Vince Cable: The banks got themselves into this mess. Why should we bail them out?

THE Prime Minister and the Chancellor have a problem – a big problem.

A reputation for economic management which took a decade to build has been all but destroyed in the last six months. The Government has dithered over a rapidly bursting credit bubble; demonstrated administrative incompetence over child benefit records; and is now starting to fall apart over the abolition of the 10p tax rate, the most regressive tax change since the poll tax.

It has now become all too clear that Gordon Brown's belief that he could use his past economic credibility to ride out this storm was, at the very best, nave.

Today, the Chancellor of the Exchequer meets with the major mortgage lending banks to discuss the credit crisis and what steps can be taken to alleviate pressures on homes owners.

When the big banks walk into Number 11, we know what they will say. They will ask the Bank of England, and in effect the taxpayer, for yet more support, on the basis that without it they are unable to maintain floods of credit.

This argument is already wearing very thin. The main high street banks have become like unruly teenagers. They want the Government nowhere near them when times are good, but as soon as they find themselves strapped for cash they believe they have a god-given right to demand it from the taxpayer.

Darling must stand up to them and say no. The banks got themselves into this mess. They must get themselves out of it. We cannot have yet more of taxpayers' money being put at risk.

The banks argue that they can't pass on interest rate cuts to consumers because they still have to borrow at high rates from other financial institutions, if they can indeed borrow at all. Yet there is a reason for this. Banks simply don't trust each other at the moment. Each bank knows that they have not fully realised the extent of the bad mortgages they are holding as a result of the credit crunch and so are unwilling to accept assurance from other banks about the state of their books for fear that they too are in a similar position. This means that lending between banks has all but stopped and as a result liquidity is very short. This must be sorted out but in the long term only banks themselves can do this.

The Government and the Conservatives support the Bank of England's policy, announced yesterday, of swapping Government bonds in return for mortgage securities. This is fraught with danger and in all likelihood will put taxpayer's money at risk, as we have no idea of the quality of these mortgage securities. They are even considering including credit card debt in the package.

Inter bank lending does need to be restarted and more liquidity is needed but this must not be at the expense of the taxpayer. Before the Bank of England can countenance accepting anything other than very secure assets as collateral when increasing its lending to high street banks, these same banks have to come clean about their losses, and shareholders, not the taxpayer, should foot the bill for writing down bad debts.

It is only through the banks themselves being honest about the state of their books, that trust can be restored to the market which will in turn bring down borrowing costs for banks and thus mortgage holders. The Royal Bank of Scotland set the right example with a rights issue raising fresh capital from shareholders. The others must follow.

This of course though is only one side of the coin. When Darling speaks to the banks today he must address the consequences of a rapidly falling housing market and rising repossessions. It is not the job of government to prop up an overheated housing market and there will have to be a significant correction. But there is a public interest in averting a wave of repossessions which would lead to local and national taxpayers shouldering the cost of housing the homeless as well as a likely overcorrection in the market.

Mortgage lenders want the Government to restore benefit entitlements – in other words, the taxpayer pays. Again the public should not be expected to foot the bill for the decisions of banks and individual borrowers who should be shouldering the responsibility.

This responsibility should be enforced by a statutory obligation on both parties to submit to an independent financial assessment by an agency like the CAB and for lenders to offer a range of payment alternatives so as to keep families in their homes – involving share ownership and rental arrangements – with an equitable sharing of losses.

There is also a good argument for social landlords to act as a buyer of last resort, to prevent a fire sale of repossessed property and to rebuild the depleted stock of social housing.

These then are measures which can be taken to deal with the current crisis but we now must also look forward to how we ensure this never happens again. Regulatory measures governing bank reserve capital can and should be operated via a counter cyclical means to ensure we do not have credit binges in boom periods and credit droughts in down turns. Equally house prices must be included in the Bank of England's remit to control inflation, to prevent future housing bubbles.

These measures I have set out are not easy options and

demand political courage, particularly in the face of unreasonable demands from the banks. However, if the Chancellor shows leadership he will receive my support and we may yet avoid a deep financial crisis.

Dr Vince Cable is deputy leader of the Liberal Democrats, and the party's Shadow Chancellor.