Let’s start by getting something straight. Gordon Brown likes to blame all our troubles on America – as though our fundamentally sound economy and banking system were hit by some nasty financial import.
But our banking system is not separate from our economy, it is a reflection of it. The unsustainable debts in our banks are a reflection of unsustainable debts in our households, our companies and our government. So while of course it’s true that some of our problems are global……we’ve got to recognise that the underlying policy failures were national.
The failure to regulate U.S. sub-prime mortgages was an American failure. And the failure to regulate public and private debt here was a British failure. It was a failure that led to our households becoming the most indebted in the world……our banks becoming the most leveraged of any major economy……and our housing boom being bigger than in the U.S.
If we’re going to restore financial confidence, we have to be honest about these home-grown failures of financial policy and regulation. If we won’t admit that anything went wrong in the past, how can we get things right for the future?
Self evident stuff, maybe, but it needs to be said. Gordon Brown needs to acknowledge his, and the government's failure here. If he really believes it is all America's fault he's even more delusional than I thought.
That's an important statement of intent. It has echoes of Ted Heaths "unacceptable face of capitalism".
Some people argue that the Conservatives cannot be the ones to take on this task. They say: “Why should we listen to you, the champions of markets, when markets have collapsed?”
They ask: “How can you – the party that believes in deregulation – sort out a mess caused by not enough regulation?” Well let me answer those points directly.
Why listen to us? Because the people of this country don’t want to turn their backs on markets. They know that the free enterprise economy is the foundation of so much we want to achieve: our collective and individual quality of life; our social progress; our ability to protect the environment for future generations. People don’t want to abandon markets, they want us to reform markets so they work properly. What they want is a sense of order and responsibility brought to the operation of the financial markets. People might not follow the minutiae of over-leveraging or short-selling, but they know that the roots of our current crisis lie in recklessness and greed.
When they look at capitalism today too many people see markets without morality, and that’s what’s got to change. As I’ve said before, we need capitalism with a conscience. That is a task for the modern Conservative Party. We are the party of law and order, so we are the party to bring law and order to the financial markets. We are the party of social responsibility, so we are the party to bring social responsibility to the financial markets.
And we understand the intimate connection between these two values – that you cannot have order without responsibility.
It is precisely because Labour do not really understand this that they ended up designing a system of financial regulation that completely failed. The right question here is not light regulation or heavy regulation. It is right regulation or wrong regulation.Absolutely right. Overregulation of a market can stifle and then kill it.
The modern Conservative Party understands the role that regulation needs to play. We understand that regulation is a vital part of making sure markets work properly. But it’s got to be the right regulation, applied in the right way to the right situation. Our approach is to cut regulation where the problem is too much of it – like the red tape that is strangling small business. And to reform it where the problem is the wrong kind – like the failed system of financial regulation. That way, we can bring to the market what we need to bring to society: freedom with responsibility.
And just like bringing law and order to our streets, in financial markets, this culture of freedom with responsibility must be promoted by the right frameworks, policed by strong institutions and enforced with real authority. The difference with Labour is stark.
Their idea of regulation is a list of rules that look good on paper. We’re concerned with what works in practice. They think it’s about the right bureaucratic process. We think it’s about the right professional judgement. For us, it’s about the right institutions, the right authority and the right discretion. That’s why with the Conservatives, the Bank of England will be back and we will restore its role in regulating the level of debt in the economy.
This approach – promoting, policing and enforcing order and responsibility in the financial markets - is what I want to explain today. First, promoting order and responsibility. One of the reasons our banks became so leveraged is because the rest of us were willing to take on more and more debt. So we need to tackle problem debt and encourage personal responsibility. That means taking into account how people really behave - not how economics textbooks presume they behave.
Because, whether you like it or not, people are not always rational. They do not always act in their best long-term interests. And they are often heavily influenced by what people around them are doing. In the bureaucratic age, that's a problem. But in the post-bureaucratic age, it can be an opportunity.
As Richard Thaler has shown, when you design policy so that it reflects how people think and act, you really can encourage greater responsibility. But we don’t just need to promote responsibility among individuals – we need to promote it across the whole financial system.
Cameron is right. Markets are rational, but only when they operate in a free flowing and transparent way. Markets which operate on a false premise can never be rational. They provoke people into making irrational decisions.
Good. Lay the blame where it belongs. At Gordon Brown's feet.
In 1997, Gordon Brown created a new institution, the FSA, to oversee our banks. Last week, Lord Turner launched a report that can only be described as a withering critique of its failings. They are failings we have long recognised. For a decade, this Government forced the FSA to obsess about products, processes and procedures, box ticking about who’s in place to do what job……while neglecting entirely a bank’s business model and what they were buying, at what price and with what debt. This wasn’t light touch regulation. It was just completely the wrong regulation. It missed a central insight into financial markets: that they’re made up of people, not units of production. It rises on their genius and innovation but falls down on their irrationalities and over-exuberance. So just as with individuals, creating a culture of responsibility across our financial markets means introducing regulation that responds to the way markets and people actually behave. We need regulation that recognises the psychological levers of boom and bust.
That’s why we led the debate in the U.K. when we called for banks to be required to hold more capital during the good years in order to absorb losses during the bad years. I’m pleased that reforms to Basel II and the need for what is known as macro-prudential regulation to manage the credit cycle have now been adopted in the Turner Review and are on the agenda at the G20.
This is about reining in that irrational exuberance that is associated with any boom – the feeling that the music will never stop, so we can keep on dancing. The truth is that it is precisely when the music is loudest – as it was over the past decade – that we need regulatory discipline strong enough to cut through that exuberance and keep banks responsible.
The next question is: how do you police this order and responsibility? In 1997, Gordon Brown removed the Bank of England’s historic ability to ensure that banking credit was kept within responsible limits. In one broad brushstroke, the only organisation with the expertise, and authority, to call time on the overall levels of debt in our economy was taken out of the picture. In its place, the then Chancellor put a Tripartite System which monumentally failed its first test. Because he cannot admit his mistakes, Gordon Brown doesn’t understand that the model he pursued for the past ten years has fundamentally failed - so he’s unable to recognise that this system needs to change. We’re clear that it does need to change.
And we’re equally clear as to how. To police responsibility within our financial services, we need to call on the only institution with the authority, respect and influence to keep our banks in check. It’s time to bring back the Bank of England and restore its role in regulating debt. When Labour took away this role back in 1997, the Bank of England’s banking expertise was allowed to wither away. We will rebuild that expertise by giving the Bank an explicit role in macro-prudential, system-wide, regulation.
We will put the Bank of England back in charge of regulating the overall level of debt in the economy, and allow it to make judgements on what is sustainable and what is not. The Bank will set out any concerns in a letter to the FSA, which in turn will be obliged to take that view into account when setting the amount of capital individual banks must hold.
So if the level of debt in our economy is growing unsustainably, the Bank will instruct the FSA to ensure banks either slow their lending or put aside more capital. But of course, we don’t just need policing at national level.
Finance is international – indeed much of the credit growth in the UK over the last decade was channelled from abroad. So we need the right mechanisms in place internationally, as well as at home. As Lord Turner has pointed out, that means greater coordination at a European level.
But in a global economy, even that won’t be enough. We need to think truly global. Yes, that means reforms to the Basel II agreement to make it less procyclical – so that banks put more money aside in the good years, to act as a buffer in the bad. And it means a greater role for the IMF in monitoring national economies – as well as a way of ensuring that its warnings don’t go unheeded as they did over the last few years.
But the ultimate authority must remain with the Bank of England, as it is British taxpayers who will be asked to pick up the bill if anything goes wrong. So we need international co-ordination……and national regulation.
When it comes to that national regulation, we are clear about how it should be enforced. It used to be said that one twitch of the Governor’s eyebrow would be enough to get our banks to behave responsibly. Our plans will restore the power of the Governor’s eyebrow.
But as Sir James Sassoon has said in the review he recently carried out for us, the Governor’s authority works best when it is backed up by real power. So we are considering the suggestion that we should give the Bank of England further power to go into individual banks…to tell them they haven’t got enough capital, tell them there’s too much leverage, tell them to sort themselves out......or expect the full authority of the Bank.
When you’ve got a problem with debt – you call for the people who understand how to control spending and get debt down. And when you’ve got a problem with law and order and a lack of social responsibility - you send for the party of law and order and social responsibility.
We know what’s gone wrong – we’ve had the wrong type of regulation overseen by the wrong type of people. And we know how to put it right. Promoting responsibility by creating the right kind of regulation. Policing it by restoring the Bank of England to its proper role. And enforcing it by giving the Bank of England the authority it needs.That way, we will bring back proper regulation of the banks and financial markets and help restore financial confidence, a vital step on our routemap to recovery.
That was an excellent speech, full of meat, full of integrity, full of vision. It shows a clear, well thought out approach to the future of financial regulation, all designed to bring confidence back to the markets.