Rt Hon Lord Lilley

    Mr. Peter Lilley (Hitchin and Harpenden) (Con):
    It is always a privilege to follow the right hon. Member for Bolton, West (Ruth Kelly) since she returned to the Back Benches. She has consistently given the House thoughtful and well-informed speeches on economic matters, even though in this case I profoundly disagree with her, on both her analysis and her prescription.

    Unless we establish the cause of the current economic crisis, we will not be able to find a cure or a way of preventing a repetition of the problem. Unfortunately, so far analysis has focused not on establishing the ultimate cause, but largely on allocating blame to greedy bankers, impotent regulators and incompetent Americans.

    Incidentally, following the point that the right hon. Lady made, the Prime Minister cannot say, as he does when he is trying to escape any share of the blame himself, that the problem arose solely in the US, and simultaneously blame the British bankers. Either the problem was caused exclusively in the US, in which case

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    not only is the Prime Minister innocent, but so are the British banks, or the British banks contributed to their own downfall and aggravated our economic problems, in which case not only are they guilty-I believe they do share in the guilt-but given that he was responsible for regulating the banking system over the past 12 years, so was the Prime Minister, the former Chancellor, guilty of his share of aggravating our problems.

    I am sure that all the alleged guilty parties deserve some of the blame, but I will argue that their behaviour was essentially a symptom of a much more fundamental underlying cause of our woes. Take greedy bankers. I am sure that bankers were greedy, but bankers have always been greedy-I cannot remember a time when they were not accused of being so. It is a fundamental axiom of logic that we cannot explain a change by a constant. If bankers have constantly been greedy, why has that only now resulted in this change in our economic fortunes?

    The interesting thing is that, in the past bankers, were accused of being greedy because they would lend only to the rich, who had ample collateral, and to low-risk projects at high interest rates. This time they are accused of greed because they have lent to poor people at low interest rates with inadequate and inflated collateral and a risky repayment profile. Bankers’ greed has been a constant feature; it is the form that it has taken that has changed and needs explaining. I shall come in a moment to a more fundamental explanation of that change.

    The second alleged culprits are impotent regulators. The common accusation is that deregulation stripped the regulators of the power that they needed to prevent the excesses of the past decade. In fact, under the regime that the Prime Minister introduced in one of his first acts as Chancellor, the regulators whose duty was to supervise the banking system in the UK had every bit as much power as they had ever had.

    The other day, my right hon. and learned Friend the Member for Folkestone and Hythe (Mr. Howard) reminded the House-and, indeed, me-that I was the shadow Chancellor when the Bill that became the Bank of England Act 1998 was introduced. In the debate on that Bill, I warned the House:

      “With the removal of banking control to the Financial Services Authority…it is difficult to see how…the Bank remains, as it surely must, responsible for ensuring the liquidity of the banking system and preventing systemic collapse.”

    I went on to say:

      “The coverage of the FSA will be huge; its objectives will be many, and potentially in conflict with one another. The range of its activities will be so diverse that no one person in it will understand them all”-

    and so it turned out. I added that I feared that

      “the Government may, almost casually, have bitten off more than they can chew. The process of setting up the FSA may cause regulators to take their eye off the ball, while spivs and crooks have a field day.”-[ Official Report, 11 November 1997; Vol. 300, c. 731-32.]

    I could foresee that then, because the problem was not deregulation but the regulatory confusion and proliferation introduced by the former Chancellor. The regulators have never had more power, employed more people or spent a bigger budget than now, but they have failed. The problem with the regulators worldwide was not lack of power, but lack of foresight and insight; until

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    the 11th hour, they were as convinced as the bankers that everything was going swimmingly. In its global financial stability report in April 2006, a year before the crisis erupted, the International Monetary Fund no less, referring to securitisation and other complex derivatives, said:

      “There is growing recognition that the dispersion of credit risk by banks to a broader and more diverse group of investors, rather than warehousing such risk on their balance sheets, has helped make the banking and overall financial system more resilient…The improved resilience may be seen in fewer bank failures and more consistent credit provision. Consequently the commercial banks…may be less vulnerable today to credit or economic shocks.”

    That is what the pinnacle of the regulatory system worldwide was saying a year before the crash. The truth is that the behaviour of bankers and regulators was not so much the fundamental cause of the crash as a symptom of a long period of easy money and irrational exuberance fuelled by excessive credit.

    Mr. Redwood: Does my right hon. Friend remember that the Government introduced a lot of mortgage regulation relating to process? When we criticised them and said that they needed to regulate the institution, which was where the damage was being done, they said that we were wrong. Do they not now see that we were right and that the institution, rather than the individual transactions, had to be regulated?

    Mr. Lilley: My right hon. Friend is absolutely right. The bulk of regulation was focused on consumer protection rather than systemic stability. There was not enough prudential supervision; if anything, there was too much detailed regulation of the consumer-lender interface.

    John Reid: The right hon. Gentleman has succinctly described the causes of this situation, and I do not want him to go off that point. Basically, he is saying that people were lending money they did not have to those who should not get it, in a form that neither side understood, for returns that were too high and with a risk that was too high, and then persuading themselves that if they spread-bet all that across the world, everything would be fine. If they had gone to Ladbrokes, they would have been told by any spread betting expert that if a bookmaker is accepting all the money on a hot favourite and all the other horses in the race have only three legs, they can reinsure all they like, but ultimately they just lose a fortune.

    Mr. Lilley: The right hon. Gentleman puts it extremely eloquently. He demonstrates why he should have been Chancellor during the past few years instead of the person who has occupied that place on the Front Bench-a point on which I am sure that we are similarly agreed.

    The monetary authorities allowed lending and borrowing to outstrip personal incomes. They ignored bubbles in dotcoms and house prices, and promised to limit the downside risk by what became known as the “Greenspan put”-the promise to cut interest rates and pump in money if ever the economy faltered. However, it was not just down to Alan Greenspan in America-the monetary authorities on both sides of the Atlantic pursued almost identical policies. Indeed, it is a bit rich for our Prime Minister to blame the United States and,

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    by implication, Alan Greenspan, when he slavishly copied Greenspan’s policies, appointed him as his adviser and awarded him a knighthood for, let it not be forgotten, services to financial stability. Of course, he went on to give knighthoods to most of the bankers he is now vilifying-for services to banking.

    Underlying that “easy money” policy was the willingness of half the world to run savings and balance of payments surpluses, tempting the other half-the Anglo-Saxon and “Club Med” countries-to run deficits fuelled by borrowing. It was lovely while it lasted, but it could not go on for ever. Our banks had to find people to lend their surplus savings to, and as they ran out of rich people with good collateral and low risk of default, they started lending increasingly to poor people with inadequate and inflated collateral and a high risk of default. The ultimate cause of our problems, which we must recognise if we are to come up with the correct solution, is that we took advantage of the cheap savings from the surplus countries until we were so over-borrowed and inflated that the system was ripe for collapse.

    We now face a huge dilemma. The cure for too much borrowing cannot be yet more borrowing-least of all for the UK, which as well as having incurred excessive private debts is running an unprecedented public sector deficit and, unlike the US, does not enjoy what General de Gaulle called the “exorbitant privilege” of having the world’s reserve currency. The deficit in this country is expected to exceed the entire defence budget, the entire children, schools and families budget, the yield from doubling corporation tax and the yield that would come from increasing VAT to 25 per cent. If we are contemplating any further discretionary borrowing on top of that, we must be mad, and we would destroy confidence in the markets.

    Ruth Kelly: Does the right hon. Gentleman accept that by far the main cause of those high deficits is the operation of the automatic stabilisers?

    Mr. Lilley: Well, let us not add to that problem by some un-automatic excessive borrowing.

    The other half of the dilemma is that if the whole world tries to save less than it is producing, output and/or prices will fall in a deflationary spiral-the point that the right hon. Lady was making. The only way in which we can reconcile those two truths-that we cannot solve too much borrowing by more borrowing, and that we cannot simultaneously, across the world, all try to spend less than is being produced-is that the countries that have borrowed too much must, sooner or later, start saving, and those that have been running prudent surpluses should start spending more. The Prime Minister is misguided in trying-to offer himself cover-to persuade everyone to do the same thing: to run discretionary deficits simultaneously. Equally, the German Chancellor is mistaken if she is correctly reported as telling everyone to do the same thing: to strive to reduce their deficits simultaneously. The spenders need to start saving and the savers need to start spending. It will not be easy to co-ordinate that, but if the Prime Minister, as chairman of the G20, does not realise that we need such a bifurcated approach, it will not happen. That should be the agenda for the G20. It is sad that he has mistaken the recipe that he is trying to cook up at that meeting.