Lord Turner took charge of the FSA just as the financial world fell apart. As he prepares to leave the regulator, the man who once described banks as 'socially useless’ tells Kamal Ahmed that behaviour has improved, why the bail-out was right, and reveals his next project - a book .
When Lord Turner arrived at the Financial Services Authority as the new chairman in September 2008, the Royal Bank of Scotland (LSE: RBS.L - news) and Lloyds TSB (LSE: LLOY.L - news) were hanging on by their fingertips in the private sector, nobody had heard of quantitative easing, and Bob Diamond, the chief executive of Barclays (LSE: BARC.L - news) , had just announced an audacious bid for the investment bank and trading divisions of Lehman Brothers a bust bank.
Britain had just suffered a second quarter of negative GDP growth for the first time since 1990 and Alistair Darling, the chancellor, was about to announce a £37bn bail-out for British banks. The West was entering the unknown.
Five years later, and as Lord Turner prepares to leave the FSA at the end of the month, few would have thought that the unprecedented events of that fateful year would still be reverberating throughout the developed economies.
In previous recessions, the route back to growth has been quicker. This time, a toxic mix of unsustainable levels of public debt and private-sector deleveraging has left the British economy in a long-term funk. As Sir Mervyn King, the Governor of the Bank of England, said last week, there are some green shoots but they are very delicate.
Banks are still in the dock. The City still feels friendless. Remuneration is still headline news. New regulations on financial services are spewing out of Parliament, Europe and the Basel III process. Mr Diamond claimed in 2011 that the time for remorse was over. Few agreed then, few probably agree now.
“If you go back to March 2009, which is the point where all of us had gone through the crisis and were coming up for air and saying 'how do we put things right for the future?’ if you look at all the forecasts, Bank of England, Treasury, the IFS (SES: E1:I49.SI - news) [the Institute for Fiscal Studies], IMF, World Bank, they all suggested a much faster and more robust recovery of the developed-world economies than has actually occurred,” says Lord Turner.
“I think that’s because we were slow to realise that once an economy has become overleveraged, once either corporates or households are over-leveraged, they will devote whatever disposable income they have to trying to get their balance sheets down, and therefore the demand for credit is depressed.”
And until the economy recovers, the financial crisis will cast its shadow over everything that happens.
It was a remarkable time and it leads to a remarkable admission from someone once closely involved in the running of banks. Lord Turner was formerly vice-chairman of Merrill Lynch Europe and a non-executive director of Standard Chartered (Other OTC: SCBFF - news) .
“I think we as the authorities, central banks, regulators, those involved today are the inheritors of a 50-year-long, large intellectual and policy mistake,” he says.
“We allowed the banking system to run with much too high levels of leverage, inadequate levels of capital, and we ignored the development of leverage in the financial system and in the real economy.
“And not only did we ignore it but we had a pretty overt intellectual philosophy that we could ignore it, because we knew the financial system was just a market like any other and whatever it did was bound to be for the good because that’s what markets are.
“That was a huge mistake.
“People just fall into the habit of believing that the system is stable. I think, unfortunately, there was the development of a set of intellectual ideas efficient market hypothesis and rational expectation hypothesis which provide an apparently sophisticated intellectual argument for why this whole system is safe.
“[But] I think the response to it, the emergency response in Autumn 2008, was very good and I’m proud to have been a part of that process.”
When he walked into the FSA, the organisation was already changing, desperately trying to catch up with a financial-services sector that had left it for dead, a sloth trying to catch up with a tiger. It wasn’t until the FSA’s own, reluctantly authored, RBS report of 2011 on the collapse of Fred Goodwin’s bank that Lord Turner fully realised how dysfunctional the system had become.
“I was very surprised that, despite the fact that we had 3,000 people, the allocation on the direct supervision of RBS was five people,” he says.
“I was more surprised the more I looked at the liquidity standards that we’d been applying and the capital standards we’d been applying.
“I was surprised at the supervisory approach. I’d been on the board of a bank, I’d been involved in banks, I’d dealt with banks back in the 1980s and 1990s, and I, throughout that, had accepted the existing capital regime as a given, right?
“I had never gone back to basics and said, 'why do we allow banks to run with 30, 40, 50 times leverage?’. And neither had anybody else, funnily.”
Why not? critics may scream or, more precisely, there were some people warning of calamity, why weren’t they listened to?
“Well, it’s partly the frog in the boiling water, isn’t it?” Lord Turner says. “It slowly happens over time. It doesn’t happen immediately so the frog doesn’t leap out. The frog dies.” And while the frog is slowly dying, everyone is living it up on the debt-fuelled proceeds.
In 2009, Lord Turner famously said that a lot of banking activity was “socially useless”, a phrase that became the standard around which many critics of the City gathered. Has his opinion changed?
“Before the crisis, there was too much trading activity in unnecessarily complicated structured credits going on,” says Lord Turner. “We have seen a very significant shrinkage in some of the trading books of our major banks.
“And I think, when all that deleveraging of trading books is completed, we will find that the real economy never needed this stuff in the first place, and in a sense we’re better off without it.
“Secondly, I think if you look at Barclays’ decision to radically reduce the size of its tax structuring activity, that is an end of a socially useless activity.”
The attitude to payment protection insurance where the banks, after years of legal battles, finally agreed to provision billions of pounds for the mis-selling of products to Libor and to reductions in remuneration (often linked to the ending of the structured credit divisions Lord Turner refers to), have left banks in a better place now than in 2009. Is it time to move on?
“I think we’ve got to move on at some stage in terms of trust in the banking system,” says Lord Turner. “It’s not a good thing for the dynamics of our society if this large, and in many ways socially useful and socially important, function because you can’t imagine a market economy without a financial system which links savers and investors is distrusted.
“You know it’s either a perception or it’s reality, but either way we’ve got to fix it.
“I think we’re at an interesting point now because after a period some bankers were in denial about how much they had to change, I think over the past year we’ve seen a major shift.
“I think the substance may now have moved on a bit more than the perception has and the perception’s got to catch up with the substance.”
Going “back to basics” about why the financial crisis happened will be Lord Turner’s next task. He reveals that he will be writing a book on the financial crisis, not a “kiss-and-tell”, he insists, but a study of the economic and financial fallout from the momentous events of five years ago.
“It won’t be a 'who did what, when’ book and [it won’t just be] on the financial crisis,” he says.
“It will be more about where are we now in capitalism why has our system, which appeared to be doing so well, ended up producing a combination of a financial crisis and ever-widening levels of inequality? Which I think are concerning.”
Looking back now, Lord Turner says that in an ideal world the Treasury, Bank of England and the FSA should have gone further in 2008, forcing more capital into the banks and controversially allowing equity holders and creditors to be wiped out. His views on the past have important lessons for the future as regulators still grapple with the problem of “too big to fail”.
“We could have been more radical still,” he admits of the bail-out. “Because I think if we had more radically capitalised the banks in that moment of crisis, there would have been fewer of the questions [now] about whether [banks] have enough capital [and] are they trusted enough to be lenders to the real economy?”
Some have complained that the Government paid too high a price for its stakes, leaving the value of the holdings in RBS and Lloyds Banking Group still well below the “in price”. Talk of a sale back to the private sector is still just that talk.
“I think we did the right thing then,” Lord Turner says. “We didn’t pay too high a price. As I’ve said, if anything, I would have liked to have put in more capital at the time, but obviously ideally, in retrospect, one would like to have wiped out the equity holders rather than simply diluted them, and one would have liked to have written off subordinated debt. They didn’t suffer losses.
“The answer is, if you haven’t planned to do that in advance, it’s an incredibly dangerous thing to do, particularly the imposing of losses on subordinated debt holders.
“Because you don’t know who owns this stuff. If it is all owned by other banks, you’re just pressing one domino over and the others are going to come careering down. The other thing to say is, legally at that time, we could only impose losses on subordinated debt holders by actually pushing the bank into insolvency procedures, and then you are going to shock the real economy, there would be fire-sale losses.
“And that’s why it’s incredibly important that we create a clarity of regime in future.”
That clarity on the resolution of a failing bank is still a long way off, at least “three to four years”, Lord Turner estimates.
Lord Turner argues that much has changed in regulation and that capital requirements and bail-inable debt have improved the safety of the system. There is always a need for wariness, though, as in the end, human beings forget.
“We’ve made enormous progress, but I believe we’ve still got more progress to make,” says Lord Turner.
“Will there ever be the same crisis again? The challenge will be in 15, 20, 30 years’ time, when another 'this is different’ myth will develop. We’ve got to embed as much as we know in the institutional memory now.”