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Professor Philip Booth is Editorial and Programme Director at the Institute of Economic Affairs.

Vince Cable suggested on Sunday that the payment of bank bonuses and dividends should be linked to whether or not they lent more to businesses. It is not clear exactly what he meant and there was no substantive mention of this idea in the Green Paper that has now been published. He seems to be all at sea and one wonders whether his ambition is to promote another financial crisis.

A few years ago, the IEA published a very good book, Fifty Economic Fallacies Exposed. I am beginning to wonder if Vince Cable should be the subject of the next edition. At the current rate, his fallacies could fill a whole book within the year.

There are many underlying causes of the financial crash and credit crunch. But, for the benefit of creating consensus, let's park, for the moment, the debate about whether there should have been more regulation, less regulation or a different type of regulation of banks' activities. Setting these issues aside, I think that all who monitor this subject seriously must be agreed that the following must all have contributed to the crash and also to the specific pattern that the crash took:

  1. The requirement and arm twisting in the US for banks to lend to poor risks.
  2. Weak personal bankruptcy law in the US.
  3. The scandal of the mass government underwriting of mortgages through the securitisation process in the US.
  4. The encouragement through the tax code for banks to finance themselves through equity and not debt and the regulatory encouragement for insurance companies and pension funds to invest in debt instruments – a further spur to securitisation.
  5. The successive bailing out of financial institutions in the US.

Dealing with all these would be win-win fixes and most of them need fixing in the US – the source of the crisis – to a greater extent than in the UK.

But politicians cannot resist meddling and giving themselves special favours. So what do we see? There is some progress on number 5 – not directly through fewer bail outs (only time will tell whether politicians can resist bailing out banks) but through better legal mechanisms for winding up. Yet there has been no progress on any of the other issues. Instead we just see more and more interfering and much of that interfering exacerbates the problems that were a major cause of the crash.

For example, Vince Cable wanted to bias the tax system even more against equity finance in the last budget by raising capital gains tax. Now, it appears, he wants bank bonuses to be based not on how profitable the loan book is but on how big the loan book is – has he not learned from the US Federal encouragement for lending to poor risks?

Furthermore, if incentives are misaligned within banks, they will be less profitable. How is it going to help pension funds, insurance companies and savers if banks are less profitable and dividends come under more regulation? And how will it help banks rebuild their capital so that they do have an appetite for risky lending again?

Politicians always seem to forget that all businesses are owned by real people – people who rely on investment returns for their income in retirement, in the event of sickness etc.

Instead of interfering further, Vince Cable should look at how the regulation of banks is reducing their lending: regulatory uncertainty, as well as proposed higher capital requirements (which will do little to help make the banking system safer), are slowing down lending. Indeed, it is ironic that the Green Paper, launched by Cable the day after his speech, mentioned that one of the problems within the banking system had been that remuneration had not been aligned with risk – something that the Secretary of State wishes to institutionalise.

The politicians' arrogance does not stop here, of course. Last Friday we had the futile exercise of the EU stress tests. These seem to have been dismissed by the markets. Why? One reason is because the one huge risk on the horizon – sovereign default – was handled in a risible way.

This is a poisonous atmosphere. Politicians, full of self-importance, are going round blaming the private sector for the economic problems for which they should bear much responsibility. The approach to the stress tests was pure hypocrisy. Interfering by writing more regulations whilst refusing to deal with the interventions that contributed to the crash also does politicians no credit.

32 comments for: Philip Booth: Vince Cable risks promoting another financial crisis

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