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It is a long-standing occupational danger for the Prime Minister of Labor. The siren call for urban lobbyists for fiscal deregulation is spoofed as a convenient fix to the UK’s flagging growth rate. Rachel Reeves appears to have fallen for that in recent rhetoric that regulations are corporate “neck boots” and a series of adjustments to deregulation for high and low finance.
The precedents of such liberalization measures in finance are not going well. Certainly, regulatory systems require a certain readjustment to address the economic and financial situation that evolves with regulatory arbitration. But the timing here is all wrong. Stocks have historically been highly valued, the market generally appears to be bubbled up, and credit terms are loose. It insists on restraint rather than licensing. The more fundamental point is that the Prime Minister’s logic is flawed.
Of course, deregulation can, in principle, help to increase the underlying growth rate by lifting innovation and productivity growth. However, financial deregulation is another issue.
City people like to quote how the London fires led to the first ever building regulations and invention of fire insurance. However, American central banker Paul Bollucer suggested that the only important recent innovation in finance is that it is automated teller, mechanical equipment rather than financial equipment, and declared that “there is little evidence that the vast amount of innovation in financial markets in recent years has a visible effect on economic productivity.”
It resonates. If you reflect how many recent innovations reflect, you will lend yourself less noticeable to hyperspeculation, moneylanders and fraud, whatever the benefits of being trumpeted at you, whether it’s a securities cut to costs to infinite fractions of seconds, or whatever the benefits of being trumped out loud.
That doesn’t mean that financial activities do nothing to promote growth. The problem is that it could be the wrong kind of growth, like the credit bubble that led to the major financial crisis of 2007-09, following Labour Prime Minister Gordon Brown’s Wright Touch Regulation System. Longview Economics’ Chris Watling said that this would require leverage to the system, which would ultimately create a wealth effect that would increase home prices and drive increased consumption.
There is no increase in productivity or create long-term sustainable wealth. The prelude to the crisis that caused losses in UK production ten years later caused a loss of 16%, 16%, compared to the pre-crisis trend, but public debt failed as the government bailed out the banks and pump prepared an abused economy.
This is not the end either. When interest rates return to more normal levels, household and business borrowers face refinance risks that can have systematic outcomes.
By switching government funds to short-term debt, as the US Treasury has done under President Biden and President Trump, potential damage can be eased by switching government funds to short-term debt. But this simply pushes the problem into the future. Meanwhile, the constant vibrations between deregulation and post-crisis readjustment reinforce the endemic boom and bust cycle since the initiation of fundamental financial deregulation in the 1970s.
An additional systematic risk arises as ultra-low interest rates combined with bank readjustment help divert capital into the private market. The resulting growth of shadow banking systems may have usefully plugged in post-crisis gaps in credit creation. However, excessive leverage and risk-taking thrive in the absence of sunlight. The opacity of the private market should help remind us that it has always been found that the system had more leverage during the boom period than is generally assumed. Similarly, that risk is rarely eliminated, but it changes shape and location forever.
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In light of all this, what should the British Prime Minister do to hone her growth agenda? The first order is to ease the endemic financial boom and bust cycle. Running a deregulation campaign in finance is clearly not the way to do it. Mantras need to be recalibrated rather than deregulation.
Critical to note is that the mortgage and housing boom is absorbing too much of the bank’s capital at the expense of more productive uses of the business. Tweeting around with Reeves’ ISA savings account is just a small help here. As Watling points out, regulators need to adjust for bank skewed incentives resulting from the weight of very low capital risk allocated to mortgage lending compared to corporate lending.
Political dynamite? perhaps. However, it is worth noting that Tory MP Tom Tugendhat raised his head above the Prime Minister in an FT article. It argues that leaving property as a sole lifelong capital gains tax exemption has distorted the UK’s capital allocation at a high cost to the Treasury and the younger generation. He says he must encourage UK families to invest in businesses rather than buildings. Tugendhat is not as much keyhotic as it is right. More active capital redistribution is at the heart of a serious growth agenda.
john.plender@ft.com
