Tories ahead, but more work still needed

Allister Heath
IN the main, yesterday&rsquo;s Tory White Paper was a success. George Osborne is right to want to abolish the FSA and make the Bank of England responsible for financial stability. I&rsquo;m delighted the Tories won&rsquo;t be proposing a separation of investment and retail banks any time soon, and that any break-up of Lloyds or RBS will involve proper due process and the competition authorities. That is all progress.<br /><br />When it comes to what the regulating should consist of, rather than its structure, the Tories have largely adopted mainstream views. Banks should hold more capital, leverage shouldn&rsquo;t be excessive and global agreements are the way forward. Details are thin on the ground, however, and the Tory analysis definitely needs more work.<br /><br />Take their claim that consumers suffered from bad advice and mis-selling, as well as from a lack of competition. The first point is partly right; yet at least as problematic was a mis-buying from greedy consumers, such as buy-to-let investors. And it cannot be denied the market was ultra-competitive in the bubble years. In fact, it was too competitive: many new entrants to banking were only there on the back of defective business models, such as relying on money markets to fund cheap mortgages.<br /><br />We must move to a more sustainable system; but that will mean fewer Northern Rock or Icelandic-style new entrants and hence less competition. The only real hope is for Tesco to muscle in. But the Tories need to join-up their thinking if they want more competition in finance: they remain irrationally hostile to supermarkets. Making it easier for new building societies to emerge is sensible; but the demise of the Dumfermline shows that co-ops are no panacea.<br /><br />There are other contradictions. The Tories want to pay private sector salaries to regulators yet are uneasy with the bonus culture; they want the Bank to recruit secondees from the City, yet this would increase the chances of regulatory capture. The Tories will need to claw back powers from the EU if they want reform &ndash; and that, needless to say, is not on the cards. They are right that &ldquo;stable consumer price inflation is not a sufficient condition for economic stability&rdquo; and that other variables, such as bank and household balance sheets, house prices, or the current account deficit, were a signal that things were wrong. But what about the money supply? It is a tragedy that it is mentioned nowhere. Returning to a consumer price inflation target which includes an element of house prices would not be enough; the Bank should also take liquidity growth into account when setting rates. The Tories are wrong to concede that interest rates are an excessively blunt instrument to control credit. Says who? On the basis of what research?<br /><br />The report&rsquo;s footnotes refer to no more than two academic papers or books; it relies too much on newspapers, speeches or government documents. Tory thinking remains ad-hoc and lacks an over-arching theoretical and philosophical vision of what kind of economy they want. They still accept too much of the received wisdom; the few economists they cite include Joseph Stiglitz or Hyman Minsky, both to the left of Labour. For all these flaws, however, the Tory vision on banking and economics has improved markedly over the past few months. And that, for once, is good news.<br /><br />