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Financial Markets

Volume 487: debated on Wednesday 4 February 2009

It is a pleasure to serve under your chairmanship, Mrs. Dean. In addition to the items declared in the Register of Members’ Interests, I should like to declare that I am a prospective pensioner of the Royal Bank of Scotland and that I have an overdraft with NatWest. Those declarations are necessary in the context of my speech.

I thank Mr. Speaker for allowing us to have this debate, but I also thank Ministers in the Department for Business, Enterprise and Regulatory Reform and the Treasury. They have gone the extra mile to give advice and help when I have approached them with concerns about important individual businesses in my constituency in this difficult time of credit famine. Obviously, our approach in this House is to be courteous to colleagues across the political divide, but I should like to emphasise that, when dealing with my concerns, Ministers have acted not only professionally, but with a great deal of care, and I appreciate it.

It is fair to say that some companies in the Croydon area continue to be hard-pressed when they seek credit in these troubled times. Rightly, the Government recognise that one of the greatest difficulties in the financial sector is the withdrawal of foreign banks from credit provision. That puts a real strain on our economy. Problems often arise from the action that the Government have found necessary to take regarding Icelandic banking institutions. Those banks had significant market penetration, and some significant companies in the UK economy have been affected. When, of necessity, credit is withdrawn, some companies are embarrassed, because they need to find appropriate credit immediately to continue their business.

Thanks are also due to the Government for listening to hon. Members’ views about the role that Northern Rock can play in the economy. It is especially good news that the Government reversed the strategy of winding down the book of Northern Rock. That policy seemed counter-intuitive, bearing in mind that the Government are keen to see the continued provision of credit to the economy as a whole.

My main motivation for leading this debate is to ask why the Government have not, at this stage, seen the bad bank solution as the one to pursue. Ministers have listened with courtesy and have not dismissed my comments in the past six months about the attractiveness of the bad bank solution. I am especially grateful to the Economic Secretary for that courtesy, but I am encouraged by what the Chancellor said yesterday. He said:

“It could be that in some cases it could be easier to do a good/bad bank split.”

When asked about the bad bank solution, Ministers have expressed concern that it is difficult to price the assets that would be transferred to such a bank. However, the best way for the Government first to provide confidence to the financial markets and subsequently to ensure the appropriate provision of credit to the economy, is to get markets going again by valuing those so-called toxic assets.

The Government have said that the problem is that they may have to rely on banks to price the assets, and they ask to what extent senior management figures in the banking industry are able to understand some of their banks’ assets. However, the additional concern—this is not so openly expressed—is that such a valuation of the bad or toxic assets may lead to the complete equity destruction of the UK banking system, especially if we bear in mind that when the bankers say that assets are unpriceable, in reality they are probably saying that the value is quite close to zero.

To some extent, Members of Parliament enjoy the rather false frisson of talking nationalisation. It would probably be more helpful to talk less about that. It comes from a retro or nostalgic desire for the halcyon days when nationalisation was seen to be an effective policy option. Instead, we should talk more in terms of some forced reconstruction of the banking system, such that the economy will regain confidence through the provision of credit.

I would like to pose a question, although I know that asking questions is easier than providing answers. What has really happened with the Royal Bank of Scotland? Coming into the new year, the Government were moving with enthusiasm towards the idea of some kind of nationalisation, but that has not happened in the case of RBS. Is it because the Government are concerned about the ensuing liabilities if the bank were to be entirely absorbed within the state sector, or did they perhaps find that the senior management of RBS are themselves entirely unsure what they have inherited from the previous senior management?

I contend that some of our UK banks are, in reality, insolvent. There are substantial assets that could be taken into any bad banking institution; I note that JPMorgan has estimated their value at £260 billion. Clearly, that is large enough to destroy completely the equity of many of our banks, although it is fair to say—I know that the word “only” might seem ironic, although it is not intended to be—that that is only 22 per cent. of GDP. The earlier the intervention undertaken by Government to set up a bad bank, the easier it will be to contain ever-burgeoning levels of toxic assets.

I know that there was controversy surrounding the issue. Joe Stiglitz enlivened the debate by saying that there was a danger of Governments paying “cash for trash”. However, it is important for us to learn the lessons from the experiences in Japan, where zombie banks were allowed to exist for many years. It was very deleterious to the Japanese economy, and is still having an adverse effect.

I fear that the Government’s attraction to the idea of insuring the bad debts remaining on banks’ balance sheets is merely deferring the recognition that the value of those assets is close to zero. The controversy is shared in the United States, and it is clear from recent debate that the new Treasury Secretary is somewhat sceptical of the attractions of a bad bank solution. Indeed, the amounts are significant. A senior US Senator—I think it was the Chairman of the Senate Banking Committee—estimated potential bad bank exposures at $4 trillion.

Clearly, the role of Government is to manage the de-leveraging process. I mentioned earlier the problem of foreign bank departures. The other problem, of course, is that the complete destruction of the securitisation market has been much more significant than anything else in the withdrawal of credit from the markets. We often hear accusations thrown in the direction of the UK banks in terms of alleged reductions in lending. In reality, as the Government would rightly point out, the amount of lending to businesses by many UK banks has risen. It is the withdrawal of credit from other sectors, such as the securitisation sector and the foreign banking sector within the UK, that has done the greatest damage.

There is a danger in the Government’s further delay in introducing the bad bank policy solution. Early intervention was likely to engender confidence, whereas reacting to further crises is likely to be seen as less decisive. Other options could be pursued, of course. One possibility is to spend much of the additional proposed money on the creation of a post bank for the UK. There are many other difficult issues before the Government in terms of developments in the financial markets.

It is interesting that Wouter Bos was willing to criticise the Government yesterday about the VAT reductions, saying that they were unlikely to have a substantial effect. Those within our own House who criticised the Government for that policy are erroneous in their judgment. It is purely a matter of the size of the VAT reduction. Obviously a 2.5 per cent. reduction is not very much. We should bear in mind that the Government’s fiscal stimulative proposals, which came at the end of last year, amounted to £20 billion. Although they are substantive and show the Government’s determination to take a determined and vigorous approach to the management of the economy, in reality these sums are very small, by comparison, for example, with the prospective losses of trillions of dollars on toxic assets in the US, or indeed in comparison with the £610 billion rescue package that President Obama is currently trying to take through Congress. So, £20 billion is quite small in comparison. It is therefore quite clear to me that, unfortunately, the Conservative party, in suggesting that less should be done rather than more, put itself on the wrong side of the argument. Given the real dangers and extreme nature of the current situation, the Government have to be even bolder in the intervention that they must pursue.

There is a great deal of criticism and attack within the US, particularly by Mr Peterson, the Chairman of the US House Committee on Agriculture, on credit default swaps. I hope that our Government will not be drawn too far down that road. In many ways, the Government’s own criticism, together with that of our European partners, of the credit rating agencies suggests that they should do their very best to encourage the further development of the CDS market. That is because the more immediate pricing that is available through CDS prices is much more likely to be a better reflection than what has proven to be an inefficient and sometimes misleading rating process, where conflicts of interest have been allowed to develop in banking practice in the last 25 years.

One other possibility, of course, is the introduction of credit controls. It is interesting to see that the Conservative party, which has previously been regarded as a free market economy party, is now very keen on that idea. However, it is quite reasonable to ask why the Government felt that asset price inflation was not a responsibility of the Bank of England. If there is time in the second half of this debate, I shall be interested to learn why that responsibility was not given to the Bank of England previously.

Another approach that could be taken is rather radical, in terms of trying to move the debate further forward. There are real dangers that the Government will now be driven into taking a significant exposure to these toxic assets through a bad bank solution, which I think in the end will in any case be inevitable. Perhaps the banks could share that risk with retail investors, if the price can be established at a very low level. The opportunity might be taken to secure savings, if the prices were significantly discounted on the assets, by sharing those directly with individual citizens within the UK.

There is a final issue that I want to raise, before I again pose the key question. Another option with a bad bank solution would be to pursue the approach that was taken in Switzerland, which was the loan solution. Money is loaned for an extended period of 10 years to institutions or banks that are in great difficulties. That might be an improved approach to the bad bank solution, in terms of not having to go immediately for the complete equity destruction of those banks. That might be an alternative way for the Government to progress on these matters.

Clearly, our European partners are very concerned about the way that matters have progressed for them and they are pushing very hard for much more centralised economic management after this crisis is over. That poses a real challenge to the Government in terms of regulation here, and it may well be best for us to turn round to our European partners and say that if, for example, they want to see Europe as a whole issuing its own debt, that is something that they will have to do without us.

I sound one last little caveat. I note that in the US it is now being suggested that for those banks that are being provided with national Government support there should be a cap on employees’ maximum remuneration of $500,000 a year. I would be interested to learn whether our Government think that that would be appropriate here.

I now come to by far the most important question that I want to ask. There is always a danger, in asking too many questions, that the Minister will not be able to respond within the traditional 15 minutes that is available in these Adjournment debates. The one key thing that I want learn from this debate is why the bad bank solution has not yet been preferred by the Government.

It is a pleasure to serve under your chairmanship in this short debate, Mrs. Dean. I start by congratulating the hon. Member for Croydon, Central (Mr. Pelling) on securing this important debate and giving us the opportunity to consider these issues further. I thank him for his typically generous tribute to the officials and Ministers at the Department for Business, Enterprise and Regulatory Reform and the Treasury who have always sought to provide him with answers to his queries on behalf of businesses in his constituency.

When people look back at recent events, many factors will undoubtedly be adduced as having created the global credit crisis that we now face. They will certainly include the employment of increasingly complex assets that were not well understood and were often linked to the mortgage market, and the bonus-driven pursuit of short-term profit in global financial institutions, which was compounded by shortcomings in regulation, most starkly in the US sub-prime mortgage market. Following the collapse of Lehman Brothers, the haemorrhaging of confidence in the financial system froze inter-bank lending, creating huge problems right across industry in the UK, Europe, the United States and more widely.

In past months, many people have been surprised by the sheer scale and speed of what has gone on, and by the impact of the recession on companies that have been unable to access the credit that they need, because of the unprecedented shock to the financial system. We are in the middle of the biggest shock to the financial system of the modern global era. In response, the UK Government have been extremely clear about our objectives right from the start. Our primary responsibilities are to support the stability of and restore confidence in the financial system, to protect depositors’ money and to protect taxpayers’ interests. Banks sit at the heart of our economy and provide lending that is vital to growth and job creation. People and businesses across Britain are feeling the consequences of the global credit crunch, which is why the Government have been doing everything possible to stabilise the financial system and restore confidence to the economy, and we will continue to do that.

As the hon. Gentleman has noted, last October, following the unprecedented turmoil in financial markets in the wake of the collapse of Lehman Brothers, we announced a comprehensive package of support for the financial system to support the stability of the banking system and to protect savers and depositors. That action has been successful in preventing the collapse of other UK banks and in ensuring that no depositors in UK banks have lost money. In our pre-Budget report we went further, as the Chancellor set out a major fiscal stimulus package to boost the economy and to deliver real help to support businesses, home owners and consumers through these difficult times.

The hon. Gentleman said that a stimulus of £20 billion is quite small, and in terms of global capital flows he is absolutely right. However, as he recognises, it is important that the Government take action. He is right to say that the Conservatives have put themselves on the wrong side of the argument when it comes to this matter. I think they will regret that and have to recant in the future.

It should not just be the UK Government who want to use fiscal measures to stimulate the economy; we need to see global action. That is why we have been particularly welcoming of actions taking place in other European Union countries, China, and most recently the United States, with the fiscal stimulus package that has been discussed under President Obama.

On top of the pre-Budget report, last month the Chancellor announced a further package of measures to support the banking system and safeguard the millions of jobs put at risk by the continuing difficulties in the financial system. Those measures are aimed at beginning to replace the lending capacity lost by the withdrawal of foreign banks and other institutions, which the hon. Gentleman discussed. The measures are also aimed at addressing the barriers that are making it difficult for UK banks to expand their lending and restore certainty to the banking sector.

The hon. Gentleman referred specifically to the bad bank and wanted to know why the Government have not implemented that option. He is aware that we have considered a number of different options and will be aware of the asset protection scheme that we announced. Troubled, or toxic, assets need to be dealt with and a major element of the package announced in January was the asset protection scheme, which is designed to protect financial institutions against exposure to exceptional future credit losses on certain portfolios of assets. In conjunction with the steps already taken by the UK authorities, the scheme is designed to restore confidence in the financial markets, promote transparency, support financial stability and improve the availability of credit to creditworthy borrowers in the economy. Under the scheme, as I think the hon. Gentleman appreciates, we are specifying that any assets protected are ring-fenced and managed separately within these banks in a way that maximizes their value. However, that is not inconsistent with a bad bank approach. The Treasury will have the ability to take over management or ownership of the assets in defined circumstances. That would enable the creation of a bad bank in due course if it proves necessary.

The Chancellor has made it clear that the bad bank approach may be appropriate in the future for certain institutions and that the Treasury will continue to examine options for any further Government action that may be necessary. With the guarantees that are provided, we believe that the asset protection scheme will work and will be important in protecting financial institutions against exposure to toxic assets.

As a further step to increase the availability of corporate credit and reduce the illiquidity of underlying instruments, we announced on 19 January that the Bank of England will set up an asset purchase scheme. The Bank will be authorised by the Treasury to purchase high quality private-sector assets, including paper issued under the credit guarantee scheme, corporate bonds, commercial paper, and a limited range of asset-backed securities. The significance of the action that we are taking in this regard should not be underestimated. This is the first time that the Bank of England will, in effect, be lending directly to the private sector. The Treasury will authorise initial purchases of up to £50 billion, and the Chancellor has this week written to the Governor of the Bank setting out how we expect to see the scheme used.

The Bank will be guided in its purchases by an assessment of the transactions that are most likely to restore the flow of finance to corporate borrowers, but also by where a viable private market will exist for the assets when markets begin to return to normal. It is important to appreciate that, during the course of this year, the corporate sector in the UK will need to refinance in the region of £90 billion to £100 billion of loans. That is why a scheme such as the asset purchase facility will be an important mechanism for the future. I note that it has been warmly welcomed by the CBI.

Complementing measures to encourage lending by financial institutions, we announced at the same time that the draw-down window for the credit guarantee scheme has been extended from April until the end of 2009. The final maturity date for the scheme remains April 2014, but again, the extension will support orderly issuance and rolling over of guaranteed paper by banks. In addition to the steps that the Government have taken, the Financial Services Authority has issued helpful guidance to address any potential uncertainty surrounding its expectations of banks’ capital reserves. The hon. Gentleman, who is knowledgeable about these matters, will understand the importance of the FSA’s statement. The FSA has made it clear that there are no new statutory requirements for institutions to hold increased capital and it reiterated its view that capital buffers built in as part of the recent recapitalisation exercise play a role both in absorbing losses and facilitating continued lending.

The FSA’s statement on capital is consistent with the remarks made on 16 January by the Basel Committee on Banking Supervision. This goes some way to highlighting the fact that we are confronted by a global problem, which requires a global solution. We are continuing to collaborate closely with our international partners. The Prime Minister and the Chancellor have held extensive conversations with international partners to ensure a co-ordinated global response to the economic crisis. I was at a meeting today with one of the governors of the Russian central bank and the Russian Finance Minister has been having talks with the Chancellor. Premier Wen met the Prime Minister only last weekend. The UK will continue to take a leading role in discussions.

The G7 autumn discussions in Washington gave an opportunity for both the Prime Minister and the Chancellor to discuss these issues with world leaders. I want to highlight the importance of the next meeting of the G20, which will be held in London in April. It will come at a very difficult time for the world economy and it is right that the Prime Minister and the Chancellor should take that opportunity to discuss with our international partners how we can further co-ordinate international action. We want to drive forward an ambitious work plan, both to tackle the problems in the global economy and to strengthen the stability and resilience of the global financial system for the future.

In conclusion, we will continue with our dual approach to tackling the global downturn and its far-reaching impacts by working internationally to tackle its causes—the global banking crisis and the lack of adequate funding in the global financial economy—and dealing fairly with its consequences here in the UK, providing the right support for people and businesses. The industrial activism approach that we are adopting as a Government, through introducing the working capital scheme, the enterprise financial guarantee and a range of other measures, not least of which is the recent support for the automotive industry in particular, which we announced last Tuesday, are all indications that this Government is looking to provide real help for businesses now to help them get through difficult times and, at the same time, supporting the banking system.

These are difficult challenges and new challenges are emerging every day, but we are determined to do everything necessary to support people and businesses through the downturn and to get our economy growing again just as quickly as possible.

Question put and agreed to.

Sitting adjourned.