Ed Miliband attacks the banks

Today, Ed Miliband, the leader of the Opposition, gave a speech on the problem of Britain's wealth. What he calls the "cost of living crisis" has come about because too much is being taken by too few people. The economic recovery, such as it is, is no recovery at all, and the Labour Party has a plan to change that.

Unusually for a speech like this, the contents had not been pre-briefed. Details only began to emerge earlier this week because Labour had been consulting the banks—it was from the City that the leaks occurred. What emerged over the week was the rumour that Ed was going to go after the banks. And he did.

Miliband spoke without notes (a familiar party trick of his), laying in to the government for its complacency over the cost of living crisis, over zero hours contracts and the predicament of the “squeezed middle”.

“Deficit reduction alone is not a vision for the country,” he said, to great approval from the room. A good line. “They’re not the solution,” he said of the Conservatives. “They’re part of the problem.” The stagnation of living standards, the squeeze on wages, sluggish economic growth, anaemic business investment and weedy productivity—all of this he put squarely at the feet of the government.

The answer, he said, was to reform the banks. Miliband had shown how to fix the energy companies, he said, and now it was time “to make banks work for the real economy again.” “We need a reckoning with our banks,” he continued, “not for retribution, but for reform.”

And after the rhetoric, the policies. A Labour government under Ed Miliband would set up a Business Investment Bank, which would lend to small and medium sized businesses, predominantly in the regions. And if there were not a sufficient “culture change” in the current large banks then he would step in and separate the high street from the “casino” elements. “Too much power is concentrated in too few hands,” he said, noting that 85 per cent of small business lending is in the hands of only four banks. “On day one,” of a Labour government he said, he would ask the Competition and Markets Authority to create two new large high street banks to compete with the present big four.

Miliband also said he wanted a branch sell-off by the big high street lenders, and in addition a bank test—a threshold that sets the maximum market share that any bank can obtain. A bank that surpassed the threshold would be forced to scale back its operations. Under a Labour government banks would not be allowed to merge with one another or acquire other banks. “Instead of you serving the banks,” he said, “the banks will serve you.”

These policy ideas will no doubt play well with the public, but there are considerable problems with them. The central assumption of Miliband’s proposals is that banks need to put their hands in their pockets and begin lending more freely. They pay large bonuses to employees and leech money from the economy—it is time they started acting for interests other than their own. There is little disagreement in Westminster that bank lending must increase. However, the regulatory pressure under which banks presently operate is encouraging the very opposite of this—bank capital requirements are forcing banks to hoard cash to comply with the new rules on risk capital. In addiction, the Chancellor has asked the Governor of the Bank of England to look into the possibility of imposing a leverage ratio on banks which, if set in place, would further increase the banks’ need to hold larger reserves—as a consequence, they would have less to lend.

We find ourselves, therefore, in a paradoxical situation in which politicians are telling banks to lend and regulators are telling banks to save. It’s not clear how, if at all, Miliband’s proposals would change that. Someone familiar with these debates told the Prospector that the Labour Party is convinced that increased competition would force banks to make more loans at more favourable rates and so the creation of new banks would inevitably bring more lending. However, rates are at historic lows—the Bank of England and Federal Reserve policy rates are both effectively at zero. Banks lend cheap money. The problem is that they don’t have enough of it to lend.

The notion of a market share cap is also problematic. If the banks’ share of the market were to be limited in this way and a bank were to fail, then all other banks in the market would necessarily experience a sharp increase in their proportion of market share. In this way, the failure of a bank would lead to other banks quickly having to reduce the scale of their operations in order to remain below the threshold. Furthermore, they would be doing so at precisely the time when they should be doing the opposite. The history of financial crises shows, from the credit crunch of 1966, to the crises of 1974-75, 1981-82 and on to the credit crunch of 2008 that the rapid decline in the fortunes of one component of the financial sector must be substantially offset by compensatory activity in other parts of the market if a widespread panic is to be avoided. Miliband’s threshold plan would make illegal precisely this sort of emergency activity.

Miliband’s other suggestion, that he would ban banks from merging with or buying other banks, would also remove a crucial safety net for preventing the spread of financial panics. The Franklin National Bank of New York, which collapsed in 1974 is a pertinent example of how a wide-scale financial crisis can be averted by the prompt intervention of other financial institutions. A further famous example was the failure in 1998 of Long Term Capital Management, the hedge fund that took highly complex bets on the convergence of bond yields, and which only survived thanks to the intervention of a consortium of other financial institutions that bailed it out, again preventing a crisis that would have ensued without the intervention of other financial institutions. More recently the Bank of America acquisition of Merril Lynch in September 2008 was one of the core emergency events that took place in the immediate aftermath of the collapse of Lehman Brothers. In all of these cases, the effects of a financial failure on the broader economy were significantly reduced by the ability of one financial institution to buy—that is, assume the debts of—another. If this were illegal, then there would only be one possible rescuer of distressed financial institutions in Britain—the government.

There is consensus among the political parties that something has to be done about the banks, which have emerged from the 2008 crash in much the same condition as when they went into it. Reports have been written and commissions of enquiry conducted by Sir John Vickers, Adair Turner and other grandees. In the United States, policy makers have gone so far as to enact a rule, the “Volcker Rule”, which goes some way to separating retail from investment banking. But here in Britain, as Martin Wolf of the Financial Time wrote recently: “The belief that the powerful sacrificed taxpayers to the interests of the guilty is correct.”