We must learn from financial history

Allister Heath
SPEAKING to this newspaper last night, Lord Myners, the City minister, points out that banks’ proprietary trading and investments in hedge funds and private equity were “in no way central” to the problems which led to the global financial crisis. I agree: Barack Obama’s plan to ban banks with retail arms from those activities – endorsed by shadow chancellor George Osborne – would have done nothing to prevent the crisis; not a single bank that got into trouble since 2007 would have been saved had those rules been in place.

Needless to say, this is an unpopular view to hold. There has been huge support for the Obama/Osborne plan, seen as a way to protect taxpayers; but all the evidence is that it would have been completely ineffective in doing so. Something must be done – but this scheme is not it.

Northern Rock, HBOS, Bradford and Bingley and the Dunfermline did not engage in prop trading. They lent to people who couldn’t repay, assumed property prices wouldn’t fall, relied on money markets for funding rather than deposits, and purchased securitised sub-prime debt as a “safe” high-yielding investment, often tucked away in off balance sheet vehicles. They held too little quality, liquid capital as a buffer against losses.

The only UK bank that suffered heavy proprietary trading losses was RBS – though it is hard to determine how much of the estimates for these came from long-term investments in dud baskets of sub-prime mortgages and how much came from real, short-term trading (these quite different concepts are regularly mixed up). In any case, given that its total assets were £2.4 trillion at 31 December 2008, even tens of billions of losses could have been absorbed had the bank been properly capitalised. It wasn’t – but that was just part of its problem. It was over-leveraged, bought vast amounts of sub-prime securities, lent willy-nilly to unsound borrowers and blew a fortune buying ABN Amro, suffering massive goodwill write-offs. RBS made every mistake in the banking book; it would have been doomed with or without Obama/Osborne.

The crisis of 2007-09 was extremely severe. But there have been other devastating episodes in the past 35 years; none would have been prevented by Obama/Osborne or by a recreation of a Glass-Steagall separation of investment and retail banks (which anyway was in effect until 1999).

Britain’s secondary banking crisis in the mid-1970s saw the Bank of England bail out thirty small firms and help thirty others, at the cost of £100m. One of the clearing banks hit serious trouble but this was hushed up. Lenders grew by borrowing on the money markets; their downfall came when property loans went wrong and the housing bubble popped.

Other disasters include the US savings and loan debacle, which saw 747 building societies go bust in the 1980s and 1990s, costing taxpayers $125bn. The Third World debt crisis of the 1980s saw many banks almost go under when developing nations didn’t repay their loans. Then there were the Japanese and Swedish disasters of the early 1990s, all triggering bailouts.

So yes – the pre-2007 system was broken. We need a financial revolution: nobody should feel they can game the system, courtesy of a taxpayer-funded safety net. I will outline how a real free-market, pro-taxpayer and pro-London system could be achieved in tomorrow’s newspaper. It will be very different to Obama’s. allister.heath@cityam.com