Sunday Telegraph article

Last autumn, the British Government stepped in with massive cash injections for the banks. A few weeks on, and ministers admit this pounds 487 billion package did not even put the main banks into a condition where they can lend normally, let alone save the world.

The country faces a severe economic decline. The Government is trying to print money, slash interest rates, expand public spending and borrowing, inject capital into certain banks, nationalise others, boost demand by an expensive tax cut, prop up certain companies and industries, while lecturing the banks to lend more. So far, none of it is working. The cruel logic of past mistakes is pushing the economy into a vicious downward spiral.

We should remember the origins of our problem. The Monetary Policy Committee kept interest rates too low for too long. The banking regulator allowed banks to balloon their balance sheets and supplement this excessive lending with off-balance-sheet devices that came to haunt them in the bad times. The economy ran faster than could be comfortably handled, leading to a large balance-of-payments deficit as we sucked in what we could not produce at home, and a large private sector borrowing binge. Asset prices escalated giddily on the back of easy money. Homes became unaffordable without taking on a huge mortgage, which would prove too burdensome come higher interest rates or job loss. Once the authorities called time on excessive debt, there was bound to be a downturn. Their decisions to hold rates too high for too long, and then to require banks to hold more capital and cash to support their lending when we were well into the downturn, made the problem considerably worse.

I argued strongly for lower interest rates a year ago to take the edge off the coming decline. I argued against nationalising banks. I would have kept them in business by having the Bank of England act as lender of last resort, providing cash and loans against proper security, and offering stronger deposit guarantees when needed. The aim should be to see them through, with their shareholders and senior executives taking all the hit for past mistakes. Government’s role towards the banks should be that of the intelligent bank manager, not the owner needing profit and access to cheap cash for himself.

The Government, as it says, needs to stabilise asset prices, get the banks to clean up their past mistakes, ensure none of the major banks goes under, and reflate overall demand. However, a number of the measures it has taken are making the problem worse.

Nationalising Northern Rock and the loan book of Bradford and Bingley were bad mistakes. On current policy, and given competition rules, neither of these institutions can now make a contribution to new mortgage lending.

Forcing three banks to take taxpayers’ cash for shares because the authorities wanted them to have more capital was not clever either. The government failed to do any proper due diligence on what it was buying and failed to require write-downs of the loan books before venturing. As a result, taxpayers now have shares in institutions that may announce further big write-offs. The regulators should have discussed with the banks how to strengthen their balance sheets through retained profit and by raising money from markets. The central bank should have stood behind them in the normal way.

In trying to stimulate demand, cutting VAT was about the worst option, and has left us with a costly hole in the national accounts for little benefit. The escalation of the government borrowing requirement, mainly through the mistaken bank nationalisation policies and the VAT reduction, is alarming.

So what should they do now? They should cancel the remaining VAT reduction, and look instead at cheaper tax reductions that put more money into the pockets of individuals and small companies. We need an expansion of cash and deposits in the hands of individuals and companies to get the economy going.

They should aim for early repayment or sale of the taxpayer shares, and ask the banks to accelerate a programme of cost reductions, asset sales, and resumption of profitability. The immediate target should be to get the cash back for the special preference shares the government bought, and to sell the mortgage books and administration of the Rock and Bradford and Bingley on to the commercial sector, where there would be more chance of building these businesses and saving some jobs.

Mr Brown should invite the Financial Services Authority, the Bank of England, the Treasury and the commercial banks to a meeting to hammer out the right mixture of regulation, loans and guarantees so that they can restore normal lending levels more quickly. The Prime Minister has to defend the taxpayer, but he also needs to listen to the people running the banks. The meeting will need to decide to temporarily lower the level of capital banks are required to hold against their lending, to withdraw the proposals on banks keeping more in cash and bonds, and to tweak the packages of short-term loans and guarantees so they are more attractive to the banks.

None of this is guaranteed to lift the recession quickly. The authorities have allowed the downward spiral to become entrenched. The banks face further write-offs from their corporate loan books as trading deteriorates and more companies go under. House prices are still high. People are reluctant to commit to large new loans when there are so many uncertainties about their jobs. Many people and companies are unable to take on more debt, if it becomes available.

The proposals above are designed to hasten the end of the recession, and to cut the risk in current policy. They would reduce the Government’s need to borrow substantially, and would speed up the resumption of more lending by banks. You cannot end a crisis brought on by borrowing too much by the state borrowing even more, or by transferring all the dud loans to the taxpayer. We have to work our way out of borrowing too much and inflating asset values too much. This package would at least put us on the right road to recovery.

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5 Comments

  1. Dr Dan H.
    Posted January 12, 2009 at 11:46 am | Permalink

    What I cannot understand about this Government’s strategy is why they even considered the VAT reduction. This reduction put a lot of people to a great deal of trouble, and hardly affected what the common man has to spend at all, and must in addition have put the Government to a great deal of trouble as well.

    A much easier way to boost personal spending power would be to increase the basic tax-free allowance somewhat, thus putting more money proportionately into the pockets of the poorest of society; i.e. they could bribe the poor working class very effectively indeed using this measure, whilst still being able to fleece the rich quite effectively.

    For a party which purports to represent the poor working class, an increase in the tax-free allowance would therefore have made a very great deal of sense. Abolishing tax credits and increasing the aforementioned tax-free allowance in proportion would have been another masterstroke, since it would have reduced the Government’s costs and fed the poorest in society another boost to their income.

    And yet, they chose the one tax adjustment which would cause them the most hassle to administer and which would do their electoral prospects the least good.

    Are they really this stupid or am I missing something here?

  2. rugfish
    Posted January 12, 2009 at 7:55 pm | Permalink

    Very sensible Mr Redwood. My only reservation is the gifting away of preference shares to foreign investors which hold a return of 12% along with the the potential of giving them the Sword of Damocles over our banking industry and thus our entire economy, although to be fair, if things worsen which we all must fear they will, then this will likely be the case because there will likely be no other avenue out of the recession/depression/slump/crisis.

    Fingers crossed that Brown “Does Something” rather than the Wrong Thing then and listens to what you say.

  3. Roy W
    Posted January 12, 2009 at 8:47 pm | Permalink

    Re VAT change (Dr Dan H.)

    “Missing something here?” – Yes, it’s employment creation! – Think of all those extra people needed to change all those price tickets and price lists now – and back again later! – and civil servants to snoop on them to make sure they do! Instant job preservation / creation – brilliant!

    But excuse me – who pays for all this? Why, we do, of course. Another act from conjurer Brown.

  4. Frugal Dougal
    Posted January 12, 2009 at 9:28 pm | Permalink

    Hear hear. I don’t know what’s changed since James Callaghan said this to the Labour Party Conference in September 1976:

    “We used to think that you could spend your way out of a recession and increase employment by cutting taxes and boosting government spending. I tell you in all candour that that option no longer exists, and in so far as it ever did exist, it only worked on each occasion since the war by injecting a bigger dose of inflation into the economy, followed by a higher level of unemployment as the next step.”

    Perhaps, for Gordon Brown, not listening to the Tories is understandable. But not listening to a Labour Prime Minister who was at that time going through the humiliating process of applying to the IMF for assistance is bizarre, stupid and unforgiveable.

  5. Hugh Watkins
    Posted January 15, 2009 at 11:06 am | Permalink

    Some very good points raised here. Possibly reducing NI rates for employee and employer would both put more money in people’s pockets and reduce (at the margin) the coming wave of layoffs.

  • 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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