Regulation and the financial crisis

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In a new ASI briefing paper – The Financial Crisis: Is Regulation Cure or Cause? – Tim Ambler examines demands for financial stability and security though increased regulation. The question the paper poses is whether existing regulation mitigated the 2008 financial crisis, had no impact, or exacerbated it. Answering this question is the key to deciding how we respond to the crisis.

A few main points:

• The crisis may have begun in the US, where regulation introduced during the Carter and Clinton presidencies was a major contributing factor, but whatever the international aspects of the crisis there are clearly a number of home-grown elements that made the UK particularly susceptible to it.
• The financial crisis was triggered by the bursting of a credit-fuelled bubble. Regulation and regulators did not cause this fatal bubble, but they did indirectly help it to grow by fostering the illusion of financial security. At no point did the UK's main regulatory institutions warn of the dangers ahead.
• The over-regulation of traditional financial services shifted enterprise towards complex financial packages that were unknown to, unseen by, and not understood by the FSA or UK Treasury. In many instances, even bank directors did not know what they were investing in.
• The regulation enforced by the FSA is predominantly legalistic and rules-based, and amounts to the micro-management of the way firms are structured and run their businesses. Compliance with rules was mistaken for the validation of business models and management practices – clearly a mistake. Regulation should focus more on principles and outcomes, not processes. We need better oversight, not more regulation.
• The most important factor in the crisis was that the UK's financial regulators lacked a clear and simple remit. This led them to overlook the early signs of the crisis and hampered their response to it. The Treasury must take responsibility for the failings of the tri-partite system, since they were the architects of it.
• The paper singles out the Bank of England for particular criticism, arguing that it was so pre-occupied with its first objective – monetary stability – that it failed to give due attention to its second one – the stability of the financial system. And even the Bank's focus on interest rates and inflation was rendered ineffective by the exclusion of property prices from their remit.
• The main conclusion of the paper is that improving regulation will not provide more than modest help in future. The important thing is that the Bank of England, the FSA and the credit agencies do the jobs they are supposed to do more effectively. The paper suggests a number of structural modifications that should be made to allow this to happen.

Click here to download a PDF of the briefing paper.

What Alistair Darling should have done

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I've written a new think piece on Alistair Darling's pre-budget report, arguing that his so-called 'stimulus package' is really just a manifesto for wasteful and ineffective spending increases, record levels of government borrowing and public debt, and higher taxes in the long term. I suggest that Darling should instead have announced a substantial rise in the personal allowance to put more money in the private sector economy, and balanced that with public spending restraint.

Click here to read the whole piece, which comes in at just over 1000 words. We haven't published many think pieces this year, but they are something we are hoping to do more of in 2009.

Guess who'll be paying for Gordon's debt?

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Hat-tip to Fraser Nelson and James Forsyth of The Spectator.

Blog Review 791

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There really is a large black hole in the budget....unfortunately. It's a £100 billion hole too.

Thre's a good way and a bad way to get through this. Guess which we're currently following?

There's a certain similarity between these two political platforms.

Another person arguing that the banks need to be nationalised.

There is a positive side to this increase in piracy.

Yes, windmill owners really do need to pay people to take the electricity.

And finally, Belgium explained (and boy, does it need explaining).

New Labour would have listened to the ASI

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With the dust beginning to settle after the pre-budget report – and not in a pattern that the government will like (see below) – it is interesting to note the question James Forsyth poses over on the Spectator's CoffeeHouse blog: what would a New Labour budget have looked like?

Needless to say, this is based on the assumption that yesterday's PBR did in fact signal the death of New Labour, as this Times leader brilliantly argues. It's not a bad assumption. It struck me as a resolutely Old Labour budget – the kind Dennis Healey could have been proud of. No more prudence, no more golden rules, no more acknowledgement that wealth creation is a necessary condition for 'social justice', rather than it's sworn enemy. Let's just spend and borrow to our heart's content, because someone else will be picking up the bill.

Anyway, James thinks he know what New Labour would have done:

New Labour might have lifted people out of income tax altogether — helping the poor but also sending out a low-tax message...

And they would have done this, he conjectures, by raising the personal allowance. Well, that's just what we suggested the Chancellor do in our brieifing paper Why Alistair Darling should raise the personal allowance. The paper called for a personal allowance of £12,000 for every UK taxpayer – a move which would take 7 million people out of tax altogether and make the average worker £100 per month better off.

James continues:

I suspect that this would have worked better both economically and politically.

Indeed it would. Are you listening, Mr Darling?

The reaction to the PBR

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The Times, Labour 1994-2008, Leader: The deep international crisis would have been difficult for any Government. For this one - with excessive borrowing already underway - the challenge is particularly severe. It has mortgaged the future on the ideas of the past

The Times,'Real' Labour regroups to fight the old battles, Rachel Sylvester:  “£150,000 may seem a lot in Edinburgh but it isn't a lot in Reading," one senior Labour figure said. “I fear that Gordon has just given a huge Christmas gift to the Tories. We are, to quote Lyndon Johnson, in danger of losing the South for a generation."

The Telegraph, Labour lands Britain in a £1 trillion hole, Leader:  Despite the best efforts of Alistair Darling to gild the lily - predicting a "shorter and shallower" recession as a result of his measures - the true enormity of the cataclysm that has engulfed us was finally laid bare.

The Telegraph, Why Gordon Brown the manic meddler had to take such a massive gamble, Boris Johnson:  The Government may treat the public like laboratory rats, but they are not entirely idiotic. They can see that this respite is only temporary. They can see that the tax rises are round the corner, and even as they tiptoe towards the cheese, they can see Alistair Darling waiting with his cosh.

The Independent: A monumental debt that takes us back to the 70s, Hamish McRae:  The Government is only raising about £7.50 in tax for every £10 it proposes to spend. That is back to the levels of the 1970s that led to us seeking a bailout from the International Monetary Fund (IMF).

The Sun, The Death of New Labour, Leader:  The clue is in the tax changes. All the CUTS are temporary. All the RISES are permanent.

The Sun, Cheat Brown has bungled the bung, Fergus Shanahan:  Gordon’s great “giveaway" amounts to no more than him acting like that loan shark on your doorstep or that drunk putting off the hangover.

The Financial Times, Say Goodbye to New Labour Again, Leader:  The pain of the Brown boom will be felt well beyond the recession.

The Daily Mail, 'I make no bones about taxing the rich': Darling resolute but Tories say radical rates cuts would be more effective, Leader:  Although the 800,000 people earning more than £100,000 will provide £3 billion of the £4 billion in extra income tax revenue, it was becoming ever clearer last night that average earners will be stung as well.

Dysfuntional dentistry

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It was reported in The Times yesterday that NHS dentists will be forced to pay back £120 million to the government for failing to fulfil their assigned quotas of cases seen. Once again we see evidence of government quotas creating a poor quality service, neglecting the areas which really matter.

According to the article, NHS dental treatments targets were missed by 5 million in the year 2007-2008. Previously, dentists were paid per treatment giving them greater economic incentives to provide a better quality service. But, under the current scheme dentists are given a set income for completing an agreed amount of NHS work. This set income minimises any incentives for dentists to provide a quality service, resulting in a ‘drill and fill’ scenario. As I have written before, the inefficiencies of the NHS mean that patients are seen as numbers, rather then people.

The inefficiencies of a quota system are clear, but if the dentists are punished for the governments failure we could see more and more dentists refusing to provide NHS treatment – already about 1,000 dentists have opted out of the NHS scheme meaning that 9,000 fewer patients have been treated – or a brain drain with dentists moving to countries such as the US where they will be rewarded more generously for their talents.

Left to the market this healthcare service would be provided in a much more efficient manner, with dentists responding to consumer needs both in terms of quality and volume of treatments.

What Alistair Darling should have done

In this think piece ASI policy director Tom Clougherty outlines his reaction to the Chancellor’s pre-budget report of November 2008, arguing that Alistair Darling’s so-called ‘stimulus package’ is really a manifesto for wasteful spending, record levels of government borrowing and public debt, and higher taxes in the long term. He argues Darling should instead have announced a substantial rise in the personal allowance balanced by public spending restraint.

Alistair Darling was widely expected to announce a package of tax cuts in his pre-budget report this week, in an effort to stimulate the economy. And a few people actually seem to think he did. In reality though, the Chancellor’s so-called tax cuts were little more than a political smokescreen, a ploy designed to wrong-foot his Conservative opponents and obscure his real agenda – more spending, more borrowing and more tax.

Look at what he proposed. First up, we’re going to get a temporary reduction in VAT to 15 percent. Isn’t that fantastic? A whopping 2.5 percent off! No doubt it will accomplish what high streets full of half-price sales and buy-one-get-one-free offers couldn’t, and get people spending again. Of course, it has also been reported that the Treasury’s figures depend on VAT rising to 18.5 percent in 2011, to pay off all the debt Darling plans to rack up. Thanks, Chancellor, but no thanks.

At least that was an actual tax cut though, if only a temporary one. Most of the measures the government is spinning as tax reductions are nothing of the sort. So the retrospective vehicle excise duty rise is going to be phased in now? Let’s call it a tax cut. No increase in the corporation tax rate for small businesses? Sounds like a tax cut to me. Oh, and the low-income households hit by the 10p tax debacle are going to continue getting their rebate? A tax cut if ever I saw one!

That’s still more than I can say for Darling’s plan to create a new higher-rate tax of 45 percent for those earning more than £150,000. I suppose it’s about time someone tried taxing the rich until their pips squeaked again, but we already know what the outcome is going to be. Most wealthy people will call their accountants and work out how to avoid the increase, while others will just move offshore. Either way, the Exchequer is more likely to lose out than see any increase in revenues.

Then there is the 0.5 percent rise in National Insurance Contributions for both employees and employers, which the Institute of Fiscal Studies has already confirmed will make anyone earning more than £19,000 per annum worse off. For the employee, this is an income tax rise in all but name. And as for the employer, their National Insurance Contributions are a perverse tax on jobs even at the best of times. Making it moreexpensive to employ people is precisely the opposite of what the government should be doing, especially with unemployment predicted to reach 2.9 million by 2010.

But like I said, that’s all just window-dressing. The real story here is that the government’s budget deficit will hit 8-9 percent of GDP over the next couple of years, as the government borrows up to £120bn per annum to fund its profligacy. Public sector debt is likely to top 60 percent of national income (so much for the long-cherished 40 percent ceiling), and even that figure excludes obligations incurred under the public finance initiative (£180bn and counting) and unfunded public sector pensions liabilities (now in excess of £1tn). The taxpayer already shells out £30bn a year servicing government debt, but that’s nothing compared with what’s to come.

And to what end? Are we really meant to believe that public spending is going to stimulate the economy? We’ve tried it before and it doesn’t work. ‘Priming the pump’ simply creates temporary and artificially high demand in certain sectors (generally the inefficient ones), at the expense of others (typically, the ones that actually create wealth). This is followed – as night follows day – by dislocation and unemployment when the artificial demand ceases.

You think borrowing money to renovate schools and hospitals is going to boost the economy, Chancellor? Dream on. Japan spent the nineties trying to kick-start their economy with infrastructure spending and it accomplished nothing except running up debts amounting to 180 per cent of GDP. In the US, massive spending hikes in the 1930s, 1960s and 1970s all failed to increase economic growth rates. And let’s not forget 1970s Britain.

Instead of resurrecting Keynes, Darling should have taken the pre-budget report as an opportunity to put some money back into the struggling private sector economy, where it actually stands a chance of being productive. He could have done this very easily by raising the personal allowance – which currently stands at £6,035 – to £12,000 for every taxpayer. At a stroke that would take 7 million low-paid workers out of income tax altogether, and ensure that no one earning the minimum wage or less would pay income tax at all.

To the average worker, this would be like getting an extra £1,730 a year in gross pay, leaving them £100 per month better off and reversing the substantial falls in disposable income that have occurred over the last 12 months. Indeed, had the Chancellor been feeling prematurely festive he could even have given this measure retrospective effect for the current tax year, which would have meant a one-off ‘Christmas rebate’ of £1,800 for a typical dual-earner family, and another £200 per month thereafter.

Assuming that the higher-rate threshold was kept where it is, and not raised in line with the personal allowance, such a measure would cost the Exchequer around £18.9bn a year in lost revenue – not an inconsiderable sum, but not an overwhelming one either. There would certainly be no need to increase government borrowing to do it: simply forcing government departments to stick to their budgets would save £14bn a year, while cutting quango budgets by 10 percent would save a further £6bn.

Needless to say, that analysis ignores the dynamic effects such a tax cut could have. By freeing up an extra £19bn to be spent or invested in the private sector economy, it could boost growth (or prevent contraction) and therefore increase revenues (or prevent them falling). Raising the personal allowance would also strengthen incentives to work, help to eliminate the ‘benefits trap’ and make low-paid jobs more economic – greatly increasing opportunities for the unemployed.

Of course, even if it didn’t do any of those things, raising the personal allowance would still be worth it, just because it would make everyone’s day-to-day lives that little bit easier. In the face of a recession, isn’t that what government should be aiming for?

Click here to download the ASI’s briefing paper on why the personal allowance should be raised and how to do it.

Blog Review 790

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We are repeatedly told about the ever longer working hours of modern life. The only problem is, as this graph shows, it simply isn't true.

There are those who say that current events show that we must abolish risk from the banking system. A slighty unfortunate thing to wish for as banks exist to manage risk for us, that's their very purpose.

Saving Lehman or not saving Lehman. Perhaps it wouldn't have made any difference either way, the financial deleveraging was going to create panic at some point.

Yes, free trade matters.

No, local trade is not better than non-local trade.

Spending how much to create how many jobs?

And finally, even if you're asking for your last cigarette you still can't smoke it indoors.

The better option

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For the £12 billion cost of Darling's 2.5 percent VAT cut, he could have raised the personal allowance to £10,000 instead.*

That would have taken 4.3 million people out of income tax, and saved a typical dual-earner family £133 per month.

* Assuming the higher-rate threshold stays where it is now.