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‘When Banks Get It Wrong, Politicians Should Reconsider Their Own Role’

When Banks Get It Wrong, Politicians Should Reconsider Their Own Role

Professor David B Smith

Friday 6th July 2012: Governments have much to answer for when it comes to the banking crisis. Here Professor David B. Smith warns that political interventions in the banking sector carry a high price. Breaking up the banks so none is ‘too big to fail’ is a far better option than ever more regulation.

This week Bob Diamond resigned as chief executive of Barclays and gave evidence at the Treasury Select Committee. His evidence to the Committee revealed an important point: Barclays understated their interbank interest rate partly because of fears they would be subject to nationalisation at the behest of the former Prime Minister Gordon Brown. Alistair Darling the former chancellor was excluded as the potential nationaliser.

One aspect of the banking crisis that has not attracted the attention it should (see my Politeia pamphlet, Crisis Management: How British banks should face the future) is the arbitrary usurpation of the rule of law in the case of the Lloyds HSBOS merger. There, the chairman of Lloyds, Sir Victor Blank, and the Prime Minister agreed at a cocktail party that the Lloyds HBOS merger could go ahead, despite its probably being contrary to the then monopolies and mergers legislation.

Certainly in my experience as an economist at a clearing bank in the 1970s, the concern was widespread that the then Labour government intended to nationalise one of the big four clearing banks, a policy advocated by Tony Benn. The problem is that when governments do not respect property rights and the rule of law, all sorts of commercially stupid and damaging decisions tend to be taken in response to perceived political threats. For example, two of the clearing banks bought American subsidiaries – they would be, it was thought, unlikely to be nationalised by the British Government because the US Government would not want that. In the event both acquisitions turned out to be extremely financially damaging to the institutions concerned.

As far as dealing room behaviour is concerned, while reprehensible, it probably will come as no surprise to those who have worked in a dealing room. All banks have made huge and expensive efforts to prevent such misbehaviour. However, the size and complexity of modern banks means that it is almost impossible to affect detailed top down management control from the centre. Socialists do not abandon their faith in socialism every time a Post Office clerk steals £10 from the till, and one has to be realistic about what can be achieved in banking.

The longer term model is that if banks are too big to fail and they can’t be controlled, they need to be broken up, as I argued in my 2009 Politeia pamphlet. The evidence is clear that small banks that face a bankruptcy threat do not misbehave. That pattern is obvious in the USA and historically in the UK. The quick and easy route to breakup would be to announce that the original constituent banks put together to form the big four clearing banks in the 1970s should be hived off (as advocated in my 2009 pamphlet). Trying to control with bureaucratic regulation on top of bureaucratic regulation is just not practical. Indeed, if you’re not careful, it will seriously damage reputation of regulators as well as financial institutions concerned.

*David B. Smith is currently Visiting Professor in Business and Economic Forecasting at the University of Derby, chairman of the IEA Shadow Monetary Policy Committee, and a visiting lecturer at the Cardiff University Business School. He is author of the Politeia pamphlet Crisis Management: How British banks should face the future.

David B. Smith

David B. Smith is a City economist who worked as a macroeconomic modeller and economic forecaster, predominantly in banks (including the Bank of England) and security houses (1968-2006). He maintains his own macroeconomic forecasting model at Beacon Economic Forecasting. His Politeia publications include Britain's Taxable Capacity: Has it Reached the Upper Limit? (2020), The Brexit Settlement and UK Taxes (2018) and Banking on Recovery: Towards an accountable, stable financial sector (as co-author, 2016).

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