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According to Sir Howard Davies, the first chairman of the Financial Services Authority, speaking yesterday on Radio 4, research in the United States has established a link between the trust that business and investors have in the regulatory system and their willingness to invest.
Thus one can infer that the speed and durability of the recovery from the current recession depends in some part on the ability of the Government and regulators to redesign the financial system in such a way that it continues to function efficiently but no longer runs out of control and lands us in another crisis like this one.
It is a laudable ambition but one which will no doubt fail, given that almost every financial crisis going back at least to the South Sea bubble almost 300 years ago has provoked legislation designed to prevent a recurrence, and quite clearly failed in that ambition. But notwithstanding the fact that repeating the same act and expecting a different outcome is a sure sign of madness, politicians will persist.
And there is popular support. While there has not yet been a similar study in this country linking regulatory trust and business confidence, the same sentiments probably apply. The shock to the wider business community brought about by the near-collapse of the banking system runs very deep.
It was therefore no surprise that regulatory reform was a major theme of Chancellor Alistair Darling's speech at the Lord Mayor's Banquet in the Mansion House last night. Nor was it any real surprise that in spite of extensive lobbying from City figures past and present to give back to the Bank of England full responsibility for banking supervision, he opted in favour of making the current tripartite system work better.
Its unfashionable to be sympathetic to this view but he has a point. People say the FSA never got on top of banking, but the truth is its banking department was that of the Bank of England, which was simply moved and rehoused in its offices. The staff were the same, the leader, Michael Foot, now with Promontory Finance, was the same, and the way it went about its duties was the same. Obviously things evolve over time, but it is too simplistic to say that results would have been different if responsibility had stayed in the Bank.
Nor should we forget that banking failures also occurred on the Bank of England's watch. The fringe banking crisis, the Johnson Matthey Bank failure, the Barings collapse, BCCI to name but a few.
But perhaps the major reason against making a substantial change is that regulatory arrangements take years to bed down, and arguably it takes a good crisis to iron out all the flaws and faults. The correct response is to learn and improve procedures so the structure is stronger and more effective, not to chuck it all up in the air and start again.
There is perhaps another reason not to obsess too much about regulation at this time. It may have been the principal theme of Darling's speech but the main thing which ought to be on the Chancellor's mind is the state of the public finances.
In the next year, we are going to have to borrow sums in excess of 10% of GDP, something never before attempted in peacetime. Many other governments will be borrowing vast amounts too so competition to sell government debt to international investors will be acute.
Rough estimates of total government debt issuance suggest that while in 2000 governments round the world borrowed $1 trillion, next year they will try to borrow $13 trillion. Our share of this is relatively modest but it has to be attractive internationally because we don't generate enough savings internally to buy it all ourselves. Our savings ratio is about 5%, less than half of what is needed.
Now as the Chancellor and Bank of England people have been pointing out recently, one of the surprising things about the recession so far is how much better we are doing in this country than overseas. There appears to be no reward for virtue because countries with apparently sounder economies are faring much worse.
Our drop in GDP from September to March was about 3.5%, according to Bank of England Deputy Governor Charles Bean. But the drop in German GDP in the same period was 6%, and in Japan it was 8%.
In manufacturing, it was even worse. Our output was down 10%, compared with 20% in Germany and 30% in Japan. Of course, manufacturing is relatively less important to our economy and it could be that we are going to experience similar levels of pain when the recession works through into services. But so far, so good.
That helps but it is still no guarantee we can raise the debt. At the very least it will require faith that the government is on a credible path towards borrowing less, and that sterling is going to hold its value. This strongly suggests that interest rates will have to be raised, regardless of whether the recovery is properly under way, in order to prop up sterling and to make the coupon on the debt internationally competitive.
So the hard fact is that talk of regulatory reform is a distraction from the real issues and challenge we face. Sorting out the government finances is far and away the biggest issue.
