Tough Choices, Part Three: HBOS’ grilling, and a Freer System

The Treasury Select Committee has been grilling former bosses of defunct banking giant HBOS, the merged lender and financial services provider which collapsed last year, now a part of Lloyds Banking Group, which posted £11billions in losses today.

The question in everyone’s minds seems to be “Why didn’t these bankers behave with more prudence?” The answer is, because it would have been unreasonable to have done at the time. The bank group certainly expanded too fast, too far- however, the interrogation by the committee of Treasury MPs is not only unjust, it is also wholly hypocritical and immoral. That is because the country is going into a period where the Bank of England is about to start printing more money than it usually does to try and inject liquidity into the economy. Not only is the base lending rate at an unfeasibly low level to reward risk-taking borrowers and punish prudent savers, but the government has already effectively risked inflation in its dealings with the financial sector- so much so, that the country may have its credit rating downgraded, in a similar move to what happened to the big banking giants once their profligacy became clear.

This article is mainly being written to answer an interrogation the sheepish former executives couldn’t answer (http://news.bbc.co.uk/1/hi/business/7881081.stm). Chairman of the Committee Mr McFall posted the inquisition: “The Oxford English Dictionary definition [of a bank]: ‘An organisation offering financial services, especially the safe keeping of customers until required and making loans at interest’…So, did your organisation live up to that definition?”
-The central crux of the answer must be on what Mr McFall would deem “safe”. The question here, therefore, is at what fraction the bank must lend of its reserves- that is, how much more over its money in its vaults is it lending. Until the closure of the wholesale markets, HBOS easily fulfilled this remit- it was thus “safe”, although it did it in a riskier manner than it should. If it did not have the agreed minimum amount of capital in its vaults, then that is clear regulatory failure- but only on the same side of the coin as the lowering of interest rates to such low official levels. Indeed, it could be argued that the Treasury’s fiscal policy in expanding the government’s budget wastefully, at the same time as the independent Bank of England was being easy with the markets, that the Treasury itself did not fulfil its remit, which is, to quote The Oxford Illustrated Dictionary Second Edition: “Funds or revenue of State…administering expenditure of public revenue, and co-ordinating the economic activities of other branches of government”- the lack of prudence by the HBOS bankers is shared by members of the Treasury, seeing as they both committed the same sin: the sin of poor judgment. The irony, is that the HBOS bankers have because of the public’s lustre and spirit of wolfishness not been afforded the same status of being human beings running on probabilities and taking risks- just as the HBOS bankers tried to please shareholders by being riskier, Treasury officials when now-Prime Minister Gordon Brown sanctioned similar risky investment in the NHS, and in costly foreign wars, one of which violating international law and being contrary to millions of protesters. The organs of the state cannot be allowed to escape here- they took the same risks the bankers did, and the bankers did based on the fact the markets were incredibly healthy and that it was unlikely the system would collapse any time soon. The Treasury, meanwhile, did not have the benefit of such statistics as it works outside the market, the investments in public infrastructure being rampantly inefficient.The Treasury may have been able to escape with some face had it handled this crisis better- it in this case had the perfect model in the case of Sweden, which brilliantly escaped a carbon-copy crisis situation in the 1990s. The Treasury should have immediately guaranteed all retail deposits, agreed to underwrite unrisky loans to help rebuild banks’ capital bases (at the same time as the recapitalisation, which actually happened), and opened a so-called ‘bad bank’ as the Swedes did, which would have absorbed all the ‘toxic assets’ and squeezed as much as possible from them and not been open to new business passed a given date (meaning, banks would not have the guarantee of pawning off poor loans onto the bad bank if they failed in years to come); however, it has performed poorly, and undercut the tax system in the worst way possible- the VAT Cut can be considered an abandonment of its remit alone, because the balance of benefit to cost has been proven to have been so poor.

The point is, HBOS failed because of its mistakes and its risky business model. If the wholesale money markets hadn’t collapsed, those men would most likely have been hailed as heroes, just as Jérôme Kerviel, the Société Générale- a French investment bank- market trader who illegitimately lost the bank billions because of a retreat in market conditions did. If we’re to enter an era where we associate good business with being scared to invest, then we will most likely have poor growth- investments generally pay off more than they fail, but it’s the failures which shape the market as much as the success: HBOS surely will serve as a model example for years to come of a humbled titan.

HBOS, then, is on the grill, and as I have detailed rather unfairly and hypocritically. The step should not be to regulate more, but ensure that when companies and individuals fail they do not impose so much cost on others for their own choices. The only way to do that is to break up the cartels which exist in government- the housing bubble was caused by low base-rate interest rates, which effectively means the Central Bank sold more bonds (which is how interest rates are lowered and raised, making money supply easier and smaller respectively), and a period of risky but successful period of lending ensued, which only encouraged banks like HBOS further. We should never punish people with hindsight wholly in mind. We must lower income and business taxes across the board, making the Treasury more prudent by restricting its opportunity for tyranny (which I have outlined, particularly in the Tough Choices, Part 1 article, available on this site), and discouraging the rich from hiding their assets and investments off-shore, which in itself made credit rating organisations’ jobs hard, as they weren’t able to fully assess banks’ capital health (riskier stuff being off-shore- Royal Bank of Scotland’s former boss revealed recently he had hidden a significant sum of loans from the bank, for instance). We mustn’t allow the markets to grow out of proportion as they have- really, inflation has effectively been alive and well in the housing and credit markets, hiding the economic lunacy to the Central Bank’s inflation target setters. We should decentralise our banking system, and return to a state where banks issue money as they did before, wagered against their reputation. This is called Free Banking. If the banks (if they so wished of course) had a currency to protect as well as a capital and deposit base, they would be far more inclined to not cause inflation. The risks of fractional reserve banking would be more or less eliminated- for instance, if I was storing millions in the bank I could opt for whichever fraction I wanted, which would be leveraged against the interest rate: those who chose the riskiest rate would be rewarded for their risk, but would have more to lose. This would put the sovereignty in the consumer’s hands, not the Central Bank’s. If, say, (to take a simple example) Northern Rock- the nationalised retail bank- had collapsed under this system and it had been a money-issuer, its currency would have been deemed worthless and would have been abandoned. Holders of the money would have been able to convert the currency with the buyers or the administrators of the bank into the more reputable currency, adding liquidity and stability to the newly formed institution, or if in the case of the administrators would have allowed the bank to reel in its assets quicker and be more efficiently sold. In the current system, hundreds of billions of pound stirling were spent and leveraged on the bank, and probably to the detriment of the Treasury (and thus Stirling) itself. Just as to encourage a child to be more independent you cut the apron strings, we should do the same with our banks- if they fail, then they’ll be abandoned and the market will absorb the losses. The success of this policy can be attested by a period of seventy years in Sweden, where only one bank went under in those seven decades of free regulation. It may seem counter-intuitive, especially in this time of crisis- but by cutting the ties we can help insure the system as a whole. What seems to be in deficit with the world’s citizens, is they don’t seem to understand that Central Banks are banks too, and that they are not just the masters of their universes, but were once members of that universe. The power of the Bank of England is frightening- they hold the keys to the overwhelming example of legal tender (the opposite philosophy as free banking, where tender would only be accepted on the reputation and judgment of the person receiving it), and with their control of interest rates they hold the keys to nearly everyone’s income, even the government’s. It not only makes economic sense, but it also makes moral sense. I don’t know about you, but I’m sick of people on Select Committees deciding what I should do. HBOS paid the price and lost its fortune and independence, it’s time the Treasury, the Bank of England and the system as a whole gets the same inquisition as these risky bankers. A privatisation of the money supply would be a good step in this individualist revolution.

Title change: Part Three in the series ‘A Matter of Loans and Taxes’ was in early writing stages, but I’ve decided to re-write this as Part Three.