A short guide to the credit crunch – a tale of government folly

First the Western governments keep interest rates too low for too long, stoking up massive borrowing.
Next, they meet and agree laxer banking regulation in Basel, allowing the financial sector to borrow like there’s no tomorrow, to take advantage of the low interest rates.
Belatedly the Western governments notice that bank balance sheets have ballooned and shadow banks have appeared with large borrowings, so they hike interest rates to cool them all down.
Then they starve the money markets of funds, forcing banks and other financial institutions into admitting they do not have enough cash and have borrowed too much.
Next the UK and the US allow a couple to go bust, and discover that is bad for the rest and bad for confidence. They discover late in the day that all banks borrow short and lend long, and need liquidity and ultimate support from a Central Bank.
Then the Western governments panic, print some money, and announce they will use it to buy shares in the banks.
They meet in Washington to condemn the bankers, and pose as saviours of the world. They announce their remedy to the problem of too much western borrowing – more borrowing, only this time by governments rather than by the private sector!
No wonder most incumbent Western governments are being thrown out or will be thrown out by electors– The Republicans in the USA and Labour in New Zealand were the first of a whole parade who will pay a price for this gross folly.

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8 Comments

  1. David Belchamber
    Posted November 16, 2008 at 12:32 pm | Permalink

    Mr Redwood – I apologise for the length of the following but do you think it might be a pratical solution to our wider problem? It is largely based on what you have been saying.

    PROTECTING OUR BANKING SYSTEM

    Some Proposals

    The underlying principles are that (i) a country cannot let its whole banking system collapse but (ii) a country cannot afford to protect every financial institution. Therefore certain institutions should be singled out for special treatment, while the others must accept the vagaries of market forces.

    * restore to the BoE the responsibility for the sole oversight of the banking sector.

    * the BoE and the government should identify a number of top British banks and mutual building societies for "preferred status".

    * the BoE should approach the Boards of each selected institution and ascertain whether they wished to bid for "preferred status".

    * those opting to do so would have to undergo a thorough inspection by BoE nominated auditors to approve the business models adopted in each case.

    * to achieve "preferred status", a bank or building society would have to agree to adhere to certain standards of prudent banking, to ensure that a proper level of liquidity is maintained at all times and that no products are offered that have not been specifically sanctioned by the Board.

    * in return for these undertakings, the institution would be ring-fenced and guaranteed support by the BoE as the lender of last resort should there be disastrous run on it.

    * institutions with "preferred status" would be able to publicise the fact to maintain confidence in very difficult times.

    * it is important that any approach to the BoE for support should be kept out of the news.

    * depositors with these institutions should have higher levels of protection for their deposits than other ones but all recognised institutions should have depositor guarantees.

    DDCB – 14 November 2008

  2. Pete Chown
    Posted November 16, 2008 at 1:18 pm | Permalink

    That sounds like a fair summary, but it's disturbing that I only read it here. If it isn't showing up in the mainstream media, people will believe the Labour story, where the economy was perfect until events from outside blew it off course.

    The problem, I think, is that the media tend to report "news" rather than analysing the past. All Brown has to do, therefore, is keep creating "news". The best example is the recent summit. Few people expect anything to be achieved, but the summit gets reported in the media, and the public see Brown hobnobbing with other world leaders.

    Is it a coincidence that these synthetic news stories began soon after Peter Mandelson's appointment? Probably not, and journalists should be ashamed of themselves if they fall for it a second time.

    Meanwhile, there isn't much you can do, I suppose! I am sure you are already reminding journalists about the dangers of reporting spin uncritically. And no doubt you are far too honest to attempt Mandelson-style news management yourselves. 😉

  3. Newton Flyer
    Posted November 16, 2008 at 9:57 pm | Permalink

    I agree whole hartedly, but I think the 1998 posturing about the BoE's independence was false and that those dinners at the Lord Chancellors with the BoE Governors were discussions on the credit models for the financial industry. I would say Brown requested the the BoE offer to back all banks provided that they loaned massively, especially to the mortgage sector as this has proved to be a big vote winner. What it did not do was regulate, instead it rushed through bankruptcy laws to allow those caught after the 2001 recession to write off massive debts. What was kept close to the heart and from the press was the eventual outcome which was to force nationalisation the the financial sector, something traditionally of a non labour environment and also the most powerful in terms of economic control over a country.

    What this meant was that labour could then hold extreme power over the finances and interests of everyone in these areas as well as have greater access to financials.

    You'll note the particular areas that they have alighted on, and which particular banks, something of a politico and business accumen approach. Now the banks are actually aware of this we are seeing a vested interested in trying to remove themselves from this plan by refinacing from external sources without the grip of government intervebtion and control.

    The regulation is still the biggest issue the financial sector faces and it is still too easy for regulators (auditors) to be fed what they are told at the company level when performing their annual checks. There is little like and want for control, and mavericks are rewarded should they produce the right result, and used as fodder when not.

  4. John, Wrexham
    Posted November 16, 2008 at 10:16 pm | Permalink

    The whole credit crunch story is very symbolic of our times: a whole bunch of people making a right hash, shirking their responsibilities and getting someone else to pick up the pieces. it used to be 'benefit scroungers' and ' absent fathers' who specialised in this kind of behaviour, now bankers and politicians seem to have joined in as well!

  5. mikestallard
    Posted November 16, 2008 at 11:13 pm | Permalink

    Excellent analysis! I have been privileged to follow it through blow by blow: thank you.
    1. It is a strange coincidence that most of the rescued banks are in the Labour heartland.
    2. Mr Brown is as tarnished as Tony Blair after David Kelly and Iraq. He lied about the Bank of England being free. He has been living on the hock ever since he came in – gold and pensions started it all off at the very start of the Chancellorship. Iron Chancellor indeed!
    3. It is humiliating to see him going round begging for even more money to waste. We have (at the proper moment when nobody much was looking) even recognised China's hold over Tibet. Now that the old IMF has gone the way of the UN into bureaucratic mismanagement , his attempts to set up a new IMF for yet more borrowing and then to parade as the new JM Keynes is really sad.

  6. Michael
    Posted November 17, 2008 at 12:52 am | Permalink

    what is a shadow bank?

    Reply: Institutions like hedge funds and investment banks who so geared their balance sheets that they helped create large amounts of extra credit.

  7. Edward
    Posted November 17, 2008 at 1:17 am | Permalink

    John

    You say 'First the Western governments keep interest rates too low for too long …'

    Well that is certainly true, however it was not the 'first' cause. One could trace the causes back to the 30s, however far easier to understand as a key, but not sole, motivating cause is the purposeful relaxation of the rules upon which Fannie Mae could designate 'conforming loans'. Basically due to social engineering reasons the rules governing what loans Fannie Mae could underwrite were relaxed during the 1990s such that people who really should not have been granted loans were. This illusion of affordability was perpetrated via the ability of these people to refinance their loans against the background of ever increasing house values.

    This was a key backdrop upon which weaker and weaker lending standards, together with the ability of institutions of being able to repackage this underlying debt over and over again, was allowed to fester. And then the regulators, here in the UK, the USA and all other key countries, basically sat on their hands. In my opinion they were allowed and indeed encouraged to sit on their hands by all the politicians who had a vested interest in this asset price bubble merry-go-round to continue as most of them were themselves invested in property and had a keen eye on their own net worth values, which for years simply increased.

    This despite the sign calls from so many people who were shouting from the roof tops that this debt mountain was going to end in tears. And so it has come to pass.

    Yes, I totally agree with your main thesis – government folly.

  8. Peter
    Posted November 17, 2008 at 9:12 am | Permalink

    "agree laxer banking regulation in Basel,"

    Yeah, we got them via the EU and can't change that. You tories won't repatriate banking regulations so what are you complaining about?

    Unless you're offering something different you should shut up.

    Reply: "We Tories" want powers back from Bruseels, and voted against Nice, Amsterdam and the EU Constitutional treaty. You should understand who your allies are in this mattter.

  • 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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