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Strict curbs on mortgage lending and a clampdown on high-interest payday lenders will be demanded by the City's former top regulator on Monday as he warns that controls on "debt pollution" are needed to prevent another credit-fuelled global financial crisis.
Lord Turner, who chaired the Financial Services Authority during the near-collapse of the UK banking system, will call for a return to 1950s-style controls on credit. He will argue that current reforms are inadequate and that reliance on ultra-low interest rates, quantitative easing and mortgage subsidies are recreating the conditions that "got us into this mess in the first place".
In a lecture in Frankfurt, Turner will blame excessive private debt, rising inequality and global imbalances between debtor and creditor nations for the financial crisis that erupted in 2007. He will say that action in all three areas will be needed to prevent a second meltdown in 15-20 years time.
Speaking to the Guardian before the lecture, Turner said the implication of his proposals was a return to the tough controls on credit that existed in the immediate post-war decades. Policy in the buildup to the crash had been based on the belief that control of inflation by central banks and light-touch regulation were all that was needed for economic success.
"That was a major intellectual mistake. What I am suggesting takes us back to before those assumptions were in place, and what's wrong with that? The 1950s and 1960s were a golden age of steady growth without crises," he said.
Turner, who was on the shortlist to become governor of the Bank of England before Canada's Mark Carney was appointed, will say in his lecture that debt grew faster than national output in most advanced countries leading up to the crash, and attempts by companies and individuals to pay off their debts resulted in the weak recovery.
He will say: "We seem to need credit growth faster than GDP growth to achieve an optimally growing economy, but that leads inevitably to crisis and post-crisis recession."
He said it was possible to have a more stable system where credit growth and national income increased at the same pace. But this would require "reforms to financial regulations and central bank theory and practice which go far beyond those agreed in response to the crisis".
In addition, there would need to be measures to tackle the causes of excessive credit creation, "in particular rising inequality and global asset current-account imbalances".
Turner will say: "My argument therefore suggests that already agreed reforms to financial regulation, though undoubtedly valuable, are inadequate to prevent a future repeat of a 2007/8-style crisis. But it also suggests that much pre-crisis economics and finance theory presented an inadequate account of the role of credit creation within an economy, and of the consequences of resulting leverage."
Attacking what he calls the pre-crisis orthodoxy, Turner will say it is a myth that credit is mainly extended to finance new business investment. "In fact most credit in advanced economies does not serve this function, but finances either household consumption or the purchase of already existing assets, and in particular the purchase of real estate and the irreproducible land on which it sits."
Turner will outline measures to clamp down on credit booms, including:
• Imposing maximum loan-to-value or loan-to-income ratios, perhaps constantly.
• Imposing rules that require mortgage lenders to assess whether borrowers can pay back loans out of cash flow with no allowance for the possibility that rising house prices will make the debt affordable. "The UK has recently introduced rules which seek to achieve this effect," Turner will say.
• Taking on payday lenders such as Wonga by "constraining the supply or at least the aggressive marketing of very high interest rate consumer lending.
• New categories of bank that are required to focus solely on providing credit to businesses.
A report by the EY Item Club research group forecasts that consumer credit in the UK will rise by more than 3% in 2014. It foresees "a swell in consumer demand for credit cards … and stronger demand for big-ticket purchases", but it says business lending remains 27% below its 2008 peak.
While accepting that austerity programmes may be unavoidable due to concerns about public debt, Turner said deficit reduction had hit growth. And he was critical of the reliance on loose monetary policy to get the economy going again.
"Ultra-low interest rates, QE or lending subsidies such as the Bank of England's funding for lending scheme are almost certainly better than the no-action alternative. But they work by restimulating the very growth in private leverage which got us into this mess in the first place."
He will add that "excess debt is a form of economic pollution" that should be taxed. He says policymakers need to view both the quantity of new credit created and the use it is put to as important economic factors that need managing by strong policy levers.
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