Ex-BOE’s Gieve Says Moral Hazard for Banks Threatens Next Cycle
Former Bank of England Deputy Governor John Gieve said government bailouts of banks have created “moral hazard” which threatens the next economic cycle as the current financial crisis shows some signs of abating.
“The government has dispelled any constructive ambiguity on how far it’s willing to let banks and investors suffer,” Gieve said at an event in Edinburgh late yesterday organized by the David Hume Institute. “There’s now a safety net covering every significant bank, even banks that have failed.”
Bank of England Governor Mervyn King said in 2007 he wanted to avoid measures to aid banks which could sow the seeds of the next financial crisis. A year later, Gordon Brown’s government spent billions of pounds to rescue Royal Bank of Scotland Group Plc and Lloyds Banking Group Plc after the collapse of Lehman Brothers Holdings Inc. rocked the global financial system.
“Moral hazard is a real issue now,” said Gieve, who was the U.K. central bank’s financial stability chief until March. “In recovery, this could make the next cycle much worse. There are already signs of that” in competition among investment banks for staff.
Deutsche Bank AG, Germany’s biggest bank, said this week it hired Ram Nayak from Credit Suisse Group AG to be head of global markets structuring in London. Job openings in London’s financial-services industry rose in May as banks and insurers resumed hiring, recruitment firm Morgan McKinley said yesterday.
Gieve said investors “must not put too much weight” on recent signs that the British economy is emerging from the recession. Surveys on U.K. services, manufacturing and construction all showed improvement in May.
Too Early
“There are some signs that the global crisis may have passed its most acute phase, though it’s too early to announce a recovery,” Gieve said. “As fears subside, we must not allow the impetus for reform to weaken.”
Gieve said that existing banking rules needed a complete overhaul instead of just a few adjustments.
“The biggest lesson for regulators is to give more weight to systemic links,” he said. “You have to watch out for the behavior which is rational and sustainable for an individual but not for the whole system faxless cash advance.”
Gieve also added his voice to calls by officials including his successor, Paul Tucker, for so-called macroprudential tools to prioritize financial stability instead of leaving that burden to less suitable monetary policy instruments.
“We need to protect the economy against the banks by taking measures to dampen the cycle” with “bigger buffers that would dampen the pace of expansion and dampen the pace of contraction” of banks, Gieve said.
King’s Speech
King said this week that new banking rules should eliminate an implicit state guarantee for firms that combine household services with risky investment banking or funding strategies. He also said banks should not be allowed to become too big to fail.
Gieve said a focus on size may not be the right response, as there may be advantages in some firms becoming large enough to provide international services. Also, financial-industry consolidation in the next two decades will produce more large firms, and perhaps a focus should be on preventing banks from developing an excessive size in a number of markets, he said.
He also said regulatory oversight should be shared by multiple organizations, though the rules for governing this should require close cooperation. Regulators need to check each other to make sure that they provide a strong enough force against risky practices, he said.
“It’s harder for them to question common practices that have built up over a number of years and been blessed by the supervisors themselves,” Gieve said. “Saying something’s dangerous and needs to be reversed requires regulators to admit they’ve made a mistake in the past.”
Gieve added to comments in March that the bank’s focus on financial stability “slipped down the agenda” before the banking crisis, saying yesterday that its handling of the Northern Rock Plc panic in 2007 was “off the mark” and its treatment of the crisis “poor” at the end of that year.