, why not do it?
This culture of dissolution was the product of government intervention. The solution is not more government intervention. Neither is it codes of conduct for bankers. Bankers aren’t more wicked than anyone else. They just respond to the incentives the system creates for them. By itself, unless the fundamental incentives change, “cultural change” of the sort Barclays’s chief executive Antony Jenkins wishes to achieve cannot hope to be adequate.
What we need is to sweep away the whole failed concept. Instead, customers must take responsibility – if you take out a pension with a company and that company goes bust, you lose your money. Tough. If you deposit money in a bank and the bank goes bust, you should lose your money. Bad luck. It shouldn’t be the bank’s job to work out what’s good for you (unless you pay specifically for the service of being told what’s good for you), and it shouldn’t be the state’s job to bail out the bank to make sure you don’t suffer. It should be for creditors and shareholders to discipline risk-taking and excessive remuneration, not regulators.
Could such a system restore the City’s reputation? Not for a long time. London’s reputation for integrity and fair dealing was built up over centuries of disciplined non-intervention by regulators, a solid application of the rule of law, respect for property rights, and the ethical my-word-is-my-bond reaction of workers to the incentives the system provided. Ruined in a two-decade orgy of self-destruction, that reputation will now take many decades to restore.
Andrew Lilico is chairman of Europe Economics.