Vince Cable: Our obsession with competitiveness risks another crash

Sir Vince Cable was shadow Chancellor from 2003 to 2010, secretary of state for business, innovation and skills from 2010 to 2015, and leader of the Liberal Democrats from 2017 to 2019.

It is now 15 years since the first tremors were felt. They became a financial earthquake that humbled — and almost destroyed — major banks. They caused immense economic damage and hardship, some of which is being felt to this day.

In trying to understand the mistakes and hubris that led the financial community into this disaster, I recall two seemingly innocent words that bankers used to explain their behavior. One was’innovation’, which turned out to involve the confection of complex, mathematically ingenious, financial products that the bankers themselves didn’t understand.

The other was’competitiveness’, which essentially involved undertaking high-risk activities with extreme leverage — deemed to be necessary because overseas or domestic competitors were doing it, and bank shareholders needed to be reassured that maximum returns were being earned.

It also involved massive bonuses for senior executives and traders, which were necessary to operate in a competitive transatlantic market for talent.

Those clearing up the mess after the party was over — in my case in the coalition government — were insistent on fundamental reforms to ensure that the same mistakes were not repeated. The Bank of England and overseas regulators agreed on stricter reserve requirements to minimise systemic risk ..

Our government — aware that Britain, in the crisis, had some of the world’s biggest banks in balance-sheet terms — insisted that, as far as possible, banks should not be deemed too big to fail. bailing out financial institutions, banks should pay insurance in the form of a levy on bank balance sheets.

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A further reform, which was sufficiently critical that it was a condition for me and my party entering the coalition, was that risky investment banking activities should be clearly separated from mainstream banking, so that if something went wrong in the’casinos’, it could not be cross-subsidised by banking activities essential for business and households.

After the Vickers Report and a prolonged implementation process, the necessary changes – ring-fencing — were completed three years ago. There was grumbling over the cost, though banks were spared the radical option of complete separation as per the so-called Glass-Steagall reforms based on post-Depression safeguards in the US.

Those who have studied the history of financial crises have often wondered why they occur with monotonous regularity. The simple reason is that the lessons of the previous ones are forgotten. Greed or amnesia eat away at restraint and discipline. A new generation comes into the business. that has no recollection of previous disasters, but finds the disaster-prevention regulations irksome and costly.

Or new forms of risky activities emerge — currently crypto markets — which are blithely assumed to be of little systemic danger.

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We can see these forces at work right now. The Chancellor has already listened to those who demanded a cut in the insurance premium — the tax on bank balance sheets — even though there is no confidence that the’not too big to fail’test has been met. Worse, banks have been agitating to water down the ring-fencing system.

It is reassuring that banks should find ring-fencing inconvenient and unprofitable; that suggests that it is doing its job. It is less reassuring that the Treasury seems to be listening to the industry’s complaining.

We shall know how far the government has been seduced by the lobbyists when we see the details of the Financial Services Bill to be announced in the Queen’s Speech on 10 May. It is widely expected that the Financial Conduct Authority and Prudential Regulation Authority will have a statutory responsibility to promote international competitiveness in the financial sector, alongside already existing objectives to promote consumer protection and competition between firms.

Andrew Bailey, who was a regulator at the FCA before becoming governor of the Bank of England observed that, under the pre-crisis regime, “the regulator was. required to consider the UK’s competitiveness, and it didn’t end well, for anyone ”.

The extensive post-mortem on the crisis by the coalition government and by Parliament found that the duty of pre-crisis regulator the Financial Services Authority to “have regard to” international competitiveness contributed to the crisis and the Treasury removed it.

Despite this recent history and the long and dismal history of financial crises following the same cycle of carelessness, lax regulation and market exuberance leading to a crash, nothing seems to have been learnedt.

Those seemingly innocuous words “international competitiveness” contain a lot of peril and, if the Financial Services Bill promotes them, I hope that wiser counsel in Parliament will prevail.