I don't often quote in its entirely a blogpost from another blog, but this one from ConservativeHome's Tory Diary merits an exception. Over to Tim Montgomerie...
There's been a lot of criticism of David Cameron recently but this extract of a speech that he gave more than six months ago showed a pretty good understanding of the issues of capital inadequacy and illiquidity at the heart of this crisis:
“As well as the reforms we have outlined for the UK financial system, we need reforms at a global level too. So let me suggest one important reform that needs to take place in light of the recent crisis in world banking.
“The Basel capital accords determine how much capital a bank must set aside for a given amount of lending. This makes good sense, and, for obvious reasons, it is right to set the rules at a global level. But economists have identified some key problems with the current Basel accord.
“First, the rules on liquidity, which has been at the core of the current crisis, are too weak. Banks can operate with enough funding only to survive for a couple of weeks, but still be within the rules. Second, we need to examine which asset classes and which institutions are covered by existing rules. For example, the zero-weighting of some triple A assets has led to distortions in asset allocation. Put simply, some of the debts were kept off balance sheet so they didn’t count as lending under the rules.
“Third, judgements about credit risk were delegated to rating agencies who themselves had incentives to expand the amount of lending that was allowed under the rules. Put simply, because they are paid fees for rating debts, credit rating agencies had an interest in there being as much debt as possible. Finally, market risk was measured by backward looking models which tend to exacerbate the credit cycle, not dampen it. When credit is easy, the models allow more lending. When credit tightens, the models reduce the amount of permitted lending.
“In short, liquidity risk was all but ignored, credit risk was delegated, and market risk was backward looking. And we now know that not only did the regulators not know, but too often the banks themselves didn’t know, the full extent of the risks they were subjected to. But let me say again, any reforms at an international level will need care to ensure that in tackling the past problems they do not create the problems of the future. At the same time, we must all recognise that crises are inevitable, so a prudent Government, as we will be, that is committed tol be, must improve our response to these crises when they appear."
Now, I don't remember Gordon Brown anticipating the banking crisis in this clear way, do you? And while I am in the mood to nick things from other blogs, take a look at THIS post from Ben Brogan, where he quotes from Gordon Brown's speech to Reuters this morning...
"In future regulatory systems there will be both greater attention to issues of solvency and liquidity and probably a pro-cyclical attitude where in a period of growth you have got to lay aside more for the possibility that there will be contractions."Isn't that what the Conservatives have been saying for the last 18 months?