Planning for a rainy day: why Britain needs a financial stability fund

We've got to try and prevent the next crisis – but also plan for what happens if we don't, writes Victoria Barr

Even with robust reform of financial sector regulation, it would be a mistake to think that a financial crisis could never happen again. With the benefit of hindsight, we can now observe a long trend in political economy in which the lessons of the 1930s were forgotten over time: depression-era restrictions separating investment from retail banking were eroded in the US, while in the UK, a "light-touch" approach to financial sector regulation was pursued by both Labour and Conservative governments.

Over time, new cohorts of personnel will staff central banks. They will have learned about the recent crisis from textbooks rather than personal experience, and will be influenced by new intellectual agendas. Within the financial sector, a new generation of bankers will emerge, confident about the merits of their financial innovation and impatient with the fussiness of their compliance departments. Finally, future politicians, mindful of the importance of the City to British economic performance, may be swayed by persuasive arguments to relax capital adequacy requirements; to allow economies of scale to be exploited from the greater fusion of retail and investment banking; or to celebrate a merger which turns a national champion into an international behemoth, ignoring that the bank may have become too big for one sovereign to bail out alone. These processes are not inevitable, but they are not impossible to imagine over, say, the next seventy years.

The concern that the financial crisis may reoccur lies behind many of the current regulatory reforms. However, the risk of reoccurrence also has implications for the management of the public finances. If financial fragility builds up, unnoticed or ignored, during stable economic periods, then it is possible that economic and fiscal forecasts could be out by a wide margin. The Treasury’s public finance forecasts and decision-making on levels of taxation and spending before 2008 were based on the expectation that the UK economy would continue to grow at around 2.5 per cent per year. This expectation was very much in line with the consensus view among independent forecasters at the time. However, the latest estimate of what the UK’s average annual growth rate will end up being between 2007/08 and 2016/17 is less than half that, at 1.2 per cent.

The UK was hit particularly hard by the financial crisis, partly because it has a large financial services industry relative to the size of the economy. The City is a source of great economic strength for Britain, a sector in which we excel internationally and which, in good times, provides a healthy stream of revenue for the Exchequer. However, as recent events have clearly demonstrated, it also brings with it fragility and risk. In this regard, it shares some of the characteristics of the so-called "natural resource curse", where the discovery of natural resources, like oil, brings great wealth to a country, but also fiscal volatility and other undesirable side effects.

Many countries have attempted to avoid the natural resource curse through the introduction of revenue stabilisation funds, which aim to smooth income over time and insulate the rest of the economy from the impact of natural resources exploitation. In fact, countries have also introduced similar "accounts", sometimes called sovereign wealth funds, to achieve a range of other objectives: to meet certain fiscal targets; to save to meet long-term obligations; and to anticipate the costs of future financial crises.

Such an approach has attractive properties for the UK. The government should establish a Financial Services Revenue Stabilisation Account, or "rainy day fund", which could only be accessed in the event of a serious financial crisis. In addition to supporting measures to maintain stability in the banking sector, the funds in the account could also be used to counteract the negative impact of a financial crisis on the wider economy (such as measures to boost aggregate demand (e.g. tax cuts) or to avoid cuts to public services).

The planned size of the fund should be subject to further analysis. As the fund is only intended for use in serious financial crises, it should be possible to allow the fund to build up over time. The monies in the fund should be invested conservatively in counter-cyclical and liquid assets, able to withstand the asset price volatility which accompanies financial crises and which can be accessed quickly without the liquidation of the fund itself causing market turmoil.

The fund is intended to improve the management of tax revenues in a country with a large financial sector. However, for simplicity, payments into the account need not be explicitly hypothecated from particular revenues from the financial services sector, although this would be the spirit of the fund. We do not recommend an additional levy to pay for contributions to the fund.

The disadvantage of a Stabilisation Account is the opportunity cost of locking tax revenues away. The funds invested in the account could otherwise be used for different purposes, such as investment, reducing taxes or paying down the national debt. These are not trivial concerns.  However, the contingency function of the fund, and the capability to respond to a serious crisis that it would give a future government, are sufficiently important to warrant foregoing other expenditure in the short term. 

At the current time, we remain in the middle of an economic crisis, and the government’s priority must be to jump start the economy out of the current slump. Payments into the Stabilisation Account should therefore not commence until the economy is growing strongly again.

In addition to regulatory reform to reduce the likelihood of a financial crisis occurring again, Labour should acknowledge that crises are difficult to predict and economic forecasting prone to error. A ‘rainy day fund’ would ensure that any future government is better placed to take action during a crisis and signal the Labour party’s commitment to securing Britain’s long-term economic stability.

A Rainy Day Fund: Why Britain needs a financial sector revenue stabilisation fund is published today by the Fabian Society – click here to read the full publication.

Photograph: Getty Images

Victoria Barr is an economist at FTI Consulting. She has previously worked at Frontier Economics, the World Bank and as the Economy and Welfare Policy Of?cer at the Labour party during the 2010 general election.

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Stability is essential to solve the pension problem

The new chancellor must ensure we have a period of stability for pension policymaking in order for everyone to acclimatise to a new era of personal responsibility in retirement, says 

There was a time when retirement seemed to take care of itself. It was normal to work, retire and then receive the state pension plus a company final salary pension, often a fairly generous figure, which also paid out to a spouse or partner on death.

That normality simply doesn’t exist for most people in 2016. There is much less certainty on what retirement looks like. The genesis of these experiences also starts much earlier. As final salary schemes fall out of favour, the UK is reaching a tipping point where savings in ‘defined contribution’ pension schemes become the most prevalent form of traditional retirement saving.

Saving for a ‘pension’ can mean a multitude of different things and the way your savings are organised can make a big difference to whether or not you are able to do what you planned in your later life – and also how your money is treated once you die.

George Osborne established a place for himself in the canon of personal savings policy through the introduction of ‘freedom and choice’ in pensions in 2015. This changed the rules dramatically, and gave pension income a level of public interest it had never seen before. Effectively the policymakers changed the rules, left the ring and took the ropes with them as we entered a new era of personal responsibility in retirement.

But what difference has that made? Have people changed their plans as a result, and what does 'normal' for retirement income look like now?

Old Mutual Wealth has just released. with YouGov, its third detailed survey of how people in the UK are planning their income needs in retirement. What is becoming clear is that 'normal' looks nothing like it did before. People have adjusted and are operating according to a new normal.

In the new normal, people are reliant on multiple sources of income in retirement, including actively using their home, as more people anticipate downsizing to provide some income. 24 per cent of future retirees have said they would consider releasing value from their home in one way or another.

In the new normal, working beyond your state pension age is no longer seen as drudgery. With increasing longevity, the appeal of keeping busy with work has grown. Almost one-third of future retirees are expecting work to provide some of their income in retirement, with just under half suggesting one of the reasons for doing so would be to maintain social interaction.

The new normal means less binary decision-making. Each choice an individual makes along the way becomes critical, and the answers themselves are less obvious. How do you best invest your savings? Where is the best place for a rainy day fund? How do you want to take income in the future and what happens to your assets when you die?

 An abundance of choices to provide answers to the above questions is good, but too much choice can paralyse decision-making. The new normal requires a plan earlier in life.

All the while, policymakers have continued to give people plenty of things to think about. In the past 12 months alone, the previous chancellor deliberated over whether – and how – to cut pension tax relief for higher earners. The ‘pensions-ISA’ system was mooted as the culmination of a project to hand savers complete control over their retirement savings, while also providing a welcome boost to Treasury coffers in the short term.

During her time as pensions minister, Baroness Altmann voiced her support for the current system of taxing pension income, rather than contributions, indicating a split between the DWP and HM Treasury on the matter. Baroness Altmann’s replacement at the DWP is Richard Harrington. It remains to be seen how much influence he will have and on what side of the camp he sits regarding taxing pensions.

Meanwhile, Philip Hammond has entered the Treasury while our new Prime Minister calls for greater unity. Following a tumultuous time for pensions, a change in tone towards greater unity and cross-department collaboration would be very welcome.

In order for everyone to acclimatise properly to the new normal, the new chancellor should commit to a return to a longer-term, strategic approach to pensions policymaking, enabling all parties, from regulators and providers to customers, to make decisions with confidence that the landscape will not continue to shift as fundamentally as it has in recent times.

Steven Levin is CEO of investment platforms at Old Mutual Wealth.

To view all of Old Mutual Wealth’s retirement reports, visit: products-and-investments/ pensions/pensions2015/