Evercore Pan Asset

Today the media is asking who was to blame for the financial crisis in the UK. This is a both a premature and fairly sterile debate. Sensible commentators would conclude that it was a lethal mixture of bad banking, aggressive use of financial instruments, poor regulation, bad macro economic management and poor Central Banking. It is only worth asking if it helps to understand what went wrong so we can try to fix it more precisely and quickly.

The UK did not have a credit explosion owing to prior deregulation. Most of the giddy expansion in bank balance sheets and investment banking activities has occurred in the last decade, following the reforms o f the UK regulatory structure in 1997

Yes, the bankers made large errors, overextending their loan books, helping fuel an unsustainable property and share boom, and building ever larger investment banking arms that took on too much risk. Now the UK government owns a couple of banks, it should be changing the business model and sorting out these obvious mistakes. Why don’t they impose some limits on the salaries and bonuses paid at until the banks return to sustainable profitability? Why doesn’t it run down the trading activities in futures, options and other financial instruments, to cut the risks?

It is true that there are downturns in many countries around the world, and true that the US, Iceland, Ireland, the UK and some other countries have banking problems of a greater or lesser degree of difficulty. This does not mean that the UK government and regulatory authorities did well, and that our problems were imported. Northern Rock was a British business under British regulation lending British money to British borrowers. It went under thanks to bad management and bad regulatory supervision. The British and European authorities allowed RBS to acquire ABN Amro without seeing the potential competitive and capital adequacy issues the acquisition posed. More recently the UK authorities have strangely allowed LLoyds to acquire HBOS, a move which has weakened LLoyds and reduced competition in the market. The British downturn is a nasty one, and owes a lot to the misconduct of UK monetary policy by the Bank over the last few years.

So let’s summarise the ten worst mistakes of the UK authorities so far:

1. The decision to take powers of daily bank supervision and the duty to raise money for the government away from the Bank of England made it difficult for the Bank to conduct a sensible monetary policy.

2. Changing the inflation target at the end of 2003 led to lower interest rates than were safe.

3. The authorities did not make the markets more liquid to prevent the run on the Rock.

4. Nationalisation of Northern Rock led to the rapid run down of its mortgage book at a time when the residential property market needed more lending.

5. The authorities failed to stimulate a successful private sector deal for the Rock, partly owing to their interpretation of EU rules

6. The authorities were wrong to keep interest rates relatively high for as long as they did

7. The authorities tightened capital requirements last autumn and proposed tightening liquidity requirements at the turn of the year when the crunch was well advanced

8 The authorities were wrong to put equity capital into banks towards the end of 2008, without doing proper due diligence and without demanding prior write downs of bad and doubtful debts

9 The government’s cut in the rate of VAT has not stopped the squeeze on demand but has added substantially to the borrowing requirement.

10 The government’s policy of benign neglect of sterling is adding to the financial strains.