Parliamentary Connections

It is hard to judge whether the massive rises on the financial markets on Friday (not so far continued this morning) were driven by anything other than a naive sense of relief. The huge, unprecedented lifeline thrown to the rapidly sinking banking sector by the US government possibly made many in the markets believe that the worst is over. In truth, for them, the worst may be yet to come.
There will be a huge price to pay for the massive support from public funds that has been made available to the financial services sector around the world ever since the Labour government in the UK took Northern Rock under its wing. These massive subsides will screw up public finances for years, leading to cuts in public expenditure and increases in taxation, most likely a combination of both. Electorates will simply not stand for that unless they feel the incompetence, greed and sheer lunacy of the financial markets have been purged and brought under control. That means regulation on a scale that hasn't been contemplated before. It is isn't about transparency - what is the point of being transparent about hedge fund and derivative products so complex that only a handful of people understand them, and certainly not very many of the people selling them?
It will be a different sort of regulation. It may even see the abandonment of the regulation by solvency and a move towards the strict regulation of products. This should be looked at as the financial services sector has an appalling record when it comes to creating the right products for the right people in the right circumstances. On the retail side in the UK we have pretty much had 20 years of product-related scandals and now, across the globe, the wholesale markets have proved themselves catastrophically inept too.
May be this morning's cautious opening on the European markets is a the start of the realisation that the world has changed forever and that the immediate future will not be very rosy for those who plunged us all into this crisis.

Up until late last night it looked as if AIG was a dead man walking. Then the US government stepped in and effectively nationalised it, the second time in a fortnight that the right wing Bush administration has played the public ownership card, following the bale out of Fannie Mae and Freddie Mac. It is a measure of the chaos in financial markets that both moves have been greeted with big upswings on the world's stock markets.
It used to be part of the mantra of the left of the Labour Party when socialism was still alive that it would nationalise the "commanding heights of the economy", including banks and insurance companies. Now that is a reality in the country that always liked to paint itself as the home of free markets and unfettered capitalism.
But, as we know all too well, state ownership of commercial businesses does not work. I am sure the US government knows that too which is why it is totally mistaken to paint this move as the saving of AIG. It is far from it. It will be dismembered and parts sold off as quickly as is decent and practical. It is also hard to see how its revenues, certainly from insurance business, will stand up. How can any broker recommend placing business with an insurer that would be bust if it wasn't for a huge state subsidy? Surely, its new premium income will nosedive? At best, AIG is living on a life support machine that, one day, will be turned off. At worst, it is a dead man in chains.
There is, however, something rather fitting about governments having to dig deep into public funds to prop up the financial services sector – we mustn't forget that the UK government nationalised Northern Rock last year too. For the best part of 20 years, governments around the world have allowed themselves to be mesmerised by to so-called Masters of the Universe that run (ran) the major financial institutions and passed far too much responsibility for the running of financial markets to them. Now they are having to pick up the tab for that reckless abdication of political responsibility as the one time masters are revealed as the Muppets of the Universe.

I have often wondered at the informal hierarchy of the City and its financial institutions which always seems to put bankers at the top of the tree. Do they deserve to be there? The case for such pre-eminence looks very shaky to me.
It seems that the live on the edge of the fool’s paradise of power without responsibility. Is that abit harsh? Just look at the current economic crisis gripping the developed world and ask yourself where does the responsibility really lie?
Bankers have been at the forefront of persuading governments to adopt a light touch in regulating them and to hand over to(central) banks control over a lot of the central levels of economic policy. Have they used that freedom and control well? The answer has to be a resounding no. Irresponsible lending, the growth of financial instruments that are little more than gambling and a dreadful track record in running their own businesses – the charge sheet is very long and very serious.
Will they be punished? Far from it. At the slightest hint of real trouble the banks have looked for state handouts and have largely been given them for the simple reason governments know they cannot afford a collapse in the banking system. Just look what happened in the UK when a relatively modest bank, Northern Rock, got into trouble and the government hesitated before stepping in.
Bankers know that they are immune from the consequences of their decisions which is why they constantly make such bad decisions. It is a pity that they don’t display a little more humility and awareness of their responsibility for the pain other business and ordinary people are now experiencing.

The first tentative steps in the government's long trek to recover its credibility were announced this morning when the Chancellor, the beleaguered Alistair Darling, announced plans about plans for tackling the next banking crisis. The trouble is they haven't solved the last one yet.
Northern Rock still looks like one huge financial black hole with billions of public money being poured into it but no plan in place to recover it. The attempts to engineer a private sector sale seem to be running into the sand because of opposition from shareholders. It still looks to me as if the only sensible option is to nationalise it, strip it down to its components and then sell off those that are viable, using the proceeds to repay the huge sums that have been required to prop up this lame duck.
Why the reluctance to do this? Shareholder power seems the common excuse. But are these the most important people? I would argue no. First and foremost are the savers whose money is with the bank and these, at least, now look safe. Then, there is a careful juggling act between the needs to look after the staff and repay the loans. Only after that should shareholders get a look in.
Is this harsh? Investing in the stockmarket is a risky investment with potentially high rewards - but investors have no right to expect all the upside and then be sheltered from the downside. Northern Rock shares were a hot buy a year ago as its "too good to be true" story seduced people, many of whom should have known better.
It will be interesting to see the detail of the government's plans when they come out next month but unless they stop pussyfooting around the problem of what to do about shareholders they won't solve the current crisis let alone create a viable plan for dealing with the next one.

Parliament is in severe danger of missing the chance to reassert its authority as the advocate of the people it purports to represent as the credit crunch drags on. In the last week it has blown two golden opportunities to put itself at the forefront of holding government, regulators and financial institutions to account.
First, last Monday, the Treasury Select Committee decided to turn itself into a glorified phone-in programme when it had Alistair Darling, Mervyn King and Lord Turner (New FSA chairman) in front of it. Instead of probing deeply into some of the governmental and regulatory shortcomings - failures wouldn't be too strong a description - that led to the cliff edge rescue of the banking system, it decided to put questions emailed in by the public to the three people who could shed most light on what has gone wrong. Predictably, these questions ranged from the pathetically obvious to the inanely trite and did nothing to disturb the three well prepared men. It was a huge missed opportunity and shows how poorly advised and resourced the select committees are.
Then, yesterday, the economic crisis was debated on the floor of the House of Commons at length for the first time since Parliament returned over a month ago - that delay itself is an abdication of its duty. You may wonder why this debate hasn't been more widely reported today. This is because it was the Liberal Democrats who initiated the debate and so frightened are the government of being exposed to any scrutiny over our economic woes they - with the limp connivance of the Conservatives - fielded a reserve team to face Vince Cable, who seems to conduct the political discussion about the crisis on a different level to every body else.
So, once Mr Cable had set out a very eloquent analysis of the situtaion and some of the remedies that needed to be applied, we heard from Angela Eagle, the newly elevated Exchequer Secretary to the Treasury (with a miss-mash of responsibilities including "better regulation") who spent 20 minutes trying hard to avoid answering any of the questions put to her by Mr Cable. She was followed by the even lower profile Tory spokesman Phil Hammond, who added absolutely nothing.
I suppose the insult to Mr Cable was to be expected given the political vacuum that Westminster occupies but the failure to appreciate that he has become the most widely respected elected politician in this country when it comes to commenting on the banking crisis and articulating the concerns of many ordinary people shows just how far removed Parliament has become from the people who put it there - and it wonders why politicians continue to fall in the public's regard and fail to engage people. As Barack Obama has just emphatically shown - to engage people you have to start thinking like them and stop playing political games they don't understand and, indeed, hold in contempt.

‘Bonus’ has become a dirty word, certainly when mentioned in the same breath as banks and in the earshot of some Labour MPs.
Last night Lloyds TSB met around 20 Parliamentarians over dinner (arranged many months previously) to share its views on the state of financial services sectors, especially mortgages, pensions and small business banking. Inevitably, the news that chief executive Eric Daniels had on Monday reassured staff that their bonuses would be paid came up.
Lloyds TSB explained patiently that this internal announcement had been aimed at call centre, branch and back office staff on relatively low salaries who have an element of performance related pay or who have reasonable expectation of receiving some very modest bonuses based on reaching certain targets, even though they do not strictly speaking have performance related pay deals. To me the shocking fact was not that these people were going to be paid bonuses of a few hundred pounds but that the basic salaries quoted for some of the people covered by the announcement were as low as £11,000, with £15,000 apparently being a fairly typical figure.
You might have expected the more left wing Labour MPs and Labour peers with strong trade union connections to have been shocked by the base level salaries Lloyds TSB pays – but not a peep on that front. They remained angry at the thought that anyone working for a bank in the current climate might qualify for a bonus. You could sense the resigned exasperation among the Lloyds TSB management at the dinner at the realisation that this was an argument that they simply couldn’t win despite the more understanding noises made by the Tories around the table.
This argument has to be put into the context of the very low esteem in which the banks are held at the moment. Recent opinion polls have suggested that the overwhelming majority of ordinary citizens on both sides of the Atlantic lay the blame for the recent financial turmoil and our present economic woes firmly at the door of the banks. They want them punished and hackles rise from Detriot to Durham at the suggestion that any bonuses should be paid. This crude, knee-jerk reaction is understandable. To carry it through to wanting to punish low paid bank staff as far removed as my paper boy from the decisions that nearly brought the entire global banking system to it knees defies reasonable commonsense. This is not the fat cats of Wall Street trying to maintain their luxury lifestyles by paying themselves huge discretionary bonuses, as revealed over the weekend.
I am all for showing those at the top of financial institutions that gambled their fortunes and our future well-being the way to the dole queues without a penny of compensation. They should have known what they were doing and shouldn’t be surprised if they have to carry the can for corporate incompetence on an unprecedented scale. Many of their staff will have to share the pain anyway as banks struggle to cut their cost base, without denying them a few hundred pounds extra in their wage packets at Christmas. That would just be spiteful.

When the dust finally settles on the wreckage of the financial system once the current storms have subsided one area the spotlight of scrutiny and blame will fall on will be the ratings agencies.
Listening to several well informed MPs and peers talking last night it is clear that they are getting a little tetchy at hearing the very tired refrain "But the ratings agencies said they were AAA". They are entitled to feel this way.
How many times have we heard people hide behind the ratings agencies when financial institutions hit the rocks? And how many times have the ratings agencies failed to do their jobs adequately? I struggle to recall the collapse of an insurer, bank or savings fund clearly predicted by the ratings agencies. Yet, people have continued to put their faith in them, a faith that for so many has now proved cruelly misplaced suspect many politicians.
Should they be regulated? Should they be expected to contribute to the compensation of people who have lost money investing in the Icelandic banks festooned with those once comforting 'A's? Should their role be taken over totally by a regulator? These are some of the questions that MPs of all parties are asking.
The agencies need to reassess urgently what their role is going to be in the future and how they are going to perform it better because these questions - and the grave doubts about the competence and adequacy of the current system that lie behind them - will not go away.

There was a useful bit of scene setting yesterday by John McFall, the combative chairman of the Treasury Select Committee as it prepares for its first foray into the violent storms gripping the financial markets.
Showing a perceptive awareness of his reputation, he said financial stability should be everyone’s number one priority, adding: “We could all have fun and games but it might only add to instability”. This dampening down of the expectation that the select committee’s sessions this autumn could be akin to a political fireworks display will be welcome news to the senior figures from the housing and mortgage markets invited to appear before Mr McFall and his fellow interrogators on Tuesday.
If those giving evidence on behalf of the markets play it right on Tuesday they should be able to illicit more sympathy than hostility by shifting the blame to the wholesale markets and regulators for creating the conditions that led the chronic overheating of the housing market. I retain a healthy degree of scepticism, however, about the ability of the Treasury Select Committee to refrain from going for the jugular when it gets senior bankers and regulators in front of it later in the month.

The cataclysm sweeping across global financial markets is moving so fast that no-one can keep up. That includes readers of this blog.
I was chided last night for my comment of a few weeks ago that AIG was a dead man in chains. A few weeks ago that is what is honestly looked like. The nationalisation of AIG by the US government looked to be just a way of postponing the inevitable demise, of managing its departure from the scene. Who, it did not seem unreasonable to ask, would want to be insured by AIG? State owned insurers simply had no place in the financial firmament.
Now state owned financial institutions are almost commonplace. We have woken up this morning in the UK to the news that many of our banks are going to join Northern Rock and Bradford & Bingley on the list of banks wholly or partially owned by the taxpayer, a solution that seems not to have ended the panic on the markets – perhaps we should close the markets down for a few days and throw a bucket of cold water over the lot of them.
Anyway, where does that now leave AIG? I still think it is in chains - just look at the exchanges over its jolly for top salespeople in Congress yesterday if you think it can just carrying on as before. But it is alive and will be kept alive simply because the alternatives are unthinkable.

The financial chaos around the world is obviously going to dominate the first few weeks of the new Parliamentary session. I noticed a few commentators wondering why Parliament wasn’t recalled early – maybe yesterday’s response to the Chancellor’s statement provides sufficient answer.
The markets are so very jittery – nervous wrecks might be a more apt description – that any word out of place by the wrong person and calamity follows almost immediately in its wake. In the case of Alistair Darling’s statement yesterday it seemed to be more about which words didn’t find a place in his statement, rather than any that did. The markets wanted to hear that the government had found a magic wand, one wave of which would solve all their problems. In practical terms they were probably looking for a huge injection of capital with as few strings as possible attached. They really were in fairyland.
It looks ever more likely that there will be a further offer of public funds to shore up British banks but it will have tough conditions attached to it. These may come in the form of high dividend expectations, profit shares that guarantee and eventual benefit to the public purse and tough restrictions on the levels of pay for executives and traders. It is simply impossible to imagine anything less getting through Parliament. After all, the political centre of gravity of our Parliament is several paces to the left of that of the US Congress and they extracted a heavy price for backing the $700bn bail out package
Another parallel with the US that we can expect to experience here is a severe grilling of anyone with any taint of guilt when it comes to causing the crisis by any Parliamentary committee that can get its hands on them. Yesterday’s grilling by House of Representatives oversight committee of ex-Lehman boss Richard Fuld gives a very appetising taste of what is to come on both sides of the Atlantic: it certainly won’t be for the squeamish.
I relish the prospect of John McFall’s Treasury Select Committee sinking its teeth deep into assorted regulators, bankers and traders during the autumn; it will be real political blood sport. Given the recent record of that committee, it should also be quite revealing and give us some idea whether any of them have a clue as to what they have unleashed, let alone ideas for controlling it.

There is no shock value in the current crisis-ridden climate when a consumer group says the financial services sector has a mountain to climb to restore consumer confidence. Which? - once the Consumers Association - set out this case with admirably clarity when it spoke to the All Party Parliamentary Group on Insurance & Financial Services recently. More of a shock was its critique of a regulatory system that we all know has failed but which few have yet pointed so clearly at where they believe the fundamental fault lines lie. More of that later.

As hard as he might try, it looks as if Gordon Brown has already lost control of the debate on the future regulation of the world's financial services industries. His pleas to President Obama and the US Congress for a co-ordinated global response sounded very fine but lacked substance and, crucially, lacked credibility. His hopes of pulling off a deal at the G20 Summit next month now look very slim.

Most of the rest of the world is not looking to the UK or the United States for a lead in reforming the way financial markets and the firms that play in them are regulated for the simple reason that they think the Anglo-US approach of the last 25 years has a lot to do with the mess the world's economies are currently in as many leading commentators are starting to point out. Europe, in particular, does not want a UK or US solution and is already busily working at its own. Last week's Larosiere report spells out a new approach that has quickly won approval in the European Commission and among key national governments in mainland Europe. The Larosiere Report?  You haven't heard of it? You can be forgiven because the coverage in the UK of this key report for the European Commission by former International Monetary Fund managing director Jacques de Larosiere has been poorly covered here. Yet, it has set the EU on a course to create three new pan-national regulatory bodies - the European Banking Authority, the European Securities Authority and the European Insurance Authority.

These new regulators will be given wide powers to impose supervisory standards on national regulators, make binding decisions on technical issues (very likely to include powers over product design) and enforce adequate prudential supervision in conjunction with another new body, the European Systemic Risk Council. Certain pan-European organisations will find themselves closely regulated for the first time with credit ratings agencies at the top of the list - they are in for a very nasty shock if these recommendations go through. For the time-being, the EU envisages micro-level regulation of individual firms being left with national regulators but it sets out a course towards far greater control in the future, threatening to bring a range of other market and conduct of business issues under the remit of its new structure.

The report and the Commission make a nod in the direction of the world outside Europe's borders by urging a "deepening of the EU's bilateral financial relations with all its major partners" but here, in the very next line, is the key statement of intent "There is an opportunity for the EU to seize global leadership". This is where the battle lines will be drawn and it is hard to see Gordon Brown's voice being heard above the noise of that battle.

There are some scores to be settled with the UK among many regulators in Europe dating back to the creation of the Single Market in financial services in 1992 when the UK won a protracted argument over the balance between prudential regulation and product regulation, with the EU rules coming down firmly in favour of the former. At the time, many financial products in Germany, France, Italy and Spain were tightly regulated in terms of design and rates. All of that was replaced by a more UK orientated system of prudential supervision and it is that system that many in Europe believe has now failed, no more so that in the UK. Larosiere comes back time and again in his report to the need to regulate at much more detailed level, especially when it comes to hedge funds, over-the -counter derivatives and credit default swaps. It also has things to say on the need for greater risk retention by the issuers of securitised products and calls for common rules for what it rather vaguely refers to as "investment funds".

The UK has given a lukewarm welcome to the Larosiere report but merely praising it as a "good basis for further discussions" as Alistair Darling did this week is hardly going to win friends at the European Commission, especially as he goes on to dismiss the idea of given any new pan-European bodies powers over national regulators. Europe sees it as the agenda for those discussions and we can expect to see France and Germany pressing this at the G20 summit. They are not interested in the sort of wishy-washy talk of global co-operation that the Prime Minister peddled to the US Congress this week: they want firm action with tough new rules and see how to deliver that as the starting point for debate, not merely as an option for discussion.

If the UK financial services sector wants to engage in the real debate over the future of regulation it will be much better advised to look to Brussels rather than to Westminster.

The last week has seen a flurry of activity around the world on the regulatory front but I have a suspicion that the only people who will be really satisfied are the very people at whom the reforms are aimed - the institutions that caused the financial storms of the last year or so. As far as I see it, the United States and Europe have such fundamentally different approaches to this that it is hard to see any global regulatory consensus emerging, let alone concerted action to put in place a regulatory system that would prevent the near collapse of the western financial system again. We have to remember that we are only looking at a slightly calmer scene now because of the billions of public money poured into propping up the system and its institutions. As Sir Martin Sorrell observed on Radio 4 last Friday, the amount of public debt racked up dealing with this is equivalent to the cost of a major war and it should be inconceivable that no-one is held account for causing that war.

Let's start in the UK.

At the annual Mansion House Dinner in the City of London last week, we saw the government and the Bank of England at loggerheads over the path regulatory reform should take. One was pleading for very limited action, saying that we should just look to the boards of the banks and other financial institutions to take a longer term, more responsible view. The other argued for some tough action to ensure that we didn't create monsters that were "too big to fail", suggesting that there could be a Glass-Steagal like split of investment and retail banking. You might have thought the Governor of the Bank of England was the one arguing for just having a quiet word in the ears of the City grandees. You would be wrong. It was a Labour Chancellor of the Exchequer, talking in the wake of the worst financial and economic crisis in over 60 Years.

New Labour has always been in thrall to the City. It is one of the reasons why the credit bubble was allowed to grow so huge before bursting and why so many high risk products were allowed to corrode institutional balance sheets. Labour trusted the City, probably because it doesn't really understand it, and its whole approach to regulation has been to allow the City to get on with making money, naively it thought for the country. I have seen no clearer indication that this is a government that has run out of ideas, incapable of changing course even when its previous course took the country onto the rocks, than its failure to grasp the need for a radical overhaul of financial regulation and the failed tripartite system.

The day after this stunning public divergence between the government and the central bank in the UK, the Obama administration in the United States came out with its proposed reforms. I don't want to be too dismissive of such a complex plan but it is a mess. There seems to be a regulator for everything, a whole new tier of federal regulation to overlay the already cumbersome regulatory system that some parts of the financial sector, such as the insurance industry, have to contend with at state level. In some ways it is reminiscent of the UK's first stab at comprehensive regulation of the financial services sector with the 1988 Financial Services Act which spawned a real alphabet soup of narrow sector regulators. There is a certain sense of déjà vu in reading US commentators attacking the Obama plan on the same grounds. It will leave gaps and create opportunities for regulatory arbitragemand these will be exploited by those who don't want to be properly supervised.

In Europe, meanwhile, there seems to be a greater sense of purpose, even if couldn't look more different to the US approach if it tried.

The European Union wants to move to fewer, supranational regulators and has an ambitious plan for getting there. Despite UK doubts - opposition would probably be a more accurate description of the government's stance - this plan is edging ahead and was largely approved at the summit of EU leaders at the end of last week.

So far, despite fierce attacks on "Anglo-Saxon" attitudes to regulation and the contribution these have made to the crisis, EU leaders have been keen to keep the dissenting UK government on board and have made compromises around the chairmanship of the proposed new regulators to achieve this. To understand why they have done this you have to look at the wider political scene in Europe.

The EU needs to get the Lisbon Treaty ratified, a process that will probably take until the end of this year. The Labour government backs the treaty and has never been prepared to contemplate bowing to demands for it to be put to a referendum in the UK. The Tories oppose the treaty and have said that if it is not ratified if (or as they see it, when) they become the government, they will stop the ratification process, possibly putting the treaty to a referendum. This is a doomsday scenario as far as the rest of the EU is concerned so they are prepared to go quite a long way to making Gordon Brown's life as easy as possible to ensure he survives until the treaty is finally nailed down. While it is very hard to imagine a British government falling over a dust up in Europe on financial regulation, such is the febrile nature of British politics at the moment EU leaders are not prepared to contribute to the Prime Minister's discomfort and risk him being forced into an autumn General Election.

So, where does that leave the much vaunted desire of world leaders (as expressed at April's G20 Summit) to make sure we never have to go through the same crisis again? Frankly, it is desperately hard to tell but I still think that the most coherent and focused case for reform has been that made by the EU. The challenge they will face is translating that into a global plan.

Meanwhile, those most in need of a firm regulatory grip being placed on their collar will look at this huge divergence of approaches with a smug satisfaction.

• Banking Crisis: International Dimensions, Eleventth Report, to be published at 11.00am on Friday 24 July
• Evaluating the Efficiency Programme, Thirteenth Report, to be published at 00.01am on Tuesday 28 July
• Banking Crisis: regulation and supervision, Fourteenth Report, to be puublished at 00.01am on Friday 31 July
• Mortgage arrears and access to mortgage finance, Fifteenth Report, to be published at 00.01am on Saturday 8 August
• Banking Crisis: dealing with the failure of the UK banks: Government, UK Financial Investments Ltd and Financial Services Authority Responses to the Seventh Report from the Committee, to be published at 11.00am on Friday 24 July
• Banking Crisis: reforming corporate governance and pay in the City: Government, UK Financial Investments Ltd and Financial Services Authority Responses to the Ninth Report from the Committee, to be published at 11.00am on Friday 24 July.