Bill Jamieson: If finance capitalism really is dead what system should replace it?

Published on Saturday 14 March 2009 13:16

First, we need to be sure finance capitalism really is dead. There is a difference between a seizure and total termination

WHAT killed finance capitalism? And what will replace it? With tentative signs last week that we may be past the worst of the banking crisis, the lines are being drawn for a policy war over the future for economic giants such as America and Britain.

The battle lines could be seen in the run-up to this weekend's summit of G20 finance ministers in London. America wants the world to focus on more reflationary action. Europe wants to see progress towards a new system of global financial regulation. China wants a fairer deal for those economies whose surplus savings have been used and abused in a deeply unbalanced world financial order. There is no unanimity on what the top item on the agenda should be for next month's grand summit of G20 world leaders. And there is even less confidence among the public that the summit will come up with any credible solutions to kick-start a world economy now heading for its first year of contraction in decades.

Britain's banks have suffered massive damage. Right up until mid-2007 the UK was seen as a model for the global financial services industry. The City of London boomed and Royal Bank of Scotland and Barclays vied to become one of the world's top five banks through the acquisition of Dutch banking giant ABN Amro.

All that is now in ruins. The IMF now estimates the cost of the Government bailout of the banks at 200bn. The wider reputational damage is colossal. Scotland is seen to have suffered particularly badly with the collapses of HBOS and Royal Bank of Scotland. Indeed, Edinburgh is only slowly coming to terms with the wider shockwaves – thousands of redundancies, the wipe-out in the value of shareholdings in the two banks and the knock-on effects across the capital and beyond. Housing turnover in affluent areas such as the New Town is down 70%. Some 30 restaurants are up for sale or in the process of being sold. The heartbeat of the city has slowed discernibly.

Much hand-wringing has been spent as if this is some exclusively "Scottish" banking crisis, with a unique impact on Scotland's financial standing and credibility. But from the start this has been a global crisis. Banks in almost all Western economies have suffered. Continental European banks face colossal problems with their loans to Eastern Europe. In America the giant investment banks have been devastated where they have been able to survive at all as independent entities. All told, there are now 252 American banks in trouble, up from 171 in the third quarter of last year. This is not, and never has been, a uniquely Scottish problem.

It is far bigger, and it has now sparked a huge debate about the 'collapse of capitalism', the end of the 'decade of greed', the need for a new financial order and for alternative models of 'new' and 'different' banks.

Some urge a retreat to 'boring' banks. Others call for a new order of 'social' banking. But if banks were ever boring, they seldom stayed so for long. Banking booms and busts have always been part of the cycle – from the European bank crisis of the 1930s to the UK's secondary banking crisis in the early 1970s.

As for the advocates of 'social' banking, Professor Richard Layard – he of 'happiness economics' – has weighed into the 'whither capitalism' debate with a call to "stop the worship of money and create a more humane society where the quality of human experience is the criterion". However, even this virtuous paradise will need a banking system we can trust to take deposits and lend money.

More extreme variants seem to envisage post capitalist banking as a giant ecological people's co-operative – a sort of ScotMid for money– and a return to 'social' sub-prime lending – the very type encouraged by many of America's politicians that helped to get us into this mess in the first place. Still others want banks to avoid innovation and new products, as if dismantling the internet was the best way to avoid the dot.com boom, or uninventing the railways was the brilliant solution to railway mania. Doubtless there will be yet more crazies to come tumbling out of their deranged blogs and green ink-tinged websites before this crisis is over.

First, we need to be sure that finance capitalism really is dead. There is a difference between a seizure and total termination. Are we really sure there will be no recovery? US giants Citigroup and Bank of America lifted world markets last week with statements that they have been trading profitably in the opening months of the year. Core RBS retail and business banking in the UK – which is at the heart of the Hester and Hampton 'Newco' recovery plan – is also trading profitably. So, I am sure, are large parts of Lloyds Banking Group. These key operations will recover and grow. Those most eager to read the funeral rites of Britain's banks have not only to be sure they really are as dead as they say they are, but also that there is widespread popular support for the alternative model of state-owned and controlled banking.

What makes us sure a state-owned monolith, with risk concentrated in and managed by one institution, will be any more stable? The state model may look an attractive alternative right now as we view the debris of RBS and the tottering edifice of Lloyds. But how might we feel two years into a fitful recovery with unemployment still high, growth low and pressure building for more bank lending to boost activity? The embrace of "boring" banks as a permanent solution may be to condemn bank lending to thick bureaucratic forms of politically correct box-ticking and the UK economy to low growth, high unemployment and ossification.

Andrew Lilico, managing director of Europe Economics and one of Europe's top experts on financial regulation, argues that the Government's nationalisation of most of the UK's banking sector has been "a disaster of the first order". In a powerfully argued paper out tomorrow from the Centre for Policy Studies* he argues that the 200bn spent pumping money into the banks would have been better spent on massive tax cuts. He says we should stop pumping cash into insolvent institutions, focus funds on the real economy, totally reform the system of financial regulation and reintroduce the principle of 'caveat emptor'. Scrapping it in favour of financial regulation, he argues, has exposed us to huge risk, and has "infantilised" the consumer by allowing regulation to do the job of buyer scrutiny. It has also, I suspect, infantilised compliance procedures within the banks themselves.

The crisis, he adds for good measure, is not about the greed or bonuses on which so much hysterical attention has been focused, but on over-confidence in regulatory approvals, the use of novel products to bypass regulatory requirements, extreme moral hazard in respect of housing, and over-dependence on inflation targets that contained not a single housing cost component.

It is hard not to agree with many of the points that he makes – in particular his plea for a return to 'Caveat Emptor' and his critique of Government policy in stripping the Bank of England of regulatory oversight. But it is too late now to unwind the huge taxpayer subventions of the banks – and last autumn there was a real risk of a systemic banking collapse. Better, surely, to regard the current nationalisation in all but name as a temporary period while banking is massaged back to life, the patient cleaned up and purged of past misdeeds. Taxpayers must be repaid for the risks they bore, and private capital encouraged back in. In proclaiming capitalism dead, be careful that you may miss the seeds of its inevitable recovery.

*What killed Capitalism? by Andrew Lilico, Centre for Policy Studies, 10, www.cps.org.uk