Adair Turner: “light-touch” regulation was too light
Read the full transcript of Prospect's interview with Adair Turner here
In a financial crisis described as the most dangerous since the 1930s, three questions stand out. Should those in charge of banks have done more to prevent it? Can politicians and regulators defuse the escalating threats—and prevent a repeat? And is it possible to regulate banks successfully at all?
Adair Turner, chairman of Britain’s Financial Services Authority (FSA), the watchdog for the financial sector, acknowledges the pressure of those questions. The authority, he argues, was “an inheritor of a sort of 50-year long giant intellectual mistake.” In an interview with Prospect, in the FSA’s open-plan offices in Canary Wharf, flanked by the glass towers of the banks which are the targets of its scrutiny, he said: “It made mistakes as well, but you do have to place them within that wider context—the whole system... was deeply, deeply wrong.”
He maintains that he is an optimist. “The world will not go into a 1929-33 [economic crash and depression] unless we deliberately fail to do things we are capable of doing. We have the tools to prevent that.” But he added: “Am I totally confident that we can avoid a Japan [stagnation] over the last 20 years? No. We need to think carefully to make sure that we don’t do that.”
In a crisis that has provoked a daily stream of dramatic quotations, Turner’s views attract more than routine attention. Appointed chairman of the FSA in 2008, he bears responsibility for the past three years’ handling of bank regulation. The authority took over responsibility for bank regulation from the Bank of England in 1998, and was given full powers of financial oversight in 2000. Turner also has a role in deciding how Britain should deal with the European Union and International Monetary Fund in preventing the euro crisis threatening to bring down important banks. The third to occupy the role, he will also be the last. In June 2010, George Osborne, the chancellor, announced plans to break up the authority, dividing its powers between the Bank of England and new agencies, including a consumer regulator.
That is a reproof to the FSA’s role in failing to head off the crisis, but also a rejection of the years of “light-touch” regulation when Tony Blair as prime minister, and Gordon Brown, first as chancellor and then as prime minister, told successive heads of the FSA to make financial institutions feel welcome in London. Turner, appointed in 2008 by Alistair Darling during Gordon Brown’s time as Prime Minister, agrees that the “light touch” was too light. Indeed, the principles of regulation which he lays out are a rebuff to the Blair-Brown approach. He also agrees that the pre-crisis division of responsibilities was wrong.
He therefore supports Osborne’s decision to change the regulatory structure while pointing out that the timing is awkward. “In an ideal world,” said Turner, “we wouldn’t be doing this change in the middle of the biggest financial crisis in the world.” He said that “an organisational division takes up a lot of top management time thinking about people, premises, systems, lots of nitty-gritty things.” All the same, he supports the principle, saying that “the end point of the reform will be better than the existing FSA.”
Looking at the past three years, what went so wrong? “The FSA has been more willing than any other institution in the world to put up its hand and admit that it got things wrong,” Turner asserted. “If you look at the [FSA’s] internal audit report on Northern Rock, that is a very, very self-critical document, produced six months before I became chairman. Back in March 2009, the Turner Review, which I produced at the chancellor’s request six months after I became chairman, was also very critical of a lot of things we did.”
The FSA’s critics would say, nonetheless, that it and the Bank of England are represented on all the key international committees that were created precisely to stop cross-border crises. Turner acknowledges that. “I think the global regulatory system in total failed,” he said. The framework for setting capital levels, designed by committees of senior bankers across the world, “was an enormous amount of intellectual effort over ten years which completely failed to address the fundamental issues.” Over the past 30 or 40 years, banks had been allowed to operate with less capital and liquidity—“dramatically so, the figures are quite startling.”
He added: “We constructed an economic theory that this was all fine because financial markets had got so much more sophisticated—that liquidity problems wouldn’t emerge because markets across the world had become more liquid and sophisticated, [that] the banks could run with lower capital because the techniques of risk management had become more sophisticated. And all this was just hugely wrong.”
In Turner’s view, politicians have been too respectful of financiers. There was, he commented, “a pervasive influence of assumptions about the City on the UK political dynamic. There was a belief that light-touch regulation, or limited-touch, would make the City bigger, and that the City was a source of employment and tax revenue. And therefore there was clear pressure on the FSA at times to say, ‘Go easy on the City.’ The FSA never used the phrase ‘light-touch,’ but politicians did, and they did it in speeches which were directed at the FSA.”
Which politicians? “Oh—ministers right at the top. Prime ministers. Chancellors of the exchequer, made speeches of that sort, in the last government.”
There was also pressure for the regulator to be an advocate for the City, he said. Regulators “mustn’t do crazy things that will necessarily harm [the sector]. But the moment you introduce an idea that they are part regulator and part, as it were, sponsor, spokesman, for an industry, that’s dangerous, that’s confusing.”
The result was that London became a centre for some of the most damaging financial activity. One example was AIG Financial Products, which specialised in issuing credit default swaps (CDS), a form of insurance against borrowers failing to meet their debts. In the run-up to the crash, the Mayfair-based AIG FP issued over $2 trillion worth of derivatives, activity that enhanced the spread of the global crisis.
“Well, AIG Financial Products in Curzon Street was actually regulated by the French,” said Turner. “It was the French regulator. There is a major issue here about clarity of who is responsible. If you set up in London, as a branch of a European legal entity, then the single market rules are very clear that the local regulator has only limited control over what you do.”
This reflects years of lobbying by Britain. Whatever ministers’ misgivings about other EU policy might have been, a consistent theme of British policy has been to push for completion of the single market. That means, as Turner put it, “that Tesco can go and set up anywhere in the European Union without being subject to regulations and can just get on with it. We picked up that proposal, which is pretty sensible in relation to manufacturers, or retailers, or coffee shops, or skiing instructors, and we applied it without enough thinking to financial services.”
“What has happened in the eurozone is a knock-on consequence of two very big intellectual mistakes,” he argues. “One is an Anglo-Saxon mistake of falling in love with liberalisation. The other was going ahead with the eurozone without thinking enough about the status of the government debt of countries which can no longer issue currency. We have ended up in a very dangerous position. There [has been] a failure to take account of just how dangerous too many debt contracts in the world are.”
He and other officials now have a clear picture of Britain’s exposure to European banks, he said, adding that British banks’ exposure to the sovereign debt of the peripheral eurozone countries—Greece, Italy, Spain, Portugal and Ireland—is “relatively small.” But there could be a “knock-on consequence, if other banks in northern Europe got into trouble,” he said.
“Our banks are exposed to them, that is inevitable… There is a level of problem in other bits of the world economy from which you cannot fully insulate your own banking system, other than by categories of government guarantee. If we didn’t want that, we should have designed a global banking system which was [composed of] completely separate legal entities.”
In a Prospect interview two years ago, he held that: “We do now have banks which have adequate capital… we’re beyond the point of fragility.” Now, he says, “I think we’ve gone back to the point of fragility at the macro level. Not necessarily for our individual banks, but for the whole system. One sometimes feels that this financial system is like some incredibly complicated waterbed, where you try and deal with something here and then something happens at the other end. We’re just not clever enough to see it.”
Given that complexity, can modern financial institutions be regulated at all? There are those who argue that they can’t, if only because of scale. The FSA has about 4,000 employees—by contrast, HSBC employs 330,000 staff worldwide. The question is important because too much regulation stops banks doing what they should be doing—that is, keeping the economy humming—but it is impossible to tell in advance what is too much.
Turner is not in that camp of extreme critics, but argues that rules that were too lax put too much burden on supervisors. “Regulation is a set of rules that you apply, supervision is the detailed process of ensuring that people are sticking to those rules, and also a process of reviewing what they are doing and responding to it in a somewhat judgemental way which goes beyond the rules. I believe that one of the reasons that we ended up with large numbers of supervisors is that we have designed the rules with insufficient margin for error,” he said. “If we had always had much higher capital and liquidity requirements, you don’t then need to supervise tightly. When you set your capital and liquidity requirements with very few buffers, close to the point of danger, you then have to supervise very intensely to make sure that banks haven’t just gone beyond… those rules.” In the future, he concluded, “Our general tendency should be to have more aggressive rules.”
In September, the independent commission on banking, chaired by John Vickers, published its suggestions for regulating banks, including the proposal that their high street operations should be separated from more speculative activities, to protect consumers. Turner, saying that he is “sympathetic” to the proposals, and supports “the broad thrust of them,” warned that “we should never fool ourselves that we could then forget about regulating what is outside the ring fence. Lehman Brothers was an outside-the-ring-fence bank, but its failure was still a major problem. Even if we ring-fence banks in the way that John Vickers suggests, we will still have to regulate what goes on outside.” He warned that proposed changes will not make Britain’s financial sector safe—merely safer.
Turner welcomes the international drive for higher capital requirements—that is, reserves which banks are obliged to hold to cushion themselves against trouble. “We have very significantly increased capital requirements,” said Turner. But one obstacle is that “you have to get a global agreement and there are different points of view around the world about how radical to be.”
The US may prove a brake, because of the influence of financial sector lobbying on Congress. He cites the case of the Commodity Futures Trading Corporation, which regulates derivatives and which proposed regulations in the late 1990s “which were pushed aside because of the lobbying power of major financial interests. If you look at the failure to regulate the major investment banks in the US in an effective fashion, I’m sure that that had a lot to do with the lobbying power of the major banks there.”
The Federal Reserve Bank and the Federal Deposit Insurance Corporation, which guarantees savers’ deposits, are strong institutions, he acknowledged. But Turner remains concerned that political pressure has checked attempts to implement the tougher regulations of the Dodd-Frank Act (2010). “What is going on in Congress is deliberate action to starve some US regulators of funds, which I think has a degree of motivation coming out of some financial interests through campaign money to members of Congress.”
A concern in tightening regulation is that it will slow the economy. If banks are forced to hold more capital reserves, they lend less, which slows growth. To try to keep growth going, he argued, the Bank of England should continue with quantitative easing, or printing money, a way of stimulating the economy when interest rates are close to zero. “The bank has to balance continually as to whether it is desirable to do that. If they overdo it, they will create too much inflation rather than simply prevent deflation. But the capacity of a central bank to stimulate aggregate nominal demand—that is one of the very few things that in this area of complex uncertainty we should be certain about. That’s what central banks can do.”
“Ultimately,” he pointed out, “at the limit, we know what to do to prevent [the great depression of] 1929-1933 happening. Ultimately it’s central banks who do it, and what they do is they print money and they use it in quantitative easing. That, of course, is the point of economics where Keynes and Friedman agreed.”
If countries do end up in a predicament like Japan’s, he argued, “although the last 20 years in Japan are unfortunate, they are still an environment of a rich country growing at something like three-quarters or a half per cent a year. It’s not a disaster.”
Global finance may now shrink, he suggested. “I think it is highly likely, at the end of this process, once we have applied sensible rules, some areas of financial activity will be smaller than they were before.” Households and some companies, particularly in property, borrowed too much, he said. “Those are bits of real economy, and if these sectors of the economy end up with lower leverage then by definition we have a smaller set of bank balance sheets.”
In just over a year, these problems may no longer be on his desk. “The FSA will almost certainly last in its current legal form till maybe March, April 2013,” he said, adding that he and chief executive Hector Sants have decided to stay to the end, although Sants considered making an early departure. “When we were in the process of persuading Hector to stay on in June last year, at a certain stage he said, ‘Well, what are you going to do?’ And I said, ‘We’ll both stay to the end of this process.’ We are both committed to doing that and I think that’s the right thing to do.”
Turner’s name flickers through discussions of who will replace Mervyn King as Governor of the Bank of England, and he is perhaps too associated with the previous Labour administration to be a front runner, for all his criticism of those policies. When the FSA shuts its doors, he said, “I think first of all, I’ll just have a very, very long sleep. And then beyond that, I’ll do something else.”
Read the full transcript of Prospect's interview with Adair Turner here
Read the full transcript of Prospect's interview with Adair Turner here
In a financial crisis described as the most dangerous since the 1930s, three questions stand out. Should those in charge of banks have done more to prevent it? Can politicians and regulators defuse the escalating threats—and prevent a repeat? And is it possible to regulate banks successfully at all?
Adair Turner, chairman of Britain’s Financial Services Authority (FSA), the watchdog for the financial sector, acknowledges the pressure of those questions. The authority, he argues, was “an inheritor of a sort of 50-year long giant intellectual mistake.” In an interview with Prospect, in the FSA’s open-plan offices in Canary Wharf, flanked by the glass towers of the banks which are the targets of its scrutiny, he said: “It made mistakes as well, but you do have to place them within that wider context—the whole system... was deeply, deeply wrong.”
He maintains that he is an optimist. “The world will not go into a 1929-33 [economic crash and depression] unless we deliberately fail to do things we are capable of doing. We have the tools to prevent that.” But he added: “Am I totally confident that we can avoid a Japan [stagnation] over the last 20 years? No. We need to think carefully to make sure that we don’t do that.”
In a crisis that has provoked a daily stream of dramatic quotations, Turner’s views attract more than routine attention. Appointed chairman of the FSA in 2008, he bears responsibility for the past three years’ handling of bank regulation. The authority took over responsibility for bank regulation from the Bank of England in 1998, and was given full powers of financial oversight in 2000. Turner also has a role in deciding how Britain should deal with the European Union and International Monetary Fund in preventing the euro crisis threatening to bring down important banks. The third to occupy the role, he will also be the last. In June 2010, George Osborne, the chancellor, announced plans to break up the authority, dividing its powers between the Bank of England and new agencies, including a consumer regulator.
That is a reproof to the FSA’s role in failing to head off the crisis, but also a rejection of the years of “light-touch” regulation when Tony Blair as prime minister, and Gordon Brown, first as chancellor and then as prime minister, told successive heads of the FSA to make financial institutions feel welcome in London. Turner, appointed in 2008 by Alistair Darling during Gordon Brown’s time as Prime Minister, agrees that the “light touch” was too light. Indeed, the principles of regulation which he lays out are a rebuff to the Blair-Brown approach. He also agrees that the pre-crisis division of responsibilities was wrong.
He therefore supports Osborne’s decision to change the regulatory structure while pointing out that the timing is awkward. “In an ideal world,” said Turner, “we wouldn’t be doing this change in the middle of the biggest financial crisis in the world.” He said that “an organisational division takes up a lot of top management time thinking about people, premises, systems, lots of nitty-gritty things.” All the same, he supports the principle, saying that “the end point of the reform will be better than the existing FSA.”
Looking at the past three years, what went so wrong? “The FSA has been more willing than any other institution in the world to put up its hand and admit that it got things wrong,” Turner asserted. “If you look at the [FSA’s] internal audit report on Northern Rock, that is a very, very self-critical document, produced six months before I became chairman. Back in March 2009, the Turner Review, which I produced at the chancellor’s request six months after I became chairman, was also very critical of a lot of things we did.”
The FSA’s critics would say, nonetheless, that it and the Bank of England are represented on all the key international committees that were created precisely to stop cross-border crises. Turner acknowledges that. “I think the global regulatory system in total failed,” he said. The framework for setting capital levels, designed by committees of senior bankers across the world, “was an enormous amount of intellectual effort over ten years which completely failed to address the fundamental issues.” Over the past 30 or 40 years, banks had been allowed to operate with less capital and liquidity—“dramatically so, the figures are quite startling.”
He added: “We constructed an economic theory that this was all fine because financial markets had got so much more sophisticated—that liquidity problems wouldn’t emerge because markets across the world had become more liquid and sophisticated, [that] the banks could run with lower capital because the techniques of risk management had become more sophisticated. And all this was just hugely wrong.”
In Turner’s view, politicians have been too respectful of financiers. There was, he commented, “a pervasive influence of assumptions about the City on the UK political dynamic. There was a belief that light-touch regulation, or limited-touch, would make the City bigger, and that the City was a source of employment and tax revenue. And therefore there was clear pressure on the FSA at times to say, ‘Go easy on the City.’ The FSA never used the phrase ‘light-touch,’ but politicians did, and they did it in speeches which were directed at the FSA.”
Which politicians? “Oh—ministers right at the top. Prime ministers. Chancellors of the exchequer, made speeches of that sort, in the last government.”
There was also pressure for the regulator to be an advocate for the City, he said. Regulators “mustn’t do crazy things that will necessarily harm [the sector]. But the moment you introduce an idea that they are part regulator and part, as it were, sponsor, spokesman, for an industry, that’s dangerous, that’s confusing.”
The result was that London became a centre for some of the most damaging financial activity. One example was AIG Financial Products, which specialised in issuing credit default swaps (CDS), a form of insurance against borrowers failing to meet their debts. In the run-up to the crash, the Mayfair-based AIG FP issued over $2 trillion worth of derivatives, activity that enhanced the spread of the global crisis.
“Well, AIG Financial Products in Curzon Street was actually regulated by the French,” said Turner. “It was the French regulator. There is a major issue here about clarity of who is responsible. If you set up in London, as a branch of a European legal entity, then the single market rules are very clear that the local regulator has only limited control over what you do.”
This reflects years of lobbying by Britain. Whatever ministers’ misgivings about other EU policy might have been, a consistent theme of British policy has been to push for completion of the single market. That means, as Turner put it, “that Tesco can go and set up anywhere in the European Union without being subject to regulations and can just get on with it. We picked up that proposal, which is pretty sensible in relation to manufacturers, or retailers, or coffee shops, or skiing instructors, and we applied it without enough thinking to financial services.”
“What has happened in the eurozone is a knock-on consequence of two very big intellectual mistakes,” he argues. “One is an Anglo-Saxon mistake of falling in love with liberalisation. The other was going ahead with the eurozone without thinking enough about the status of the government debt of countries which can no longer issue currency. We have ended up in a very dangerous position. There [has been] a failure to take account of just how dangerous too many debt contracts in the world are.”
He and other officials now have a clear picture of Britain’s exposure to European banks, he said, adding that British banks’ exposure to the sovereign debt of the peripheral eurozone countries—Greece, Italy, Spain, Portugal and Ireland—is “relatively small.” But there could be a “knock-on consequence, if other banks in northern Europe got into trouble,” he said.
“Our banks are exposed to them, that is inevitable… There is a level of problem in other bits of the world economy from which you cannot fully insulate your own banking system, other than by categories of government guarantee. If we didn’t want that, we should have designed a global banking system which was [composed of] completely separate legal entities.”
In a Prospect interview two years ago, he held that: “We do now have banks which have adequate capital… we’re beyond the point of fragility.” Now, he says, “I think we’ve gone back to the point of fragility at the macro level. Not necessarily for our individual banks, but for the whole system. One sometimes feels that this financial system is like some incredibly complicated waterbed, where you try and deal with something here and then something happens at the other end. We’re just not clever enough to see it.”
Given that complexity, can modern financial institutions be regulated at all? There are those who argue that they can’t, if only because of scale. The FSA has about 4,000 employees—by contrast, HSBC employs 330,000 staff worldwide. The question is important because too much regulation stops banks doing what they should be doing—that is, keeping the economy humming—but it is impossible to tell in advance what is too much.
Turner is not in that camp of extreme critics, but argues that rules that were too lax put too much burden on supervisors. “Regulation is a set of rules that you apply, supervision is the detailed process of ensuring that people are sticking to those rules, and also a process of reviewing what they are doing and responding to it in a somewhat judgemental way which goes beyond the rules. I believe that one of the reasons that we ended up with large numbers of supervisors is that we have designed the rules with insufficient margin for error,” he said. “If we had always had much higher capital and liquidity requirements, you don’t then need to supervise tightly. When you set your capital and liquidity requirements with very few buffers, close to the point of danger, you then have to supervise very intensely to make sure that banks haven’t just gone beyond… those rules.” In the future, he concluded, “Our general tendency should be to have more aggressive rules.”
In September, the independent commission on banking, chaired by John Vickers, published its suggestions for regulating banks, including the proposal that their high street operations should be separated from more speculative activities, to protect consumers. Turner, saying that he is “sympathetic” to the proposals, and supports “the broad thrust of them,” warned that “we should never fool ourselves that we could then forget about regulating what is outside the ring fence. Lehman Brothers was an outside-the-ring-fence bank, but its failure was still a major problem. Even if we ring-fence banks in the way that John Vickers suggests, we will still have to regulate what goes on outside.” He warned that proposed changes will not make Britain’s financial sector safe—merely safer.
Turner welcomes the international drive for higher capital requirements—that is, reserves which banks are obliged to hold to cushion themselves against trouble. “We have very significantly increased capital requirements,” said Turner. But one obstacle is that “you have to get a global agreement and there are different points of view around the world about how radical to be.”
The US may prove a brake, because of the influence of financial sector lobbying on Congress. He cites the case of the Commodity Futures Trading Corporation, which regulates derivatives and which proposed regulations in the late 1990s “which were pushed aside because of the lobbying power of major financial interests. If you look at the failure to regulate the major investment banks in the US in an effective fashion, I’m sure that that had a lot to do with the lobbying power of the major banks there.”
The Federal Reserve Bank and the Federal Deposit Insurance Corporation, which guarantees savers’ deposits, are strong institutions, he acknowledged. But Turner remains concerned that political pressure has checked attempts to implement the tougher regulations of the Dodd-Frank Act (2010). “What is going on in Congress is deliberate action to starve some US regulators of funds, which I think has a degree of motivation coming out of some financial interests through campaign money to members of Congress.”
A concern in tightening regulation is that it will slow the economy. If banks are forced to hold more capital reserves, they lend less, which slows growth. To try to keep growth going, he argued, the Bank of England should continue with quantitative easing, or printing money, a way of stimulating the economy when interest rates are close to zero. “The bank has to balance continually as to whether it is desirable to do that. If they overdo it, they will create too much inflation rather than simply prevent deflation. But the capacity of a central bank to stimulate aggregate nominal demand—that is one of the very few things that in this area of complex uncertainty we should be certain about. That’s what central banks can do.”
“Ultimately,” he pointed out, “at the limit, we know what to do to prevent [the great depression of] 1929-1933 happening. Ultimately it’s central banks who do it, and what they do is they print money and they use it in quantitative easing. That, of course, is the point of economics where Keynes and Friedman agreed.”
If countries do end up in a predicament like Japan’s, he argued, “although the last 20 years in Japan are unfortunate, they are still an environment of a rich country growing at something like three-quarters or a half per cent a year. It’s not a disaster.”
Global finance may now shrink, he suggested. “I think it is highly likely, at the end of this process, once we have applied sensible rules, some areas of financial activity will be smaller than they were before.” Households and some companies, particularly in property, borrowed too much, he said. “Those are bits of real economy, and if these sectors of the economy end up with lower leverage then by definition we have a smaller set of bank balance sheets.”
In just over a year, these problems may no longer be on his desk. “The FSA will almost certainly last in its current legal form till maybe March, April 2013,” he said, adding that he and chief executive Hector Sants have decided to stay to the end, although Sants considered making an early departure. “When we were in the process of persuading Hector to stay on in June last year, at a certain stage he said, ‘Well, what are you going to do?’ And I said, ‘We’ll both stay to the end of this process.’ We are both committed to doing that and I think that’s the right thing to do.”
Turner’s name flickers through discussions of who will replace Mervyn King as Governor of the Bank of England, and he is perhaps too associated with the previous Labour administration to be a front runner, for all his criticism of those policies. When the FSA shuts its doors, he said, “I think first of all, I’ll just have a very, very long sleep. And then beyond that, I’ll do something else.”
Read the full transcript of Prospect's interview with Adair Turner here
