It’s the recession we cannot afford

Some analysts and commentators think there are two different problems, the banking crisis and the threat of recession. Now large sums of public money have been offered throughout the western world to increase bank capital they imply that the first crisis is on the mend, and maybe sometime we can start thinking about the second problem.

Unfortunately these two problems are all part of the same crisis. The banking crisis began when people in the USA were unable to pay their mortgages, and in the UK when a mortgage bank was unable to meet the demands of its depositors. The banking situation deteriorated this summer as forecasters came to see that it was not just US sub prime mortgages that could destabilise banks.

It is now important to make sure that the measures taken to restart the inter bank and money markets do not make handling the recession more difficult. If the economies of the west fall too far and stay down for too long, the banks will lose a lot more money on bad loans. It will not just be the UK and US mortgage books that cause problems, but the outstanding loans to companies will also be a source of weakness.

It is also important to ensure that public finance does not become overextended. In the days of the credit boom the UK government helped stoke the fires by its own activities. It borrowed huge sums under the Public Finance scheme and through Public Private partnerships, as well as through traditional borrowing. It added the loans of Network Rail to the taxpayer’s account. It is now about to add further huge sums through its bank nationalisation scheme.

The problem with a sharp slowdown or recession is that it damages the financial position of most people in the country and it greatly increases the strains on public budgets. Tax revenues fall. In this downturn Stamp Duty has been hit severely as the housing market dries up. Taxes on company profits, especially those on financial sector companies, will be greatly reduced in due course. Income tax on high incomes and bonuses will fall as a result of the job losses and lower profits. Spending on unemployment benefits, housing support and other government measures to handle the human misery that comes from a downturn will rise.

Gordon Brown used to call such spending the “costs of economic failure” which he rightly wished to reduce. Containing its increase should now be the prime concern of the government. Public finances are in a weak shape going into the downturn. We need to limit its depth and duration to keep government borrowing in some check.

My critics still complain about my support for lower interest rates. Savers understandably do not want their interest rate reduced, and tell me that we need to encourage savings because we have saved too little. Encouraging more savings by higher interest rates would have been an excellent policy three years ago to reduce the extremes of the boom, but is not the right measure now. Today we need to limit the downturn. That requires more spending. The danger now is there will be too little spending, cutting the money people pay to companies for goods and services. That leads to a bigger downturn, a more expensive burden on the state and more people out of work. In the end it also damages savers, because in the end in a big downturn interest rates have to be slashed to very low levels to try to get activity going again and to save some businesses. Savers cannot earn a high return with no risks. If savers want too high a rate of interest there will be more bank and savings institutions struggling, as the borrowers will be unable to cope. There are limits to how many risks the government can underwrite and how many financial institutions it can take over.

This crisis began because the banks lent too much to the private sector as well as the government borrowing too much. Between them they created a debt mountain. The Central bank and Regulator allowed this to happen, and even encouraged it by keeping interest rates low and drawing up easy going rules on the capital banks need. The Crunch began when the central banks decided to tighten conditions, with higher interest rates and less money available for the banks. Now the authorities seem to want to cut private sector lending sharply, by requiring more banking capital for a given volume of loans. Some of the strain will be taken by cutting bank lending to the private sector. If this has to be more than matched by more borrowing by the public sector to keep the banking system going and to pay the costs of recession, it is difficult to see what we have gained.

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22 Comments

  1. Monoi
    Posted October 17, 2008 at 10:02 am | Permalink

    I despair at the feebleness of the shadow cabinet response.

    W Hague had Harman as a sitting duck at the last PM questions, and all he could do is smirk when she was coming out with lies.

    How Brown can get away with it all is beyond belief.

    • mikestallard
      Posted October 17, 2008 at 5:44 pm | Permalink

      This point was very well made in today's Telegraph. A reader's letter asked where George Osborne had gone on holiday. Jeff Randall, wrote a whole article on it.
      The Spectator thinks the trouble is that you can understand exactly what Gordon Brown is talking about. It's not me – it's the global recession.
      What are the conservatives talking about?
      "This is the time to unite behind the government."

      Reply George came up with the excellent soundbite that Labour failed to mend the roof when the sun was shining. He has subsequently used the metaphor of the hosue burning down.

  2. Brian Tomkinson
    Posted October 17, 2008 at 10:40 am | Permalink

    If interest rates were cut to 2%, as you wanted done immediately yesterday and others talk about 1% interest rates, why would anyone bother to keep their savings in a bank or building society? Surely such action would lead to a further but this time far larger withdrawals from these institutions.

    Reply: 2% is better than zero.

    • APL
      Posted October 17, 2008 at 3:03 pm | Permalink

      JR: "Reply: 2% is better than zero."

      Not when inflation is approaching 5%

      • APL
        Posted October 17, 2008 at 3:04 pm | Permalink

        Sorry, I should have said, 2% or 0% doesn't make much difference when inflation is approaching or has exceeded 5%.

    • Brian Tomkinson
      Posted October 17, 2008 at 7:01 pm | Permalink

      John.
      I was hoping for a rather more constructive reply from you. If people withdraw their money because the interest rate is too low, where does that leave the banks and building societies? The fortunes of the ordinary saver, many of whom depend on their savings as a source of income, seem to count for nought in your thinking but what about the consequences which may well flow from such large reductions in interest rates?

      Reply: On the contrary, I am most concerned about savers. If more damage is done to the economy as a whole savings will be at more risk. There is going to be plenty of opportuntiy to lend money to the government for varying time periods given the huge borrowing requirement.

  3. haddock
    Posted October 17, 2008 at 11:10 am | Permalink

    It was the boom that we couldn't afford, not the recession. You cannot spend your way out of debt, you work your way out, save your way out.
    We could work our way out in the past because we had industries other than the financial sector. Now we have only the pyramid scam scheme of selling debt. You and others were wrong in saying that slashing interest rates would restore stability, it did not…. and I predict…. will not.
    Time for everyone to roll up their sleeves and do some real work instead of relying on overpaid and ill-informed gamblers.

  4. Acorn
    Posted October 17, 2008 at 11:38 am | Permalink

    Good thoughts John but a bit parochial, the picture is much much bigger.

    A few posts back, I said I couldn't wait for the movie of this mess. I still think the best tittle is going to be "Sting 2". The global taxpayer and shareholder will be "the mark". The best outline for the script I have found so far is this:-
    http://www.marketoracle.co.uk/Article6826.html

    I also said that if you are a government that needs to shift a lot of government IOUs into the market, you have to make sure that there is nothing else worth buying out there … like shares traded on stock markets for instance; (getting my drift yet?).

    Now, at this stage your family may be thinking that your cash flow may suffer in the next few years so selling that oversees villa and bringing the cash back to stick it under your mattress might be a good idea. Snag, lots of other families will have the same idea. Snag 2, you will bring back the cash in pound notes that will have to be – or have been previously – supplied by the BoE to the bank where your villa lives; hopefully the villa is not in Iceland, (worried yet?).

    Unfortunately, the big boys in the city are way ahead of you. The US FED is shipping shed loads of dollars oversees (swaps) to repatriate cash from those sold oversees assets. Snag 3, the same thing is happening in every country on the planet. Take a fairly advanced case; if I had one, I could sell my villa in Zimbabwe repatriate my cash pound notes and buy twenty Silk Cut.

  5. Neil Craig
    Posted October 17, 2008 at 11:45 am | Permalink

    The underlying cause of the banking & credit & recession crisis & indeed the oil crisis is a productivity crisis. In the western world we have been increasingly regulating innovation & increases in productivity out of existence. We have maintained the illusion of prosperity by buying & selling money to each other while increasibgly cheaper Chinese goods reduce inflation. That elastic can only stretch so far. The solution, which has quickly operated for oil is to allow new technology & new production to work (new technology is making the Canadian tar sands usable & despite eco-complaints new fields are coming on line). In the same way allowing the building of nuclear electricity generators (French electricity is 1/4 the price of ours), GM research & exploitation, building without multiplying the cost 13 fold by regulation & generally allowing the market to work for new manufacturing industries would provide all the profitable investment opportunities the banks want without the financial sector having the feed itself by swallowing itself.

  6. Stephen Jenner
    Posted October 17, 2008 at 12:16 pm | Permalink

    Mr. Redwood… Bearing in mind your party has completely failed to provide any form of opposition to this travesty of a government, isn't it about time that the REAL conservatives in the party, of which you are one; either mounted a coup, or left to form a proper conservative party, or failing that, joined the only other conservative party… namely the UKIP.

    Even the LIBDUMS are providing a more coherent opposition than Cameroon and his chums.

    • mikestallard
      Posted October 17, 2008 at 5:52 pm | Permalink

      According to the Spectator this week, the difference between Gordon Brown's "genius" and the Conservatives under George Osborne is that Gordon Brown talks in language that people can understand. In other words, he uses soundbites.
      These are conspicuously absent from Conservatives at the moment.
      I like the idea of the house of cards being built, and then the wind blowing it over.
      I like the idea of the heavy laden ship sailing towards the rocks. The captain, instead of slowing down, hoists yet more sail and refuses to throw anything overboard.
      I like the idea of the three little pigs. One built his house of straw and then the wolf came and blew it all down.
      Is it beyond the wit of anyone in the Conservative party to come up with other ideas or even just ONE strap line?
      How about "LABOUR ISN'T WORKING?"

  7. James
    Posted October 17, 2008 at 12:21 pm | Permalink

    Am I the only one in this country who didn't take out a mortgage,HP,Loan or credit card debt in the past 12 years?

    Being one of the 'old school' I learnt at an early age to live within my means.

    Unfortunately, being responsible and taking out a personal pension many years ago has now cost me dear, and it looks as if my savings are heading in the same direction.

    But I wonder what to do with them. Should I keep them in the Banks to help them fund loans for others, or should I be irresponsible and blow the lot and thus give a little help to local businesses.

    On the bright side, I sleep at night, have no fear of having my home reposessed and can keep up with the utility and food bills.

  8. Lola
    Posted October 17, 2008 at 12:27 pm | Permalink

    Mr Redwood said;-

    "This crisis began because the banks lent too much to the private sector as well as the government borrowing too much."

    Perhaps you should add –

    …and government lost control of/vastly increased the money supply.

  9. Stuart Fairney
    Posted October 17, 2008 at 1:02 pm | Permalink

    I saw Mr Cameron's speech this morning. If I may, an excellent diagnosis of the problem (has he at last been listening to you, or is that too much to hope for?). Where he was much less convincing was what do do about it. Perhaps understandably he doesn't want to put up any target for Labour to shoot at. Nonetheless simply watching Labour implode is a slightly lopsided strategy albeit the election is probably some time off yet (unless Brown gets a bounce from all this wholly uncritical 'dear leader' nonsense the BBC/Pravda has been running and he calls a snap election when ahead in the polls for five minutes)

    I shall read the manifesto with great interest.

    • APL
      Posted October 17, 2008 at 3:00 pm | Permalink

      Stuart Fairney: "Perhaps understandably he doesn’t want to put up any target for Labour to shoot at. "

      That is exactly the trouble with Cameron!

      Who cares if there is a target to shoot at, if he has a coherent position, which can be well defended, the attacks can be repulsed, policy proposals put forward and the Labour party put to flight. The problem is he hasn't even tried.

      We have the WORST PRIME MINISTER and the most INCOMPETENT administration since Jim Callaghan's, and David Cameron can't be bothered to put an alternative Conservative agenda.

      • Lola
        Posted October 17, 2008 at 11:33 pm | Permalink

        Yep, but how? If Cameron goes on the attack with the only medicine – cuts, cuts in taxes, cuts in spending.- New Labour resort to the 'Tory Cuts' mantra believed by a fair chunk of the electorate. And of course cuts is exactly what are needed. And since Brown has got us into such massive debt we will have to work for 20 plus years to sort out the mess. How many of the electorate are going to be able to face such sacrifice, now, for a future beyond most of their time horizons, focused as they have become on immediate gratification?

        Personally I reckon the Voter is ready for 'cuts' if made in conjunction with the analysis of why they are needed – Browns incontinent profligacy. Cameron could at least give it a whirl couldn't he, or perhaps launch it via a minion of some sort and guage the reaction.

        • mikestallard
          Posted October 18, 2008 at 10:49 am | Permalink

          It is NOT A CASE OF CUTS.
          Labour spends money as if it were going out of fashion. Nobody doubts that. That is why we are somewhere near £2 trillion in debt at the moment (and rising). They have also cooked the books by not including Northern Rock, PFI and all the billions on the other banks.
          We are in very real danger of going bankrupt as a country (again). It is always like that with Labour.
          What is wrong with them is the fact that (quite literally) they cannot organise a booze up in a brewery. Remember the Dome? Remember those telling pictures of the inside of the Treasury with people rushing round in baseball hats?
          What about the unbelievable numbers of CDs/data that have got missing?
          What about all those moneys not paid? Remember the Child Allowance fiasco? Or Margaret Beckett and the farming non payment and fine?
          What about all the flagship projects like, for instance, the Olympics? Or the NHS Computer?
          The general line of attack which I am waiting for is along these lines: efficient government.
          There is absolutely no reason why, with the past record of the Conservatives, this cannot be put most effectively.

  10. mikestallard
    Posted October 17, 2008 at 5:57 pm | Permalink

    I must admit that I did not even know that David Cameron had made a major speech this morning.
    While I was watching Sky News in the Gym, it wasn't even mentioned.
    Please – please – please – do not let this mob get re elected.
    Please. Please.
    (Remember how Oliver Letwin took a runner when he made the mistake of advocating reduced public spending as shadow Chancellor?)

  11. david
    Posted October 17, 2008 at 9:12 pm | Permalink

    Hmmm John this from DC's speech, like to comment?

    Crucially, he said some things that may upset the Right – and even scare voters in London and the South East.

    Why? First, he said that it was time to "rebalance" the economy away from financial services. "You cannot rely on unsustainable growth in a few areas to increase prosperity for everyone.. We need to decentralise our economy so the South doesn't overheat" Now, for all the nervousness in the City, few Londoners like the sound of this.

    Second, and perhaps more interesting, was his attempt to redfine Toryism in relation to the state.

    He said: "The central political idea underlying my Conservatism is the idea of responsibility". So far, so Cameroonian. But then the Tory leader added: "Not freedom, which some may wrongly assume is the animating force of Conservatism, but responsibility." That sounds like a pretty sweeping re-writing of Tory history – which has long had a tension between liberty and authoritarianism. Thatcherites may not be pleased to hear that Freedom is being relegated. Why couldn't he say that BOTH freedom and responsibility were central to Conservatism?

    To underline his point, he stressed that the state needed to intervene to boost the supply side of the economy, such as spending on high-speed rail. But then he used a strange formulation: "It's not enough for Government to get out of the way – they've got to get involved". How can you be both "out of the way" and "involved" at the same time? Labour may pick up on this confusion I suspect….

  12. Atlas shrugged
    Posted October 18, 2008 at 1:42 am | Permalink

    John; one thing to remember, which is something I personally will never forget. Is that the people who caused all this utter chaos can extremely easily afford absolutely anything, with or with out a complete collapse of the entire financial system.

    I wont embarrass you by mentioning their names. But I am sure you know exactly who I am talking about.

    You are of course right as usual.

    The only way we can get ourselves out of this horrendously deep deep deeeeeeep hole, is to cause massive inflation not seen since 1930s Germany. I am sure you are well read enough to know what happened shortly afterwards. So I wont bore you with the details.

    New World Orders especially the one Gordon Brown is so keen on mentioning at his meetings with the CBI, need the old order to be seemingly DESTROYED before the new one can arrive.

    You seem like a sensible chap, so why dont you start being completely honest for a change. If so, you will go down in history as being the first one ever in history. Surly this alone is worth giving it a shot. I for one would be happy to visit your funeral and send some nice flowers.

    I can see that you have some idea how bad things really are, but as a small business man, I can tell you that you still do not have the imagination required to understand quite how bad. If this country is only just about solvent now, wait until about this time next year and you wont need to imagine anything.

    My industry has been on its face for the last two years. However as I dont trust BANKS politicians and especially the media as far as I can spit on all of them, my order book is so full I cant even find the skilled workers to do the work.

    Unfortunately for the rest of British industry, they are going to go down the pan so fast, even you will be calling me for a job soon.

  13. nick
    Posted October 18, 2008 at 10:21 am | Permalink

    Can you borrow their way out of debt? You tell me. What governments can do, of course, is wipe out internal debt by debasing the currency. Is that what they'll do? Can we simultaneously have an inflating currency and a deflating economy? Mr Mugabe seems to have managed it. Why shouldn't we?
    I'd vote for any bunch which acted on Burke's dictum that "the best policy for any government is simplicity of heart". Fat chance!

  14. FatBigot
    Posted October 18, 2008 at 12:42 pm | Permalink

    Reducing government spending can be proposed in a way which will find favour with much of the electorate. George Osborne's proposal to save money on consultancy fees to help with council tax went down very well. A great many of the current government's pet projects are deeply unpopular because there is seen to be little benefit in return for vast expenditure. Proposing a cull of these unnecessary fripperies is a vote winner and would not be harmed by shouts of "Tory Cuts" because people are crying out for the expensive nonsense to be cut.

    What should not be done is to make vague promises of cutting waste. Everything should be targeted at readily identifiable and quantifiable projects. Put a cap on spending on the Olympics at, say, £5billion and tell the organisers they just have to cope. Scrap ID cards, the farcical NHS computer, the £12billion mega-snoop into emails and phone calls. Identify the most useless quangoes, name and shame them, point out just how much they cost and how little they achieve. Where there is duplication of quangoes, as in much of agriculture, identify the duplication and people will say "about time too" when you save money. Propose an immediate end to financial aid to China and India, they are coping very nicely by themselves.

    None of this risks losing more votes than it gains and it sets the right tone – not just that in difficult times the governmental belt must be tightened but that the profligacy of the last decade must end.

    And throughout stress that spending on the NHS and schools will be unaffected.

  • 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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