In the UK, we had thought we had made it just about impossible for mainstream banks to collapse. Prior to Northern Rock, the last run on a significant British bank was in 1866. The secondary banking sector has always generated a steady flow of casualties - Johnson Matthey Bankers, British & Commonwealth, Barings - but the boring high street banks and building societies, which provide current and deposit accounts and mortgages to millions of people… for decades it has been all but inconceivable that any of these could get into trouble.
And yet they did. And here we are. It gets worse every day. The government is contemplating offering government guarantees on bank loans to companies. These guarantees may help some legitimate employers to preserve jobs, but what about the moneybaggers who will also line up for a share of this bounty? Who will take responsibility for loans guaranteed by the government? No-one. The taxpayer will pay up again.
Regulation only part of the answer
Better regulation is a popular prescription to avoid recurrence of current troubles, but it is not a promising one. Regulation is David against Goliath. It's the rule-book-wavers against the ground-breaking, innovating, (and apparently - until it's too late - profit-making) heroes. The Financial Services Authority (FSA) may have missed a few tricks in its periodic assessments of Northern Rock, but stand back from those and consider the basic politics. Northern Rock was widely admired. Its innovative business strategy seemed to be minting money. It was well-connected - the chairman of its risk committee, Sir Derek Wanless, had been President of the Institute of Bankers and is on first name terms with Gordon Brown.
For the FSA to have said, back in 2003 or 2005, "Hang on a minute, Northern Rock… you are heading for oblivion" would have required in the first place a middle manager at the FSA to figure out a situation that escaped the notice of a past president of the Institute of Bankers. Then he would have had to persuade his bosses to buy his view. That's asking a lot. Yet more was required: the bosses would have had to gather the courage to tell the City that the £3bn valuation it then placed on Northern Rock was dubious. (Restraining Northern Rock could not have been accomplished in private, because the process would have been leaked.) A regional success story apparently making £500m a year has a lot of fans. Scores of institutional shareholders held this FTSE-100 stock. And on whose side do you think north-eastern MPs would have lined up?
If you think this regulatory process would have worked, I'd say you are naïve. But we would not have been relying on the regulatory process just to restrain Northern Rock. We would have been relying on it to second guess every bank. Notwithstanding protestations by the FSA that it won't be caught napping again, in ten or 15 years from now, that's exactly what will happen.
Real penalties for failure
Regulation is essential, but it is not the answer to the monstrous financial madness which brought the banking system down.
In my book, we can also write off nationalisation. The banking rescues have already resulted in the semi nationalisation of several banks, and the process seems likely to go further. This is no bad thing for the moment, but in the long term, the state should not run businesses. It's worse than capitalism. I don't propose to argue this point in detail. If you disagree, we'll have to differ.
So what should we do? In the case of businesses which are so very fundamental to the economy - such as banking - that their failure and subsequent rescue hurts us all, perhaps we should reconsider the view that it is not a crime to run the business into the ground. The risk-reward ratio for the directors of these businesses is too heavily skewed in favour of rewards. Those who fail can expect to retire with at least a few million pounds in the bank and a handsome pension. A few more risks are required. Should not the state routinely seize the personal assets of these people? And what about locking them up for a while? They might then consider exercising the restraint that conventional regulation cannot achieve.
