When Ed Balls was financial secretary to the Treasury, he won many admirers in the City for being that rare beast: a Labour minister who seemed to understand how financial markets worked and who was prepared to fight the City’s corner, fending off EU attempts to impose bureaucratic regulation on London. Those former admirers will now be scratching their heads and wondering if it could be the same Ed Balls who this week said to the Labour party conference: “Those people who think that the global market can be run without regulation, or with self-regulation, or with light-touch regulation have been entirely routed.”
Balls’ shameless attempt to pander to his party’s left-wing may have gone down well in the conference hall, but his attack was clumsy and irresponsible. Clumsy because it took bloggers all of about ten minutes to dredge up numerous on-the-record comments by Balls as a minister that were directly at odds with his conference comments. Irresponsible because, as he knows full well, at a time of financial turmoil and public anxiety, his duty as a Government minister is to help shore up confidence in our markets, not lead a witch-hunt against an entire industry – and Britain’s most important industry at that – or to fuel demands for action that could damage the country.
Let’s be clear about the City and regulation. The City is already heavily regulated – rightly, given it is an industry that uses huge leverage to gamble with other people’s money, that operates with an implicit Government guarantee over retail deposits, and whose leading players have access to central-bank, lender-of-last-resort facilities. Look at the way the Financial Services Authority was able last week to introduce a ban on short-selling in financial stocks overnight and without consultation. The FSA’s problem isn’t lack of powers, but its failure – in common with other global regulators – to use the powers that it has.
Regulators failed to ensure the financial system was adequately capitalised, largely because they failed to understand the extent to which banks were using off-balance-sheet vehicles and derivatives to hide their leverage. They failed to recognise the liquidity risk presented by new sources of funding, such as the mortgage-backed securities markets. Nor did they appreciate the extent to which banks were taking advantage of low real interest rates to borrow short-term money to lend for long-term projects, creating a so-called liquidity mis-match.
But these failings can be rectified under existing regulations. Bank regulators are working hard in Basel on new global capital adequacy rules. Accountants are working on new standards to improve disclosure of off-balance-sheet vehicles. And the FSA has already said in its response to Northern Rock that it recognises the need to give greater focus to liquidity. So what new powers do Balls and others in the Labour party who lined up to attack the City want? And what impact will “heavy-touch” regulation have on the rest of us?
The number-one target looks likely to be City bonuses – something Brown now says he wants to tackle. But how exactly? There is talk of forcing banks to spread bonus payments over long periods to allow time for mistakes to become apparent. But perhaps Brown doesn’t know that most banks already pay large proportions of their bonuses in share options that bankers can’t get their hands on for several years – and that the bank that paid the highest proportion in share options was Lehman Brothers, now bust. Besides, the outlandish bonuses of the past few years were largely a function of the credit bubble and huge rise in bank proprietary trading. In the new post-credit-crunch world, it’s a fair bet the bonus culture will look after itself.
There are also calls for further action against short sellers as a way to hit back at “spivs and speculators”. But whereas I know nobody in the City who thinks the current ban will make much difference to share prices over the medium term (smart hedge funds will find other ways to express their views on stocks), I know plenty who think it could do damage as funds find it harder to hedge positions and liquidity shrinks. Of course, if the Government really wanted to hit the City, it could pass laws dictating what rates banks pay on deposits, or what return they are can make on their loans.
But Balls should be careful. A shift to heavier regulation presents real risks. The first is that the UK financial services industry will simply shift off-shore, much as large parts of the bond market did when the US imposed withholding tax in the 1960s and a good part of the foreign listings market did in this decade after the US imposed the Sarbannes Oxley Act. Heavy regulation will further restrict the supply of credit to the economy, just as it is most needed to pull us out of crisis. A knee-jerk regulatory backlash now could leave us with a stalled economy, high government borrowing, a falling currency and a brain drain – just like in the 1970s, the last time socialists were in charge.
• Simon Nixon is the author of Credit Crunch: How Safe is Your Money? Priced £5.99, www.pocketissue.com. Email: spjnixon@googlemail.com.