Don’t they know there’s a credit crisis?

The budget looked insignificant and irrelevant the day it was announced. It looks absurd this morning.

The near collapse of the 5th largest investment bank in the US and the rapid action taken by the US authorities to avert a crash in the wider mortgage and banking markets matters to us as well as to Americans. We are all in this together. If major US institutions run out of money or stop trading, London based financial institutions will take some of the hit.

Those who think this is just a worry to highly paid people in finance who have good times for too long should also think again. If the banks run out of money, in the end we all run out of money. Many businesses and individuals need access to borrowing to keep trading, to buy homes, to buy new equipment. Borrowing will be getting even scarcer if the authorities do not sort out the banking problems.

We still have very different attitudes either side of the Atlantic. In the US, the President, the Head of the Federal Reserve Board, and the Treasury Secretary are all of one mind. This is a serious crisis in the mortgage and banking areas, and everything has to be done to prevent a collapse. We have seen big cuts in interest rates already – we should expect more. We have seen big sums offered to markets to buy up good quality paper that the market no longer trusts – we should expect more when needed. We have now seen direct lending to a bank in trouble, and should expect similar support if market bear raiders try it on with another institution.

In the UK we have had lectures from the Chancellor and the Bank Governor that the banks have been guilty of bad lending and there will be no bail outs. We had a steely performance last summer, until the Northern Rock problems got out of control, when they announced a comprehensive bail out for one mortgage bank, leading to its eventual nationalisation. In the last week the Bank of England did join in concerted central bank operations to make more money available to distressed markets, but it was on a modest scale, suggesting a friendly intent but a lack of conviction in what they were doing. It may also show that after Northern Rock, where UK handling has led them to take on more liability than I think they need have done, they are short of fire power.

The problem remains at base a simple one. We all know that banks have made too many loans, and that some of those loans will turn out to be bad ones where the borrowers will be unable to repay the money. The trouble is no-one knows just how many loans will turn out to be bad, and which of the banks has too many of them. Whilst banks are increasing their provisions against bad debts in the future, and raising new capital to strengthen their balance sheets, fear stalks the markets. People are now worrying that perfectly good loans and mortgages will turn out to be worthless. Investors are dumping investments in good loans as well as bad, driving the value of all a bank’s loans down.

That is why there is a serious threat to the world banking system. Banks only work because most people trust them, and most depositors are happy to leave their money in their accounts knowing they can get their money out when they want it because not everyone will want their money at the same time.. They work because they can play a numbers game, knowing they will do well if say only 1 in 100 loans goes bad, and still survive if 4 in a 100 go wrong. If depositors no longer believe they can get their money out, and if investors believe large numbers of usually good loans will go wrong, the system breaks down. The authorities prime duty is to make sure we never reach such a self defeating set of attitudes. It is after all in the end our own ability to save and spend, to make payments and earn interest that is at stake here. The US authorities once again did the right thing this week. They have shown they understand the gravity of the threat to the system, and showed they are resolute in defending people’s money. Next week they are likely to continue their good and essential work to reassure markets, and therefore move to underpin everyone’s bank account.

Listening to the deafening silence of the Chancellor this week, I was left asking myself “Doesn’t he know there is a credit crunch?”. Yes, he said he understood there were storms in the world economy, but then he raised a children’s umbrella and plodded on. He should show some urgency in tackling the overspending and overborrowing in the UK public sector. He should produce a statement on how the Bank of England’s powers in money markets will be urgently restored, learning the hard lessons of the combined failure to avert the Northern Rock crisis last summer. Behind the scenes, instead of playing silly politics with drink and green issues, he should be devoting his sole attention to international collaboration, to make sure the world authorities get ahead and remain ahead of the pack of bears seeking to make money out of bringing down other financial institutions and financial products.

The world system does need to cut its over borrowed state, but in an orderly way at a sustainable rate.

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6 Comments

  1. Brian Tomkinson
    Posted March 15, 2008 at 12:02 pm | Permalink

    The financial crisis is indeed very worrying but seems publicly to be of little concern to Brown and Darling. When considering the Brown/Darling virtual denial of any consequences to the UK from the crisis in this week's budget, we should not forget that they knew about the Northern Rock difficulties well ahead of the final crisis. In fact, they exacerbated the situation by their actions and words both before and after the public became aware of it. It is frightening to contemplate what they are aware of now and have chosen to remain silent about.

  2. Iain
    Posted March 15, 2008 at 12:26 pm | Permalink

    I suppose you could be generous and say Darling couldn’t do much in the budget to tackle the credit crunch, but then as that’s the result of the economic mismanagement of the public finances by Gordon Brown you can see why Darling treated it as an issue that didn’t exist.

    More difficult to explain is why the Conservatives aren’t making it and the budget a headline issue, instead gone to Gateshead to talk about families, something the Labour Government must very grateful to them for.

  3. Neil Craig
    Posted March 15, 2008 at 1:23 pm | Permalink

    Alternately if a few banks went into administration others would buy up their mortgages, probably at a discount, the share holders would lose out, some jobs would be lost, the deposiors would be, at least 90% covered & business would resume once the chaff had been shaken out.

    Bankruptcy is a necessary part of the business system. What would be much worse is that government policy should be determined for a couple of decades by a need to prop up insolvent banks. This would include actively preventing house price falls by continuing, or even accelerating, the regulatory controls that are the cause of housing shortages & high prices. This is pretty much what Japan did, going from 10% growth to 2 decades of literal stagnation.

  4. Matthew Reynolds
    Posted March 15, 2008 at 2:46 pm | Permalink

    Green taxes should be revenue neutral as they should be high enough to change behaviour & thus not bring in too much extra cash which can then fund other tax cuts . Nick Clegg is quite right about that . I think that road fuel duties should rise to finance axing VED to make taxation far simpler and that landfill duty ought to rise along with anti-flytipping fines as the UK needs to recycle more as landfill space is fast running out and the countryside looks horrid when buried under plastic bags . Any money produced could fund trimming stamp duty on shares by 0.1% to 0.4% & lowering CGT to 15% . Climate change levy can go up so that along with the revenue that the Shadow Chancellor plans to raise from axing a number of business tax breaks there is enough money to fund cutting business tax rates to 23% & 17% respectively . A plastic bag charge along the lines suggested by the Chancellor is wise as it means fewer bags which cuts co2 emmissions & business costs while extra cash is raised for green charities – win -win for business & the environment . Green taxes can raise funds at the start to make pro-enterprise tax reforms ( like Lord Howe did when he raised VAT & cut income tax in 1979 ) – but as people get greener and green tax revenue falls the economy will be gaining from pro- business tax reform and so a bit extra money may come the Treasury’s way ( making up for lower green tax revenue ) . Aviation tax could rise to discourage pointless shorthaul flights to fund axing Labour’s mad non dom tax plans . Since 1990 emmissions are 15% lower & the economy is 50% bigger so green growth is sustainable & ethical prosperity . Cash affects behaviour and so speeding up this welcome trend via these sorts of tax changes would adress the present economic problems while helping to conserve the environment for future generations .

  5. Matthew Reynolds
    Posted March 15, 2008 at 2:46 pm | Permalink

    Green taxes should be revenue neutral as they should be high enough to change behaviour & thus not bring in too much extra cash which can then fund other tax cuts . Nick Clegg is quite right about that . I think that road fuel duties should rise to finance axing VED to make taxation far simpler and that landfill duty ought to rise along with anti-flytipping fines as the UK needs to recycle more as landfill space is fast running out and the countryside looks horrid when buried under plastic bags . Any money produced could fund trimming stamp duty on shares by 0.1% to 0.4% & lowering CGT to 15% . Climate change levy can go up so that along with the revenue that the Shadow Chancellor plans to raise from axing a number of business tax breaks there is enough money to fund cutting business tax rates to 23% & 17% respectively . A plastic bag charge along the lines suggested by the Chancellor is wise as it means fewer bags which cuts co2 emmissions & business costs while extra cash is raised for green charities – win -win for business & the environment . Green taxes can raise funds at the start to make pro-enterprise tax reforms ( like Lord Howe did when he raised VAT & cut income tax in 1979 ) – but as people get greener and green tax revenue falls the economy will be gaining from pro- business tax reform and so a bit extra money may come the Treasury's way ( making up for lower green tax revenue ) . Aviation tax could rise to discourage pointless shorthaul flights to fund axing Labour's mad non dom tax plans . Since 1990 emmissions are 15% lower & the economy is 50% bigger so green growth is sustainable & ethical prosperity . Cash affects behaviour and so speeding up this welcome trend via these sorts of tax changes would adress the present economic problems while helping to conserve the environment for future generations .

  6. mikestallard
    Posted March 15, 2008 at 9:37 pm | Permalink

    In the days of Dad's Army, Mr Mainwaring knew each of his customers by name. The Regional Manager knew Mr Mainwaring and the people in London knew the Regional Manager. So trust there had to be.
    When Mr Mainwaring was removed, however, the system failed to work because nobody knew who the investors were and they did not care either.
    Like many others, I was refused a loan of £2,000 when I got into difficulties in the 1990s, despite the fact that I had banked with NatWest (note the change of name) for some 20 years as a reliable investor. I was immediately given the loan when I went round the corner to Nationwide, where I still am.
    In the 90s, people were paid, at the bottom levels, by results, targets etc etc. Hence the present crisis: who are we dealing with exactly? How do people know? They cannot know.
    People often talk clever talk about being out of touch with the grass roots. This is an outstanding example of exactly that: it is VERY dangerous. As we are about to find out.

  • About John Redwood


    John Redwood won a free place at Kent College, Canterbury, and graduated from Magdalen College Oxford. He is a Distinguished fellow of All Souls, Oxford. A businessman by background, he has set up an investment management business, was both executive and non executive chairman of a quoted industrial PLC, and chaired a manufacturing company with factories in Birmingham, Chicago, India and China. He is the MP for Wokingham, first elected in 1987.

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