Hurtling Towards The Next Crash

Professor Prem Sikka, Lord Sikka writes:

A wise man once said that “history repeats itself, first as tragedy, second as farce”.

Successive UK governments have learnt so little from financial crises and the UK is hurtling towards the next crash. The country has had a banking crisis in every decade since the 1970s. Each crisis drew attention to frauds and predatory practices, but governments remain besotted with light-touch regulation. The finance industry is always bailed out and rarely bears the full cost of its own failures. After the 2007-08 crash, the obedient state provided £1,162bn of cash and guarantees (£133bn cash + £1,029bn of guarantees) to bail out banks. Another £895bn of quantitative easing was handed to capital market speculators. Households are yet to recover from this and the real median wage has hardly grown since 2008.

The tragedy is that deregulation fever is deeply rooted in institutions of government and at the behest of financial elites most of the post-2007/08 banking crash reforms have been dismantled. How long until the next crash and at what cost?

In folklore, regulators are there solely to protect people from predatory practices but that is not the case. The Financial Services and Markets Act 2023 introduced by the Conservative government, with full support from Labour, has returned to the pre-crash position. The Financial Conduct Authority (FCA) has a secondary objective to support growth and competitiveness of the finance industry over the medium to long term. This is a race-to-the bottom. The industry will exert pressure on the regulator by claiming that country X has lower consumer protection and regulatory requirements, and that is making us less competitive.

This dilutes the FCA’s consumer protection duties in a sector riddled with scandals. It is hard to think of any financial product that has not been mis-sold. Car loans are the latest example. Banks gave car dealers secret commissions to entice people into taking loans. The compensation bill could hit £30bn. Rather than helping victims get speedy compensation, the FCA says banks can take up to a year to hear complaints.

Not that the FCA has ever been in a hurry to resolve cases of frauds by banks. Frauds at HBOS date back to 2002 and may exceed £1b. The FCA neither investigated nor prosecuted anyone connected with them. It deemed it to be a matter for Lloyds Bank (Lloyds acquired HBOS in 2008). To disarm critics, in 2017, Lloyds appointed former high court judge Dame Linda Dobbs to investigate and publish a report by 2018. To date, no report has been published and the FCA has not inquired into its disappearance.

Growth of the finance industry is now a major plank of the Labour government’s economic policy. The government wants the FCA to tear up rules and encourage more risk-taking across the City i.e. grow the finance industry for the sake of its own growth. The UK is supposed to be a major global financial hub but industry has been starved of investment. Despite a plethora of subsidies and tax reliefs, amongst industrialised nations the UK languishes near the bottom of the investment in productive assets league tables. In pursuit of short-term gains, the finance industry prefers speculation i.e. gambles on the price of shares, bonds, derivatives and other securities. The price of food and commodities is increasingly determined by speculation by banks, private equity and hedge funds, rather than farmers. They play a major role in creating hunger and poverty.

Deregulation has attracted plenty of predators but has never secured much needed investment in the UK economy, which requires an effective industrial strategy, education, infrastructure skills and focus on the long-term. Significant parts of UK industrial sectors such as rail, water, motor vehicles, energy, steel, shipping, airports, ports, and microchips are all owned from abroad as the finance industry has shown little appetite for long-term investment and risks.

In pursuit of short-term profits private equity has devoured town centres. Its victims include Bernard Matthews, Body Shop, Byron Burger, Casual Dining, Cath Kidson, Comet, Debenhams, Flybe, Four Seasons Health Care, HMV, Maplin, Monarch Airlines, Paperchase, Poundworld, Southern Cross, Thames Water, TM Lewin, Toys R Us and more.

Huge swathes of shadow banking, which includes private equity and hedge funds, remain unregulated. The opaque $63 trillion global industry is bigger than the regulated banking sector and is enmeshed with insurance, pension and banking sectors. Any turmoil will crash the entire economy. The governor of the Bank of England has highlighted dangers but there are no capital adequacy requirements or regular stress tests. The state actually subsidises the sector. For example, excessive debt is the prime investment strategy for private equity. The government grants tax relief on interest payments and thereby reduces the cost of debt and inflates returns to shareholders. The government has no plan to end this subsidy.

Deregulation creates opportunities for bankers to take reckless risks with other people’s money, collect bonuses and destabilise economies. In 2014 to prevent economic shocks a ‘cap’ on bankers’ bonuses was imposed. In October 2023, Conservative government, with full support from Labour, abolished the ‘cap’. Bankers are free to be reckless as they pursue riches and have been encouraged to develop an industry beyond the reach of formal regulations.

Instability is checked by higher capital buffers, but they are also being eroded. The Bank of England has watered down capital requirement rules meant to shock-proof the banking system from another 2007-08 style crash. Banks would have to increase their current capital buffers by “less than 1%” to abide by the Basel 3.1 standards. That is down from previous proposals for a 3.2% rise. Capital adequacy rules for insurers are being rolled back with the claim that this may generate £100bn of private investment in infrastructure. How much will end up in dividends and share buybacks? The more important question is what would happen when financial institutions with low capital requirements have problems? That would destabilise the economy and no doubt the government would once again bail them out with public money.

Deregulation is creating a new Eldorado for bankers. There will be no limits on bonuses and no clawback of gains made with predatory practices. Prosecutions of offending bankers are rare. During the parliamentary passage of the Bank Resolution (Recapitalisation) Bill I urged government to impose a clawback of salary and bonuses of executives facilitating bank crashes. The government refused and the Minister said: “it is a key principle of the resolution regime that natural and legal persons should be made liable under the civil or criminal law in the UK for their responsibility for the failure of the institution. This is delivered by Section 36 of the Financial Services (Banking Reform) Act 2013, which provides for a criminal offence where a senior manager of a bank has taken a decision which caused the failure of a financial institution”.

So, how many bankers have been prosecuted. When asked, the Minister of Justice replied: “The Ministry of Justice Court Proceedings Database has not recorded any prosecutions under section 36 of the Financial Services (Banking Reform) Act 2013 since its introduction”.

Major political parties are obsessed with deregulation and the UK is hurtling towards the next financial crash. Regulators have been emasculated, regulation has been weakened, and enforcement is diluted. The government claims that growth of the finance sector will somehow bring economic prosperity to the UK, something it failed to do in all previous bouts of deregulation. The City has always focused on short-term returns and neglected long-term investment. That will sharpen as bankers will want higher bonuses before moving on to the next job. Equitable distribution of income and wealth to boost purchasing power of the masses, and free education to build a skilled labour force are key requirements for reinvigorating the industrial base but that is off the political agenda.

The next crash won’t just affect banks, pension funds and insurance companies; it will infect all sectors of the economy as private equity and hedge funds binging on debt now own large swathes of the high street and industry.