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Financial Markets

Volume 482: debated on Wednesday 12 November 2008

I am grateful to the Speaker for selecting this debate. I give special thanks to the Financial Secretary, bearing in mind that there has probably been a surfeit of scrutiny of financial issues, what with recent debates in Westminster Hall on international regulation, a debate yesterday on bank lending and one on the economy in the House on Monday. It is a sign of just how concerned hon. Members are about financial issues. Bearing it in mind that the Financial Secretary no doubt has many things to deal with at this difficult time, I am grateful that he is here.

I wish to declare some interests. They are already in the register, but it bears repeating publicly that I am employed by Tokai Tokyo Securities Europe Ltd, on behalf of which I deal with clients such as the World Bank and Scandinavian local government financing agencies. I should also mention that I am a prospective Royal Bank of Scotland pensioner, as long as the fund holds up, and that I hope that NatWest will continue to provide me with credit, so I have an interest.

In these times of instant media and instant judgment by talent shows and telephone polls, Treasury Ministers also face immediate, “X Factor”-style judgment of their performance in what happens in the markets, because of how our very transparent and liquid credit default swap markets now show—

Sitting suspended for Divisions in the House.

On resuming—

I was referring to credit default swaps, which are measured in basis points, so 15 basis points would be 0.15 per cent. The premium charged for insuring UK Government debt on 1 August was 15 basis points, the equivalent of £15,000 on £1 million of debt. That is the same level as that which was chargeable on the American debt at that date. However, since then, and in terms of today’s trading levels on CDS at five years, the UK now stands at 59 basis points or £59,000 for every £1 million, whereas the USA has gone up to only 35 basis points. The UK has moved from being third equal in terms of credit quality as charged by the markets to sixth, behind even Belgium. That should not be taken as a fundamental worry, but it is a sign of the challenges that the UK faces during the credit famine.

In the time remaining, I want to talk about the impact of the credit famine on Croydon and about the efficacy of fiscal and monetary policy. I have mentioned in previous debates not only the desire to rescue the banking sector, which the Government have done effectively and with great robustness and rigour, but the fact that the banking sector should be repaired to ensure that there is not a second damaging rescue process.

If time allows, I shall say a little about the practice of giving Government guarantees to banks for the issuance of debt and about the reform process that will be considered at the meeting in Washington at the weekend.

In Croydon, there is much that we can be proud of in the economy. In dealing with the challenges, we should thank the Government for the local enterprise growth initiative money that has been provided. It has been important in dealing with the challenges when businesses face difficulties. Even in these difficult times, Croydon Business has been able to support the creation of 70 new businesses.

I have spoken to a number of businesses about how they are experiencing the credit famine, and it may be helpful to give a feeling of what is happening in a strong suburban economy such as Croydon’s. I shall do that partly out of care and concern for Croydon and partly because it might be instructive. Only one company was willing to speak openly, but it is a company that is well placed to comment. The company is called Frost Group Ltd and is run by Jeremy Frost. It is an insolvency practice based in Croydon and is therefore well placed to be able to give a judgment on how to set about saving the livelihoods of Croydon people. It is encouraging to report that, without attribution, many companies were willing to say that the banks were behaving better than they were six months ago.

Many companies that face real cash shortages and cannot expand should go for insolvency. The reality is that, in terms of previous business practice, people who were willing to seek insolvency but who wanted to be able to pursue a business at a later stage had a lack of confidence that they would be able to do so, because they felt that there was no prospect of money being offered in the future.

Another complication reported by Croydon businesses is that, in previous recessions, they would perhaps have to deal with only one banker. However, given the exuberance of the credit markets in the last economic boom, many of those small businesses have to deal with three or four different banks. There are therefore great complications in being able to keep such businesses going, because of the inability of banks to work together to reach a satisfactory resolution to the problems.

The Frost Group also reported unfortunate examples of gross stupidity on the part of British banks in their lending to some local companies. A company with only a £2 million turnover was readily offered £250,000 as a lending facility. There was no hope of that money being paid back. In many ways, the response was that a lot of smaller businesses were also reliant on a mixture of borrowing against their own businesses and personal financing—even to the extent that smaller micro-businesses used credit cards to fund their activity. It is good that the House has looked at the idea of creating a maximum rate for credit card debt. That is something that the Japanese Diet did effectively last year—I think it capped the rate somewhere around the rate proposed in the House.

I should also like quickly to consider the issue of fiscal policy compared with monetary policy. An interesting article in last month’s International Monetary Fund publication, “World Economic Outlook”, considered the arguments against using fiscal policy as a means of pursuing a rescue from the current difficult market environment. It suggested that there are obvious risks in terms of the mistiming of public sector investments in the economy. Ultimately, that approach could be compromised by the cost of the debt that the Government are issuing being adversely impacted by the amount of public expenditure that takes place.

Despite the fact I have a point to make later about the policy of guaranteeing bank debt, I strongly feel that it would be wrong to accept such advice. Unfortunately, the economic downturn will be so significant that there is probably no risk of bringing on a great deal of public expenditure on capital projects in some kind of upturn. More importantly, as the Financial Times recently stated in its Saturday editorial, in current circumstances, with the credit market so badly damaged

“monetary policy may remain ineffective”.

We need only look at what happened in Japan with the complete failure of monetary policy to stimulate the economy. It was completely impossible to force banks to lend when they knew that asset prices would only fall further. We should also look at what has happened in the US with the stimulative effect of the moneys in the $800 rebate that was available from May. Although that was somewhat obscured by the increase in oil prices, there can be a great deal of confidence that it had a positive effect.

It is very good news that the Government are being so positive about the fiscal stimulation of the economy in their approach. However, given that, as the Prime Minister stated in the House today, so many Governments are pursuing such capital expenditures, we should bear it in mind that there must be a finite number of engineers around the world who can help by, for example, building a motorway in New Zealand, supporting $568 billion-worth of capital expenditure in China or, indeed, building an Olympic village and stadiums in London.

As I said, some people will say that, ultimately, fiscal policy will be damaged by the amount of debt that is issued by Governments. I think that that cannot apply in the case of the UK, bearing in mind how low UK debt-to-GDP ratios are, but I have a concern about how the Government have readily agreed to provide guarantees to our banks to issue debt. The rates at which those issues are being launched in the market are over LIBOR. The rates are coming down as investors see the very great value offered on the table. However, that can be as much as 85 basis points—0.85 per cent.—higher than would typically be payable if the Government were issuing gilt debt themselves.

Even when one takes account of the transfixing up-front payments that the Government are receiving from banks for that issuance, it is possible to postulate that perhaps up to 40 basis points a year are being lost. If the full £250 billion-worth of a three-year issuance is made, that could cost as much as £3 billion extra on top of the cost of normal gilt issuance.

That was a matter of comment on Bloomberg yesterday in the “Chart of the day”. It was about the distortive effects that the bank guaranteed debt is having. It strikes me, bearing in mind the number of Back Benchers who keep lobbying Treasury Ministers to impose their will on the banks, that it would be easier to impose that will if the Government were issuing more gilts and then lending that money directly, rather than giving a free passport for the approach to the market.

I am coming to the end of the time available to me, so I shall have to pass by the issue of the Washington meeting, but I will turn to another. I am grateful to the Financial and Exchequer Secretaries to the Treasury and the Chancellor of the Exchequer for responses to questions that I have asked here in Westminster Hall and in the main Chamber about the dangers of the Government being pushed into a second significant rescue of the banks. In many ways, the vigorous action that the Government took in dealing with the financial difficulties has given great confidence to financial markets, but if we have a second significant leg down in the markets and the Government find it necessary to provide yet further bail-outs for the banks, the Government’s political credibility will be questioned and, far more importantly, financial markets will lose their faith in the ability of Governments to hold the ring in financial markets.

After all, over the weekend, we saw AIG—American International Group—having to come back for a second rescue in the United States. Today, we have seen that the Paulson plan, which is admittedly based on taking bad assets off financial institutions, has had to be changed because of just how severe the situation now is in the US. So difficult is it that the remaining $350 billion of the $700 billion spend is to be spent on buying distressed car loans and credit card loans. That is a sign of the real dangers for Governments in a second significant financial crisis.

I believe that the banks are in such a poor state that we need to follow the policy that was pursued in Sweden in 1992 and is being followed in Switzerland with UBS of trying to remove those bad debts to clean the banks’ balance sheets of them, such that banks are confident once again of being able to offer credit to one another. I am grateful for the answers that I have received that the short-term liquidity scheme has been the means of being able to do that, but that does not strike me as a medium-term solution that will provide banks with the confidence to deal with one another and to start lending again to the excellent Croydon businesses that I mentioned at the beginning of my speech.

I welcome the information given to us by the hon. Member for Croydon, Central (Mr. Pelling) about the effects on his constituency of the unprecedented turmoil in global financial markets. The Bank of England’s financial stability report suggested that the global banking system has undergone its biggest episode of instability since the start of the first world war—that is the scale of what we are going through. The Government’s priority is financial stability and we will do whatever is necessary to ensure that. It is encouraging to hear that firms in Croydon are seeing improvements in how the banks are behaving, compared with six months ago.

A number of factors came together to set the stage for these problems, and no doubt economists and historians will debate exactly what those were far into the future. However, the factors certainly included low interest rates and investors’ consequent search for higher returns, the use of increasingly complex assets and a lack of transparency about what they contained, and the bonus-driven pursuit of short-term profit in global financial institutions.

Investors were overpaying for risky assets, a bubble had formed, and as American sub-prime mortgages defaulted—one in five people are behind with their payments—the prices of assets linked to those mortgages fell. The shock was huge, and quickly transmitted across other countries and to other asset classes. Having paid too much for the assets, financial institutions now have to revalue them, booking losses of more than half a trillion dollars in the process. That collapse became the catalyst for a global financial crisis.

The Government are taking decisive action to tackle the problems. On 8 October, after consulting the Bank of England and the Financial Services Authority, the Chancellor of the Exchequer announced specific, comprehensive measures to ensure stability in the financial system and to protect depositors and businesses who rely on that system. The hon. Gentleman referred to a number of elements of that programme, which include providing sufficient short-term liquidity by increasing the amounts available to the Bank of England special liquidity scheme to in excess of £200 billion. He also mentioned new capital for UK banks and building societies, and efforts to ensure that banks are willing to lend to each other with confidence—freeing up inter-bank lending—by offering a temporary Government guarantee for eligible new debt issued by banks.

The hon. Gentleman suggested that instead of recapitalisation, we could have used the “bank for bad debt” proposal.

Let me make myself clear. I was saying that the Government have been excellent in rescuing the banks, but it is now time to repair those banks. It is an additional burden rather than an alternative one.

It is helpful to have that clarification. Our judgment is that recapitalisation will have the desired impact. The problem with the “bad bank” idea is that it is difficult to put a value on what are sometimes called toxic assets. The people who know the value of those assets are the same people who want to get rid of them, so how can the Government decide what is the appropriate price to pay? In contrast, recapitalisation allows banks to absorb future losses due to toxic assets, while ensuring that taxpayers share in any upside, which we hope will follow.

The troubled asset relief programme in the US is open also to UK banks that operate in the US. That will help to create a market in toxic assets and, in due course, make valuations easier. However, it is worth noting that this year’s Nobel prize winner for economics, Paul Krugman, said that

“the British Government went straight to the heart of the problem—and moved to address it with stunning speed.”

He favourably contrasted what we have done in the UK with the approach taken in the US. He rightly acknowledges that, since we announced those measures, other countries have followed Britain’s lead.

The Government are implementing a comprehensive set of measures. On 13 October, the banks participating in the recapitalisation scheme and the Government announced steps to strengthen those banks’ capital positions through their own actions and, when requested, through support from the Government’s recapitalisation and credit guarantee schemes. In total, we are providing £37 billion to RBS and, following their merger, to HBOS Lloyds TSB.

At the conclusion of his remarks, the hon. Gentleman made some interesting points about the international nature of the crisis and the need for countries to work together to resolve it. I agree with him about the importance of that. We are therefore working with other countries, through the Financial Stability Forum, to strengthen the oversight of capital, liquidity and risk requirements; to increase transparency; to change the role of credit rating agencies, because problems there were a big part of what went wrong; to make regulatory authorities more co-operative and responsive to risks, including the establishment of international colleges for each of the largest global financial institutions; and to develop work by the Financial Stability Forum on the pro-cyclicality of the financial system.

The international community needs to take action to prevent further contagion and to support vulnerable emerging markets. A number of steps have already been taken by the IMF, and we need to ensure that it has the resources and instruments that it needs.

We also need to put in place a process to strengthen the legitimacy and governance of the Financial Stability Forum. The number of countries represented on the FSF is small, and we want to strengthen the links between the FSF and the IMF so that they are able to foster the international co-operation needed to promote global macro-economic and financial stability. We need to reaffirm our commitment to meeting global challenges despite the financial turmoil, including maintaining aid flows to meet the millennium development goals; moving rapidly, I hope, to a conclusion of the Doha trade round; and combating climate change.

As the hon. Gentleman knows, on 22 October it was announced that a summit of G20 leaders would be held in Washington later this week to address the global credit crisis. Last weekend, I attended a conference of G20 Finance Ministers and central bank governors in Brazil, where all these issues were debated ahead of the Washington conference. I agree with the hon. Gentleman that this week’s event will be important.

We should be grateful to the Minister not only for throwing himself around the world, but for coming to Parliament to be held accountable. Will he have time to comment on the merits and demerits of giving the banks guarantees to issue debt, rather than the Government doing the borrowing and then lending the money on to the banks?

All that I want to say at this stage is that, as the hon. Gentleman said, the facility being provided is being taken up. Some welcome unfreezing is taking place as a result. I am sure that he welcomes that as much as I do. That is one reason why we have seen the improvements on the position a few months ago that he mentioned. I assure him that we will follow closely how it works in practice. If changes need to be made, we will be willing to make them.

I conclude by saying that this is the first great financial crisis of the global age. Its effects are being felt across the world, and in many cases they will be lasting. Banking will surely be different in future. The roles of Government and regulators are being redefined. However, new opportunities are certain to emerge from the crisis; we should be confident that the UK is able to seize those opportunities. The Government will support the system to get us through the problems in the best possible shape, and to do it in a way that is fair to everyone in Britain.