Bill Emmott - International Author & Adviser


The three worst words of all: ‘off balance sheet’
The Times - September 1st 2009

Careless talk costs lives, said the wartime poster. Nowadays, it can damage the talker´s credibility, as it has in the case of the remarks by Lord Turner, chairman of the Financial Services Authority, in his now notorious roundtable interview in last week´s Prospect magazine. Much more important than that, however, it cast a fog around the real issues that need to be discussed and addressed.

            September will be a month packed with financial summitry, full of anguished talk about the weak global economy and pious promises to prevent a crisis from ever happening again. The piety begins with the finance ministers of the newly influential Group of 20 (G20) countries this coming Friday in London, moves on through their bosses´ full G20 summit in Pittsburgh on September 24th-25th, and reaches the annual meetings of the IMF and World Bank in Istanbul as October opens.

            That is not even to mention Britain´s own conference season, during which at the TUC in Liverpool and then at the three political parties´ conferences the air will be thick with talk of bankers—for once not meant as rhyming slang—and what to do about them, their beastly bonuses and much else.

            So for such a month, and after such a financial crisis, what is wanted from an independent, apolitical figure such as Adair Turner is clear thinking and clear talking, in order to guide the debate towards the things that matter and away from those that don´t. That is just what did not come from his Prospect interview, which has focused minds on the meaningless issue of what the right "socially useful" size for the City might be, and the irrelevant issue of whether it could make sense to tax more financial transactions in future.

            Yet there are at least two much more important issues that need to be addressed by the summiteers, regulators and conference-wallahs this month, and which careful talk from Lord Turner could assist with.

            The first is whether the vital rescue measures deployed by governments around the world in the past year are storing up new problems for the future, whether in the form of creating a new crisis or of leaving lasting and damaging distortions in economies. Deposit insurance has essentially been made universal in all the main rich countries; since Lehman Brothers last September governments have declared that no big financial institutions will be allowed to fail; and on both sides of the Atlantic central banks and treasuries have been subsidising banks with hundreds of billions of pounds worth of cheap funding and official guarantees. As Peer Steinbruck, Germany´s finance minister, indicated in his letter to his G20 counterparts yesterday, if there were moral hazards that led bankers to think their business was a one-way bet before, those hazards have now been multiplied many times over.

            Understandably, and surely rightly, central bankers and finance ministers decided that when you are putting out a blazing fire there is no point in worrying about the next conflagration. They have been deferring talk of tighter regulation or bigger capital requirements, for fear of deterring banks from lending money just at the time economies need it. This must not, however, be deferred for much longer.

The trouble is that governments face big conflicts of interest in tackling this issue. Having semi-nationalised many big banks, they are quite happy to puff up the banks´ profits both to cut governments´ own short-term losses and to inflate the value of their assets for when they reprivatise them. Ministers may fulminate against bankers´ bonuses, but they have their own political and financial bonuses to think about too.

            The same conflict applies in Britain to fair competition in financial services. The Lloyds TSB takeover of HBOS would not have been allowed had there not been a crisis, and Northern Rock would not have been allowed to compete in the way it has since its nationalisation. But the government stands to be the main beneficiary of any abuse of dominant position by Lloyds or unfair practices by Northern Rock, at least until it has sold its shares, so it can hardly be trusted to act as the policeman.

The way to get this problem addressed is for respected, independent figures such as the chairman of the FSA and the governor of the Bank of England to lobby publicly and privately about it, and to use peer pressure and the glare of publicity at G20 summits and the IMF meetings. That is why credibility of such figures matters.

The second important issue lies at the heart of Lord Turner´s remit. It is the question of how to make the financial system more transparent.

For all the endless chatter about "efficient market hypotheses" and other nonsensical notions of market perfection, what banks were actually doing in the run-up to the crisis was concealing their securities holdings and operations as much as they could. As Enron should have taught us seven years ago, the most deceitful words in the English language are not "the cheque is in the post" or even "of course I will love you in the morning", but rather "off balance sheet".

Banks dodged the internationally agreed capital requirements by using off-balance sheet investment vehicles. The securities they traded and held through those vehicles, the notorious credit derivatives, were dealt "over the counter", which in finance-speak means the opposite of what it does in retailing, ie not openly at all and not on a recognised, regulated exchange. As a result no one, including banks themselves, knew where the risks lay nor how large they were.

Some of that problem has been dealt with. But not all. And a main reason why it has not is that it requires international agreement, preferably among a group as broad as the G20. For if one big financial centre enforces transparency, slaps capital requirements on the business and insists on dealing through an exchange while others don´t, the business will simply move to the ones that don´t.

In his interview, Lord Turner raised this point but then obscured it by floating the question of whether the FSA should in future ban certain financial products, rather as if they were dangerous drugs. Yet with full, and internationally co-ordinated, transparency, combined with adequate capital requirements, it wouldn´t need to. A principle as old as money itself could then apply: Caveat emptor.


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