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Lord Turner, chairman of the Financial Services Authority, has caused much controversy with an interview in Prospect magazine calling for a "Tobin tax" on financial transactions and claiming that much of banking consists in "socially useless activity".
The Times's view, in a leader on Saturday, is that Lord Turner's argument:
"... is not foolish. There is no inherent patriotic reason for defending British banking, and it is not the FSA’s task to lobby for the businesses that it regulates. Lord Turner has nonetheless proposed an unworkable remedy for an exaggerated problem."
Meanwhile Prospect has published on its website a range of responses to Turner. Robert Kuttner of The American Prospect supports a Tobin tax. The monetarist economist Tim Congdon believes a Tobin tax would be national suicide. George Magnus of UBS argues that big banks should be broken up and regulated rather than taxed. And there is also an article by me, arguing that Turner has unreasonably concluded, from the dysfunctional state of the banking sector, that finance is parasitic on the real economy. I am not in favour of a Tobin tax, because it wouldn't work (even supposing it could be implemented globally) and might cause further financial instability.
Barclays and HSBC reported first-half results yesterday. Neither received taxpayer support amid the financial panic at the end of last year. Barclays instead raised £7 billion of capital, on punitive terms, from the Middle East. Both banks reported pre-tax profit of £3 billion. For Barclays that was a strong result; for HSBC it represented a sharp fall from the level of a year earlier, owing to a rise in bad debts.
It's good news if the banks are profitable again. An expansion of credit and hence economic recovery depend on it. But Barclays' recovery is driven by investment banking; it would be odd not to make profits in the securities business as the stock market has soared since March and the cost of funding is low. The political debate inevitably comes down to bonus payments when the banking system is being underwritten by the taxpayer.
Bonuses are the main constituent of bankers' earnings. I'm not in favour of capping them, even in the publicly owned banks. That would be a magnet for mediocrity. The problem with bankers' pay is rather that the rewards for risk-taking (which is what banks are supposed to do) are not balanced by penalties for failure. This is particularly obvious in cases where bonuses are guaranteed, and I'm surprised that Barclays hasn't stamped out this practice. There is an issue too about the public disquiet of high bonus payments when the economy is in a deep recession and many people are suffering - but it is a separate issue from banking regulation, and should be dealt with through the tax system.
(I made these points in a television discussion yesterday evening with Vincent Cable, of the Liberal Democrats, who added that there should be much greater transparency in bonus payments as well, with every payment above a certain level being publicly disclosed. I have nothing against this in principle, but I can imagine circumstances in which it would stimulate a bidding war among banks for star traders and thereby worsen the trouble it's intended to rectify.)
Northern Rock reported today, and it's grim: a first-half loss of £724 million. But what's especially worrying is that the Rock, now fully nationalised, has no clear direction on the aims it should adopt. The banks that have been rescued are required to expand lending, build up their reserves and repay the taxpayer - but these are not compatible objectives, or at least not in the short to medium term. The Rock is an extreme case in the financial crisis owing to the ferociously irresponsible business strategy that ultimately caused its failure. It wasn't a bank so much as a financial engineering shop, which borrowed short-term in the wholesale market and lent long-term to its mortgage borrowers. When the wholesale lending market froze up, Northern Rock suffered a huge crisis of liquidity and couldn't meet its obligations.
How the Treasury intends that the Rock be restored to financial health is a mystery to me. The longer that obscurity persists, the stronger will be the case - advanced by Vincent Cable, whom I respect but don't agree with on this - for full nationalisation to persist for years. I'd prefer the taxpayers' stakes in the fully or partly-owned banks to be sold when liquidity returns to the market, because the banks' assets are far from valueless. The task should be to realise a profit for the taxpayer rather than have the Treasury make decisions about credit allocation.
Boris Johnson argues: "I don't say this in any particular spirit of perverse wanting to stick up for bankers, but it is very important that we defend an industry that generates huge sums of tax for this country."
The sector Johnson is defending is hedge funds, which he says were not the culprits in the financial crisis. I have a column in the paper today agreeing with him:
"In the greatest financial crisis since the Great Depression, hedge funds are an easy target but no villain. The collapse of the financial system was engineered not by unregulated hedge funds but by the most regulated part of the system, the commercial banks, through irresponsible risk-taking and lending. Giving new life to cliché, the EU proposals seek to close the stable door after the horse has bolted, but succeed merely in kicking the farmyard cat in frustration."
I have a column in tomorrow's paper about the allocation of blame in the financial crisis. Here is its thesis:
'In the wake of the greatest financial crisis since the 1930s, President Obama's Administration is preparing sweeping changes to banking regulation. Not so Alistair Darling. Even though UK financial regulators presided over the first run on a British bank (Northern Rock) for more than a century, the Chancellor insists that the regulatory system was not to blame for the credit crunch. Rather, the culprits were to be found in bank boardrooms.
'“Too many people did not understand the risks to which they were being exposed,” said Mr Darling yesterday. This sounds like special pleading by an embattled Government looking for someone else to unload on. But Mr Darling is essentially right. While there is much blame to go round in the collapse of the Western financial system, the problem is not one of regulation.'
The Treasury Select Committee has published a report on corporate governance and pay in the City. The headline coverage in the press is that the report regards the culture of big bonuses as a contributory factor in the banking crisis. It's a more nuanced document than that and it makes some important points that I agree with.
The problem is not, in my view, that City traders took high risks in the search of big profits and hence big bonuses. Financial markets serve an important economic role in allowing businesses and retail investors to manage their risks better. The risks are, in effect, shared owing to the existence of lquid and efficient capital markets. But banks - despite being the most regulated part of the financial system - took on risks that they didn't understand and greatly underestimated, thereby contaminating the financial system with bad debts and plunging the economy into a bitter recession.
The bonus culture contributed to the crisis in the sense that the costs of failure were not commensurate with the potential rewards for success. That misalignment needs to be corrected. I have sympathy with the Committee's recommendation that bonuses should be partly deferred - paid out over several years - in order to tie pay more closely to long-run performance.
I discussed this issue on the Today programme this morning with John McFall, the chairman of the Select Committee. You can listen to us here.
My friend John Rentoul notes that a normally perspicacious political columnist once marvelled at the ability of Gordon Brown to "think five moves ahead".
This sort of thing offers a rich seam to be mined. Here, for example, is Polly Toynbee in The Guardian in 2006: "People used to laugh when Brown bombastically promised to end boom and bust: it was once the natural British economic weather. Who's having the last laugh now?"
John, who was immune to such sentiments, nonetheless fears that it may be unfair to dwell on those who were more susceptible. I disagree: it strikes me as undiplomatic but entirely fair. A herd of media commentators, not all of them Labour sympathisers, consistently misoverestimated Brown's leadership qualities and economic nous. Yet it had long been clear from his systematic disloyalty to Tony Blair what sort of obtuseness and tortured political soul Brown possessed.
Incidentally, while I can reasonably claim always to have said that Brown would be a useless Prime Minister, I date my own epiphany regarding his economic management from roughly the middle of his tenure as Chancellor. Till about 2002, I counted Brown's economic management a success, largely because he had taken politics out of monetary policy and operated a counter-cyclical fiscal policy. The silliest criticism made of Brown in the early years of new Labour government came, as you would expect, from the Liberal Democrats. The party's Treasury spokesman was not then Vincent Cable but, bizarrely, Malcolm Bruce, followed by Matthew Taylor. Bruce complained that Brown was building up a "war chest" that he ought to be spending, because - hey! - the economy was growing. The essential principles of Keynesian stabilisation policy were then unknown to the party of John Maynard Keynes.
After 2002, the economic record of new Labour was squandered and Tony Blair's premiership repeatedly obstructed. It was obvious to any critical observer who was responsible.
The speech given by George Osborne, the Shadow Chancellor, to the RSA yesterday is an interesting indicator of the direction the Tories are taking on financial regulation. It's worth reading. He makes some good points about capital adequacy rules and the role of the credit ratings agencies in worsening the crisis. The ratings agencies, who generate their income from debt issuers, are a particularly weak link in the financial system, owing to the conflict of interest between their consultancy and ratings arms.
But the point that has been noted in newspaper coverage is about the size of banks. According to Osborne: “We should look at whether Britain in fact needs smaller banks. For it would be a bitter irony if we came out of this crisis with a banking system that was even more concentrated and even riskier than the one we had before it.”
Yes, it would be, but I doubt very much that Osborne's proposal would limit systemic risk. It would increase it. It has been relatively easier for European governments to recapitalise the banks because the sector is more concentrated than its American equivalent. In the US, the very definition of a bank is at issue: once you attempt a bank rescue, then numerous types of institutions - say, the finance arms of car manufacturers - will claim to be banks.
It is not the size of banks that has brought us to this pass, or even a failure of regulation. It is a failure of risk management by the banks themselves, which are far the most regulated part of the financial system. The role of the banks in the crisis is paradoxically so central that it's easy to underestimate. Many commentators argue that the activities of hedge funds and derivatives markets have caused a financial implosion, but - as I've argued here - this is to pick the wrong target. A typical bank is several times more leveraged than a typical hedge fund. Excessive leverage, fuelled by the cheap cost of borrowing, is how we got here.
 This is significant: "The Government admitted yesterday that, for the first time since 1995, investors had been unwilling to buy the full complement of its so-called gilt-edged bonds at one of its official auctions."
Let's go through the rationale of the Government's plans. In a downturn, deficits arise automatically because tax receipts fall and welfare spending rises. There is in principle a strong argument for running deficits beyond this so-called automatic stabiliser: a shortfall in private demand needs to be offset by government action, otherwise the recession will intensify. The Government needs to borrow: it does this by issuing gilts.
There is an argument in this crisis that, as the problem in the first place is the collapse of a credit bubble and extended indebtedness, it makes no sense for government to borrow more, which would merely compound the problem. But that argument is wrong. If government does not borrow, then the private debt burden risks escalating dramatically. If, as happened in Japan in the 1990s, the economy were locked into deflation, then the real value of household would go on rising. There is inevitably an element of bailing out the imprudent and penalising savers in a plan for fiscal stimulus. But the alternative is intense hardship and human misery.
The problem the UK has, however, is that public debt has grown massively and rapidly. In his Pre-Budget Report, Alistair Darling announced that the borrowing requirement for this fiscal year would be £78 billion - double the previous assumption. And it will in fact sharply exceed that total. Next year's deficit looks awesome. The PBR forecast was £118 billion; the IMF's is for £165 billion. It isn't really a justification to say that the overall debt level is within the range of other developed economies. As the Labour Government of 1974-79 found, you can't demand market confidence: you have to demonstrate that it's well founded.
Market confidence is being shaken. The justification for running deficits now is that they will be offset by a fiscal contraction - tax increases and spending cuts - when the economy finally recovers. International investors are indicating that they don't have confidence that this will happen. They also fear, with justification, that the radical monetary easing of today will be followed by a spike in inflation. The interest rates on British government securities have to be set at a level that will compensate investors for the perceived greater riskiness of sovereign debt.
(As an asset class, bonds do particularly badly in inflationary conditions, because they pay out a fixed rate of interest. Equities don't do well either, for the same reason - inflation erodes the real value of a nominal return. But at least equity investment represents a claim on a company's assets rather than a contractual right to a stream of interest payments.)
This is a seriously worrying scenario, and it explains an intervention this week by Mervyn King, Governor of the Bank of England. We ran a long leader yesterday saying that the Governor was right to speak out. We concluded: "One historian a few years ago described the Bank of England as manifestly the money-printing wing of the Treasury. That role was decisively established almost a century ago, when the Bank unwisely impeded the Government – during wartime – from gaining access to official gold reserves. The governor of the time wrote a humbled letter to Andrew Bonar Law, the Chancellor, pledging to “work loyally and harmoniously” with him. It has taken extraordinary times and unabashed economic mismanagement for the Old Lady of Threadneedle Street to stir. Mr King’s cautionary words are nuanced and devoid of drama. But they are a cogent critique of failure, which the Government must now heed."
It is a mere truism to say that these are extraordinary times in the global economy. The UK's prospects are not encouraging when this sort of thing happens.
 It's not yet online as I write this post, but tomorrow's top leader in The Times deals with the politics of printing money - how we got to the stage where the risk of a deflationary spiral in the economy has caused the Bank of England to adopt a policy of "quantitative easing". This means that the Bank will buy up assets - corporate and government bonds - and thereby increase the amount of money in circulation.
The policy is right for the times, because deflation - as happened in the Great Depression of 1929-33, and the Long Depression of 1873-96 - imposes terrible hardship. But the resort to such a drastic policy is definitive evidence of the failure of Gordon Brown's economic stewardship. The purpose of inflation targeting - introduced by the Tories in 1992 and extended by Labour, through granting independence to the Bank of England - was to help achieve economic stability. Rather than being a mechanical rule, such as monetary targeting or exchange-rate targeting (both of which had been tried by the Tories between 1979 and 1992), inflation targeting was more flexible. The jargon term was "constrained discretion".
As the economy is in deep recession and the financial system is broken, the policy has obviously not worked. The inflation targeting remit was too narrow, and overlooked the damaging consequences of an asset price bubble. The housing bubble was accompanied by an irresponsible expansion of credit. The economic outcome requires a public response - through accepting the debt burden on to the public balance sheet and then "printing" money (it's not literally done on the printing press, but is done with a stroke of the computer key) to pay off the debt, or injecting the money into the economy.
It will be obvious that this sort of policy, while strictly necessary, carries huge inflationary risks later. The problem has arisen because the credit expansion was unsustainable, and has now undermined the goal of price stability. It has also destroyed the other principal aim of the Bank of England, namely financial stability. The banking system would have collapsed without taxpayer support. Not since the 1970s, when central banks in effect abdicated the function of price stability, has there been such pure failure in economic and financial policy.
UPDATE: The leading article is here. Among the comments posted underneath by readers is this one from A. Harris in Kettering: "I note that the writer has remained anonymous; speaking out against this government has become a risky business."
That wasn't a consideration, as it happens.
 The pension arrangements of Sir Fred Goodwin, ex-RBS, have attracted a lot of vitriolic comment. I had a short commentary in Saturday's Times on the "Toxic Effect of these Golden Goodbyes", in which I argued that inequality in unemployment is becoming at least as potent a political issue as inequality in income.
I mention this because no commentator is more critical than I of Sir Fred's performance at RBS and his feeble not-for-anything-in-particular apology before the Commons Treasury Select Committee. The urge to build corporate empires was evident in RBS's determination - when it could have walked away - to acquire ABN Amro at the top of the market for a preposterously inflated price. It was a gross dereliction of Sir Fred's fiduciary obligations.
But consider Andrew Rawnsley, always a thoughtful commentator, in The Observer: "[I]t should not be beyond the capacity of the politicians to cut through the legal thicket. This is one of the advantages of being the government: if the law is a ass, you can change it. Had RBS been any other sort of business, it would now be bust. But for the billions poured in by the taxpayer, this bank would be kaput. There would be no pension honey pot for Sir Fred to stick his paw in. If the law is the problem with stopping him, then the law can be changed."
Except that the legislation would have to apply retrospectively. Retrospective legislation to abrogate a contract by withholding benefits is a terrible precedent. It is difficult to conceive of a harder case on which to defend this principle than Sir Fred Goodwin, but principles are tested by their most difficult cases. Our leader last week may have been alone in the British press to argue this case, but it is in my view the right one: "The Government is justified in attacking Sir Fred's lamentable performance. Indeed, it has an obligation to the taxpayer to explain what has happened at RBS, and to ignore the sensibilities of those who caused its ruin. It is something else, however, to seek to overturn by legal manoeuvres a contractual obligation that the Government inherited from a dysfunctional RBS board, and then agreed to.
"Contractual arrangements that are a symbiosis of incompetence and cupidity are still legally binding. What is more difficult to accept, but ought to be recognised, is that they are also morally binding. A system of rules protects worthier cases than Sir Fred from public hostility."
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