Former monetary policy committee member Willem Buiter yesterday predicted functioning money markets would return within three years as he joined fellow former rate-setter Charles Goodhart and other business heavyweights to criticise the government's "counter- productive" interest rates on its capital injection into banks.
Asked yesterday by MPs on the Treasury committee whether investors would continue to shy away from buying up parcelled up debt from banks, a key way they financed their lending until the credit crunch struck, Buiter said: "For three years they will withdraw. That is the half-life of memory in financial services."
He added "there is nothing wrong" with securitisation, where banks bundle up and sell on loans to fund future lending, but originators of the loans should bear more of the initial losses to restore confidence in the system.
Buiter, professor of European political economy at the London School of Economics, said: "You have to force orginators to take a sizeable chunk of the first loss. That keeps the incentive for getting the information and maintaining the information intact."
Money markets effectively gummed up 18 months ago when investors who thought they were holding high grade debt discovered they were exposed to rising defaults in the US sub-prime mortgage market.
Buiter is cynical about the ability of regulators to handle the financial services sector, arguing for international regulators to stop "regulatory arbitrage" where companies move to locations with the softest rules.
"With a big asset boom there is universal capture of the regulators and the political process by the financial industry. It is very hard to interrupt that spiral until it is done by brute force by implosion."
He added: "Every regulatory regime will have the US doing its own thing because they are not gong to be bound by international agreement and certainly not regulated by foreign institutions. The best we could hope for is a single regulator for the European Union. That would take care of 27 dimensions of regulatory arbitrage."
But Buiter and fellow former Bank of England monetary policy committee member Charles Goodhart are sceptical about the merit of preference shares paying 12% interest banks such as Royal Bank of Scotland and HBOS were forced to accept as part of their government-backed fund raising. Until these are repaid banks cannot pay dividends to shareholders.
Goodhart, professor emeritus of banking and finance at LSE, told: "A lot of countries followed the measures and steps taken by the Prime Minister but none imposed so severe a penalty rate on the banks as we did. It was counter productive."
Buiter said: "I think there is nothing wrong to make the banks pay for government support. After all they have failed and you have to discourage that kind of behaviour. It is of course as a consequence that banks stop lending because they want to repay the government and those who are not yet subject to the arrangement do not want to fall into it."
Other witness appearing before the Treasury committee backed a relaxation of the regime.
Jon Moulton, managing partner of private equity firm Alchemy said that the holding should be converted into a larger share ownership of the institutions. "It takes the pressure off the bank."
Richard Lambert, director-general of The Confederation of the of British Industry added that the preference shares "create a disincentive for banks to lend."
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