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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."
 The interview with Lord Turner, chairman of the FSA, on Andrew Marr's programme this morning is worth listening to, because it conveys some good sense on the financial crisis. It gives me confidence that financial regulation will be stronger and better informed than it has been since Gordon Brown created the tripartite system in 1997. Here is how the BBC report concludes:
"Lord Turner is currently reviewing the way the financial sector is regulated and will publish his findings on 18 March. He said his review would bring about "very major changes" to the way banks are regulated, such as how much cash they have to hold in reserve. He also said there would be changes to rules on credit rating agencies and how bankers are paid.
"Lord Turner defended the decision to pay bonuses to the FSA's staff, but added that the authority's chief executive Hector Sants would not be taking a bonus. He said that for the rest of staff, getting rid of bonuses would mean cutting pay by an average of 15%, at a time when politicians such as David Cameron are saying that the regulator needs to attract better staff."
This is all fair and all reasonable. There are grievous failings among the banks, the regulators, the central bankers and the politicians. It makes eminent sense to hold accountable, and replace, the bankers with whom this crisis originates through their pitiful incomprehension of the risks they were taking on. It does not make sense to get rid of bonuses or impose ceilings on remuneration.
The problems that Turner points to are the essential ones. First, bank regulation paid too little attention to the need for liquidity.
Secondly, ratings agencies had a scandalous conflict of interest: their consulting business advised banks on how to structure complex financial products in such a way that these would be given triple-A credit rating; the ratings business would then come in and award the rating. The ratings business needs to be broken up in the same way that the accountancy profession was split apart between auditing and consultancy after Enron's fraudulent operation collapsed.
Thirdly, bankers' remuneration must be more closely tied to long-run performance and risk-adjusted measures of profitability. Banks are regulated businesses: it's open to regulators to impose onerous capital charges on banks that stick to the traditional methods of rewarding their staff. They should do it.
There's an enormous amount of comment in the papers on the vexed question of bankers' bonuses, especially at institutions that have received taxpayer support. We've done two leaders in the past few three days on this, here and here. Ceilings on bankers' pay are a bad idea - and this applies to banks where the taxpayer has a majority stake as well as others that don't. But there is a big problem where remuneration isn't tied reliably to the risks that banks take on.
There is a small precedent for reform. It's a commonplace that the performance of asset managers is measured after adjustment for risk. If you are part of a company pension scheme, then the managers of that scheme will have their performance assessed relative to a passive portfolio (i.e. one generated by a computer programme) with similar risk characteristics to the actively-managed fund. Performance measurement is a complex actuarial calculation, but it's intended to weed out managers who can generate consistent risk-adjusted returns from those that take big bets that turn out to be lucky. I don't know of any comparable exercise on, say, the proprietary trading desks of investment banks.
Incidentally, Barclays today announced that it was scrapping its dividend (though would resume dividend payments in the second half of the year). That's clearly the right decision when the banks collectively need to be recapitalised. If I were part of the management of the banks where the taxpayer holds a stake (of which Barclays is not one) then I would press for them all to suspend dividend payments. This seems to me more important than the symbolic issue of bonuses, for the simple practical task of making the banks solvent. When a company passes a dividend, the stock price typically falls, because the market interprets it as an indication of future problems with profitability. But we're not in a normal market. If as a matter of policy all the UK banks announced that there will be no dividend payments in 2009, then this would be merely sensible and a belated recognition of past policy failures.
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