Banking (No. 2) Bill [HL]

My Lords, that is right. We presented that proposal to the Government. My noble friend Lord McIntosh, who has just reminded me what the provision actually said, was on the Front Bench dealing with that Bill, so he was the one who rejected what my noble friend Lord Barnett and I proffered. My noble friend and I were very annoyed at the time. Many years later I have reflected on that, and I can now think of a reason why the Government adopted the remit for the Bank of England Bill that they did. After 18 wasted Tory years, with our side coming into power, it was vital that we were credible as regards economic policy making. Central to that credibility would be a commitment against inflation; therefore, I have a feeling that what lay behind the rejection of the proposal my noble friend and I put forward was a desire in the early days to establish the credibility of the new Government regarding inflation. I freely add the point that it never occurred to me 10 years ago that anything like what is happening today was possible. Indeed, my favourite joke is that, if any student had described the present state of affairs to me, I would have said, ““Don’t waste my time. That’s a completely impossible state of affairs””. In some sense, when I cannot sleep at nights I still say to myself that it cannot be happening, I must have missed some essential fact, but that is by the way. This is a Second Reading debate, so I wish to devote my speech to general principles. Fundamental to this Bill is that banks—or, more generally, deposit-taking institutions—are of special importance to the economy. Most other types of private enterprise do not have special legislation devoted to them, involving a special resolution regime to deal with failure, an administrative procedure relevant to a so-called partial transfer of business, a special insolvency procedure et cetera. Why is that so? What is the case for saying that banks are of such significance? In considering this question, we must also be aware that, in addition to what is in the Bill, there is the regulatory regime or regimes to which they are all subject and which, again, the Government propose to strengthen. As opposed to the Official Opposition’s Front Bench, I am not an apologist for all the bankers; quite the contrary, in this country and elsewhere the bankers have behaved appallingly. They have taken excessive risks, and the reason for that is simply greed. There is no doubt about what the bankers were up to. The Treasury Select Committee in the other place published a superb report on Northern Rock. It highlighted some regulatory failure, but that is secondary to the main fact that the banks caused the trouble in the first place, with sub-prime lending and the marketing of toxic assets. I say again to the noble Lord, Lord Saatchi, that I keep a list on my desk of all the acronyms. I remember what they are but always have to go back to the original sources to work out what they do, and by the time I have gone back, I have forgotten them again; therefore, I would fail totally in his party game. As far as I can understand it, there was a great deal of corruption involved in the banks in the United States, particularly with the valuation of assets. We do not know whether there has been any corruption here at all, and almost certainly we never will know. In an earlier debate, my noble friend Lord Myners appeared to say that there would be an inquiry into all this, but he then said more recently that he had been misunderstood and did not promise a full investigation of the banking operations in this country in the past few years. Of course one has to accept his word on that, which I do. None the less, we would be better informed of what the banks were up to, why and who was responsible if we had a full inquiry. Again as background, we must distinguish the banks’ role as money transfer bodies—that is, as part of the payment system—and as borrowing and lending institutions which are meant to get savings into investment via the loans market. As I understand it—this has been a growing problem for the banks, and others with more expertise can tell us more—the banks make very little money from acting as money transfer bodies; therefore, if they are to make money and satisfy their greed they need to get more into the borrowing and lending business. Related to that is an important economic proposition: financial institutions such as banks operate essentially by borrowing in a liquid fashion and lending in an illiquid fashion, or, as we used to say, borrowing short and lending long. Such a system is inherently unstable. By this is meant that, in normal times, these institutions can function in a stable way but, subject to an abnormal shock, such as what has hit our system and the world system generally, the effects are transmitted from one bank to another in a self-sustaining and dangerous fashion. That means that if depositors at a bank think it might fail, they will start to close their accounts. Once this starts, other depositors will follow suit, thinking that there must be something behind all this. Eventually, even if all the bank’s loans are sound and therefore it is solvent, it will run out of reserves. If one bank is in trouble, depositors in other banks will have to ask themselves, ““Is that bank unique? What about our bank?”” and they will start to do the same thing. All this will happen even if the overwhelming majority of banks are solvent and sensible. In other words, as long as some banks have been behaving wrongly and making unsound loans, depositors will not know which they are; therefore, the whole banking system is placed at risk. If there is general depositor insurance, or other forms of underpinning, there is no incentive for any depositors to go into this any further because they are protected. What makes matters worse is that, if another shock were to hit the economic system, one that did not originate in the banking system, what were sound loans, again, would cease to be so—not in the least surprising. In addition, people who lose their job or who have their income cut cannot service their loans. This, too, becomes a problem for the banks and is what we are observing. All of this amounts to reminding us how unstable the banking system is and how dangerous it is to let it operate on its own. Milton Friedman argued that the problem of the great depression, which was the biggest crisis of modern times—I have always thought that it was greater than we are going through, but I could well turn out to be wrong—was exacerbated by the Fed’s failure aggressively to expand the money supply. Professor Bernanke pointed out that there was also a real side to this, precisely along the lines that I have put forward: if banks in trouble started to demand the repayment of existing loans, as they did in the great depression, that would add to the troubles, financially, and in terms of spending in the economy. Professor Bernanke, at the head of the Fed and the world’s greatest living expert on the great depression, was absolutely certain he was not going to let that happen again. That is why he operated positively—to the amazement of some of us who recognised him as essentially a monetarist—to increase the money supply in the United States and push in the way that he did. He also seems to have persuaded President Bush also to expand fiscal policy. It is interesting that in our country, my right honourable friend the Prime Minister was doing this ahead of what was happening in the US. I assume he had some very good advisers telling him about all of this. I do not know where they were, but clearly they were not in the Bank of England. The Monetary Policy Committee had the benefit of one of my old students, Professor Blanchflower, who was taught economics by me. He was in a minority of one for nearly all the period that he was advocating interest rate cuts while everyone else was saying no. As I say, none of the other Monetary Policy Committee members was taught by me at all. To bring all that together, once the thing goes wrong it is not in the least surprising that it continues to go wrong. It is also not in the least surprising that it is incredibly difficult to get it to go right again. It seems extraordinary to criticise the Government, who are trying hard to get it to go right, and to suggest that they might well get it all right by a snap of the fingers. It takes time. Speaking from this side, all of us must be honest: it is not absolutely certain that it will go right. Anyone who reads the Pre-Budget Report should be aware that the Government themselves are saying that they are doing what they think—and they are entirely right—is the right thing. However, there is no guarantee of certainty. We are, as my noble friend Lord Barnett said, pursuing the right policies, although there are details on which we can disagree. This leads us to the view that the remarks of the German Finance Minister were completely absurd. We know that what he said was for internal political reasons; he wanted Germany to get a free ride on all the other countries in Europe, plus the United States, so that we would push the thing forward and he would gain all the benefits. Finally, observing the banks now, two things have not changed—again, I echo my noble friend Lord Barnett: the ethos of greed is still with us, as strong as ever, and the same useless people are appointed as overpaid, blind-eyed non-executive directors. We have a new version of Gresham’s law: bad banking drives out good. I hope that the Bill is the first step towards eradicating that.