Sunday, September 28, 2008

Mislaid another bank

Bradford and Bingley has collapsed and it to be nationalised. This is for the same reason, broadly speaking, as Northern Rock: a dodgy mortgage portfolio sold without adequate credit risk control that was paid for from the money markets rather than retail deposits. So, when the money markets dried up no one would take the mortgages a security, or at all, and that was that. The government is probably right to step in, provided it does what it should have done with Northern Rock and immediately breaks up the business. It needs to sell off the good bits, shut down the bad bits, and reassure depositors. Sadly, that probably means the end for the B&B's loyal staff, most of whom were not a party to the poor decisions of their board, exacerbated by a tripartite regulatory system that is a new synonym for failure.

So, what needs to be done now? Well the Conservatives are starting to propose the sorts of measures that are needed in the form of a reform of banking regulation, and public finances that are not built on excess debt and off balance-sheet vehicles. I have no inside information, but this is what I think: first, we need transparent public finances. No more rubbish about 'borrowing only to invest across the economic cycle' or an 'end to boom and bust', with rhetoric replacing realistic public policy. Fortunately, the smart money is that is exactly what George Osborne will be talking about tomorrow at Conservative Party Conference. Then we need to revert to a system of banking regulation that actually works. That means an end to the Treasury, the FSA and the Bank of England collectively failing to notice a crisis until queues started forming outside of bank branches. So, one regulator, and I would plump for the Bank of England in that role. Then we need to look at Bank's capital adequacy requirement, which is how much cash they keep on hand relative to lending. This needs to be increased and banks cannot be allowed to sidestep it by securitising loan books, which takes them off the balance sheet in a way that avoids regulation but not risks. We also need a better way of measuring asset quality, though the markets are probably taking care of that, and a way of reflecting the underlying funding for bank business. So, there needs to be a limit on what proportion of loans can be funded out of money market activity as opposed to customer deposits or other long-term debt. Put simply, the timescale for most long-term lending must match the timescale for the funding. Otherwise institutions are exposed to grotesque market risks. It is not accidental that the banks that have failed had the highest exposures of this type.

As Gordon Brown said, the 'age of irresponsibility' is at an end. Given he is the architect of it then he goes too.

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