Our full time Executive Chairman, Stephen Knight, is also non executive chairman of Cicero Consulting, a public policy advisory firm.  At a recent Cicero House of Commons breakfast meeting where Stephen, Vince Cable (Shadow Chancellor, Lib Dems) and Thomas Huertas (Director, Banking Sector, FSA) were all speakers, the article that appears as a blog below summarises the discussions.

For me, this was the most interesting part of the debate that took place at Cicero’s first House of Commons breakfast meeting of 2009 entitled “The Future of UK Financial services Regulation”.

Speaking in favour of nationalising the main high street banks was our host, Dr Vince Cable, MP, Shadow Chancellor for the Liberal Democrats. It’s hard to resist Vince Cable’s arguments, because he has been right on so many aspects of what we have come to know as the credit crunch.

Dr Cable believed that full nationalisation was inevitable, with the markets testing the banks’ share prices until this event was brought about. Better therefore to do it now, spend a period forcing the banks to lend more and then, after 5-10 years, attempt to return the banks to private ownership.

Opposing this view was our guest speaker, Dr Thomas Huertas, Director, Banking Sector, Financial Services Authority.  Dr Huertas, who reports directly to Hector Sants, Chief Executive of the FSA, is in charge, amongst other things, of implementing changes in the prudential regulation of banks. He was therefore the ideal person to consider Dr Cable’s suggestion.

Dr Huertas felt that it was not the role of Government to run banks. This was best done by the professionals in charge. The only reason the Government invested in the first place was to safeguard the banks’ future and protect customers.  As soon as appropriate these shareholdings would be reduced or eliminated.

Many of our clients, and potential clients, had views on this subject and a fascinating debate ensued.  My guess is that there was an overall balance in the room. It certainly got me thinking. However, even though Dr Cable always impresses me with his insights, on this occasion I was with the regulator.

In my view the Government was right to step in when they did with the two banks in question.  But I think they should be clear with the markets that full nationalisation is a step too far. For a start, it would be imprudent in the extreme for a Government department, i.e. the Treasury, to be responsible for policy formulation, policy implementation and regulatory supervision of major clearing banks.

It is already happening with a smaller specialist mortgage bank, Northern Rock, with muddled consequences. For example, NR was told to repay Government borrowing and increase its lending at the same time. They were told to increase their profitability and their capital base while suffering punitive coupons and guarantees for the use of Government funds. This is containable at NR, but would have wider consequences at a major clearer.

In fact, every initiative the Government has taken in this sector has resulted in an outcome which is the reverse of the good intention. Gross lending is projected this year to be one-third of 2007’s level, and some bankers think it will be lower than that, yet the Government wants increased lending.

One of the most crushing blows to the availability of liquidity is an action designed to stimulate lending, namely base rate reductions. These are now at a level where savers are ‘enjoying’ a negative real rate of return. The savers are therefore taking their money out, seeking higher rates with foreign institutions or via corporate bonds.

It is pretty much a ‘given’ that savers will not stay for a negative real rate of return, absent of really threatening economic conditions. The first thing that Government should do is therefore to remove any prescription or criticism as to where the banks set their savers’ and mortgage rates, to ensure available liquidity.

The liquidity freeze is primarily responsible for the dramatic fall in property prices, and they will keep on falling until actions are taken that directly increase liquidity.

One such action, discussed at the breakfast meeting, would be to extend the Government’s ‘hold, purchase and guarantee’ regime for mortgage-backed securities to wholesale lenders, who could as a result re-introduce liquidity from the capital markets to our domestic mortgage market.  In fact, so many of the clearing banks (not all) have  blown up on service that this is the only way to immediately and dramatically increase the availability of mortgages.

For the capital markets to be interested these would need to be highly conservative structures (maybe 98% AAA) at ten times the return (say LIBOR + 90bp versus 9bp at the height of the boom for AAA quick pay pieces). But these returns, on lower LTV lending, and backed by a Government guarantee, could get the market moving again.

The other problem in the UK mortgage market is that you can pretty much get the loan you want today at 75% loan-to-value (LTV) or below. Yet that is where the Government has targeted many of its new initiatives.

Help is actually needed up to 90% LTV, and the Government could achieve this by supplying itself, or maybe being a stop-loss partner with an insurance company, the equivalent of a mortgage guarantee where the premiums of the many would cover the claims of the few, and return a profit. The Government is already effectively in this space with its 100% LTV shared equity HomeBuy scheme, so why not extend that?

Of course, we don’t expect the Government to have intimate and practical knowledge of how specific markets work. That’s why they shouldn’t run banks.

The other major topic to engage our guests at the breakfast was the issue of pan-European, or even global, regulation. Here there was almost unanimity: it wouldn’t work. And the meeting was right-our vibrant markets would suffer if one (lowest common denominator) form of regulation was applied to a number of culturally diverse set of financial institutions.

As I said in my opening remarks at the breakfast, the credit crunch makes it even more important for financial institutions to engage with public policymakers of all types: to listen, learn and input. I’m proud of what we do at Cicero to help our clients navigate the legislative and policy-making agenda. And there will be more House of Commons breakfasts in 2009 once we have put across our clients’ views at the forthcoming G20 summit.