Can the Treasury be trusted?

John EatwellLord John Eatwell is Labour's Shadow Treasury and Economic Affairs Minister in the House of Lords

The fundamental thing learned in the crisis was that focussing on the stability of individual institutions, however large – so-called micro-prudential regulation - is not enough. The whole is bigger than the sum of the parts. Systemic risk cannot be managed by individual firms.

Macro-prudential regulation poses major new challenges to policy-making. It will necessarily involve measures that cross the boundary between actions that might reasonably be left to unelected officials, and actions that are necessarily the province of politically accountable decision makers.

The essence of the government’s Financial Services Bill is that the Treasury cannot be trusted. 

Just as it was feared that they might approach interest rates with an inappropriate eye to political advantage, hence the Bank of England being given control over the policy; now it is feared that they will fail to deal with overly loose credit in order to reap the short-term political benefits of a debt-fuelled boom. Accordingly, the Bank is given, via the new Financial Policy Committee, virtually autonomous control over a variety of instruments to manage the supply and demand for credit. In addition, micro-prudential regulation is also taken into the Bank, in the form of the Prudential Regulation Authority.

This agglomeration of powers poses two vital questions. Is the governance of the Bank such as to result in accountable, clear, efficient and transparent utilisation of these extraordinary powers? Equally, does the relationship between the Bank and the Treasury, as set out in the Bill, meet the test of those four principles?

With respect to the governance issue, the government has responded to the evident lack of coordination in the crisis, by designing a model of perfect coordination – namely that one person should be responsible for everything.
The Governor of the Bank will chair the Monetary Policy Committee, the Financial Policy Committee and the Prudential Regulation Authority, as well as being in overall charge of the Bank’s special resolution unit and its payment/clearing and settlement systems’ oversight department (he or she will also in spare moments chair a number of important international committees).

Even if it is possible to find the exceptional individual who can effectively take on all of these tasks simultaneously, that person will be driven mad – for many of these activities will demand contradictory policies. Moreover, if ever there were a structure likely to result in the dangers of Group Think, this is it – since the group is a group of one!

In Grand Committee in the Lords, Labour will propose wide-ranging reforms to the governance of the Bank to ensure it has a structure of decision-making appropriate to the first half of the twenty-first century, rather than to 1694. 

The Financial Policy Committee of the Bank is described by the government as ‘a powerful new authority sitting at the apex of the regulatory architecture’. The mechanisms to ensure democratic accountability, to the Treasury and Parliament, need to be commensurate with the strength of its powers. And the most important aspect of this relationship is what should be done in a crisis. After all, it was in a crisis that the system failed last time. This is spelt out in draft Memorandum of Understanding: “Where the Bank is able to manage a financial crisis without public funds being at risk, it will have autonomy in exercising its responsibilities...”.

This is the most extraordinary nonsense, and a fetishisation of the use of public funds. Households may be losing their savings, businesses collapsing, and economic activity in precipitate decline as the result of financial instability, and if there is no threat to public funds the Treasury is shut out of any active financial stability role until the Governor invites it in. It betrays a lack of understanding of the mutually reinforcing cooperative role the Bank and the Treasury need to adopt in tackling macro-risk.

If an open and successful financial services industry is to prosper it is imperative that an accountable, clear, efficient and transparent mechanism for the management of systemic risk is established. And, moreover, that mechanism must have as its ultimate objective, the promotion in our country of employment and growth.

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