Some home truths about the Credit Crunch

Many policy makers and commentators are looking for a magic bullet, a single package, a measure which will solve the crisis. They will look in vain.

We need to remember that the UK crisis – and the US one – were born of over borrowing. Collectively British people and their government spent too much and earned too little. Collectively they borrowed huge sums from banks and from abroad, to pay for large quantities of imports. Now it is the time of reckoning.

You cannot solve a crisis of borrowing too much by borrowing more. The UK private sector needs more cash – more earnings, more turnover – more than it needs more borrowing. The UK government, borrowing too much when we were apparently doing well, now wishes to borrow unheard of amounts. That just delays the full reckoning a little, and means much higher taxes in the years ahead when the money has to be paid back.

The banks too were mightily overborrowed and over lent. You cannot solve a crisis of too many bad loans in private sector banks by simply transferring the loans or the risk on them to the public sector. In the case of the UK the banks taken together are too large for the state to bail out comprehensively. Giving them new capital or subsidy merely delays the need to sort out their risky assets, trim back their commitments, cut their costs, and start making some proper profits.

Whenever people propose things that sound crazy because they say we need radical and new measures to tackle the problems of the time you should ask why the normal laws of arithmetic, and commonsense, have been suspended. Why does it suddenly make sense for the state to take on the debts of the banks? How can the state run them better? Why should taxpayers pay for the mistakes?

Let’s take the idea of a Bad bank which is surfacing again. In a way the UK already owns three or four bad banks – it has after all taken control of RBS, Northern Rock and the assets of Bradford and Bingley, and has a large stake in HBOS. These are bad banks in the sense that they are all coming forward with large write offs or trading losses, and have all needed injections of government capital. These are so large that they stretch the state’s capacity to fund them. Why should we want to create yet another bad bank to take on the dfficult assets of the other banks in the system, when those banks seem capable of sustaining themselves in the private sector? There has to be some limit to how much the state takes on, before its own ability to raise money is damaged and it has to pay a higher rate of interest for its money.

The truth is the banks have to work their way through their positions, reducing the scale of their risks in the most sensible way possible. This may need management change in the case of the banks that are losing large amounts. It does not need nationalisation to do it. Indeed, nationalisation may delay such a necessary process, as politicians would want the banks to do more than just sort themselves out and slim themselves down.

How do you sort things out? The banks should close down their overextended positions in financial instruments as opportunity presents. They should net out positions that can be netted out, to degear the overall system. Where they have non performing loans extended to private companies, they should consider debt for equity swaps or delays to interest payments where they think there is a viable long term business that can one day repay with suitable penalties.

There is no quick fix. Swelling the public deficit too much just creates another problem of too much borrowing, which will become a crisis or a major problem at some point in the future. We need some good bankers who can patiently work through the bad debts, doubtful loans and huge positions which their banks have taken. The state should be the lender of last resort, making sure no major bank goes under. It should not be the funder of first choice, subsidising bad practise, bonuses and overextended banking. If a bank needs short term state lending it should get it, but on terms which protect the taxpayer and encourage them to stand on their own two feet.

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24 Comments

  1. Lola
    Posted February 6, 2009 at 9:48 am | Permalink

    Mr Redwood, you say “Where they have non performing loans extended to private companies, they should consider debt for equity swaps or delays to interest payments where they think there is a viable long term business that can one day repay with suitable penalties. ” This should also apply to the banks themselves.

  2. kinglear
    Posted February 6, 2009 at 10:47 am | Permalink

    Couldn’t agree more. Particularly important would be a clearing house to nett off all those weird instruments – which we were always told balanced each other out. Its interesting that Lehman’s $400 billion or so ended up with little more than $7billion adrift – peanuts. I suspect the same would be true if there was a proper trade-off

  3. Blank Xavier
    Posted February 6, 2009 at 11:01 am | Permalink

    JR wrote:
    > Swelling the public deficit too much just creates another problem of too much
    > borrowing, which will become a crsis or a major problem at some point in the
    > future.

    An Italian-style solution.

  4. Jonathan Cook
    Posted February 6, 2009 at 11:08 am | Permalink

    This crisis needs an injection of both “common sense” and “calmness”.

    One of the key problems we face in the UK, is that all measures seem designed in part to position political dividing lines.

    Unfortunately I don’t think our current PM is capable of separating his political position from sound management of the economy.

    We will continue to be hobbled by Brown until we can change leader at a general election and remove politics form our management of the economy.

  5. backofanenvelope
    Posted February 6, 2009 at 11:11 am | Permalink

    The last time I heard from Lloyds Banking Gp (I am a minute shareholder), they said they hoped to pay off the government this year (2009/10). This suggests to me that they are busy saving their bank. I feel sure that they, for all their more recent errors, know much more about banking than The Great Helmsman. I expect that the other banks, including RBS, are doing the same. Wouldn’t you?

  6. Tony Makara
    Posted February 6, 2009 at 11:12 am | Permalink

    There is a way for the state to provide liquidity to solvent business and that is by creating a brand new short-term issue of money, to be loaned out with a determined recall date, after which the issue is destroyed. This will allow the healthy side of economy to remain fluid, while at the same time not placing a burden on the taxpayer.

    The government’s borrowing and the MPC’s extreme rate cuts are only going to extend the life of bad debts, undermine Sterling and will lead to imported inflation. The bad debt in the economy has to be allowed to die, while at the same time there has to be liquidity to allow healthy business to grow. This can be achieved if the government just stops panicking and looks for a logical solution. A new issue of money, in the shape of short-term loans can do this.

    • Acorn
      Posted February 6, 2009 at 4:14 pm | Permalink

      Tony. Have a read of the IFS Green Budget 2009. Particularly chapters 7 and 8. The BoE beat you to it, we are all in the “repo” business now. (Or rather, the “reverse repo” business if you are the lender like the BoE).

      http://www.ifs.org.uk/budgets/gb2009/gb2009.pdf

      • Tony Makara
        Posted February 7, 2009 at 10:53 am | Permalink

        The greatest concern to all of us should be the way that government is prepared to extend the life cycle of bad debt, the very debt that has created this crisis in the first place. This debt circles over the economy like a bird of ill-fortune and while it exists our economy is on a knife-edge. The opposition, who will inherit this mess, must make clear that they will support solvent business while at the same time making it known that there can be no bail-outs for bad business. The debt has to be cleared, not extended.

  7. "East Anglian Troy"
    Posted February 6, 2009 at 11:17 am | Permalink

    In a mad world it is great to come over to your blog for a daily dose of common sense.

    • THE ESSEX BOYS
      Posted February 7, 2009 at 12:16 am | Permalink

      Troy…good to hear other sensible East Anglians rooting for common sense!

      We liked JR’s comment here…

      “you should ask why the normal laws of arithmetic, and commonsense, have been suspended”

      We’ve banged on to the Tories for ages that “(CONSERVATIVE) COMMON SENSE & COMPETENCE” is all we really need from the next government. Certainly that will distinguish it from this wretched one!

      Funnily enough a pal sent us just this evening the piece below which we’d like to share with the folks…

      *********************

      An Obituary printed in the London Times…….. Interesting, and sadly rather true.

      Today we mourn the passing of a beloved old friend, Common Sense, who has been with us for many years. No one knows for sure how old he was, since his birth records were long ago lost in bureaucratic red tape. He will be remembered as having cultivated such valuable lessons as:

      Knowing when to come in out of the rain; why the early bird gets the worm; Life isn’t always fair; and maybe it was my fault.

      Common Sense lived by simple, sound financial policies (don’t spend more than you can earn) and reliable strategies (adults, not children, are in charge). His health began to deteriorate rapidly when well-intentioned but overbearing regulations were set in place.

      Reports of a 6-year-old boy charged with sexual harassment for kissing a classmate; teens suspended from school for using mouthwash after lunch; and a teacher fired for reprimanding an unruly student, only worsened his condition.

      Common Sense lost ground when parents attacked teachers for doing the job that they themselves had failed to do in disciplining their unruly children.

      It declined even further when schools were required to get parental consent to administer sun lotion or an Aspirin to a student; but could not inform parents when a student became pregnant and wanted to have an abortion. Common Sense lost the will to live as the churches became businesses; and criminals received better treatment than their victims.

      Common Sense took a beating when you couldn’t defend yourself from a burglar in your own home and the burglar could sue you for assault. Common Sense finally gave up the will to live, after a woman failed to realize that a steaming cup of coffee was hot. She spilled a little in her lap, and was promptly awarded a huge settlement.

      Common Sense was preceded in death by:
      his parents, Truth and Trust;
      his wife, Discretion;
      his daughter, Responsibility;
      his son, Reason

      He is survived by his 4 stepbrothers;
      I Know My Rights
      I Want It Now
      Someone Else Is To Blame
      I’m A Victim

      Not many attended his funeral because so few realized he was gone. If you still remember him, pass this on. If not, join the majority and do nothing

      Reply: Brilliant!

  8. A. Sedgwick
    Posted February 6, 2009 at 11:46 am | Permalink

    As usual you write what should be obvious to those making the decisions. I believe there is a magic bullet – reduce state spending by 10%. It may increase the financial squeeze for a year or two, on the other hand it may not with government borrowing going into business. With many others I have been pessimistic about UK plc for several years and feel unless someone such as you gets a grip on our national finances we aint seen nothing yet!

  9. David Burch
    Posted February 6, 2009 at 1:42 pm | Permalink

    I have read you comments on the credit crunch over the past six month and agree with your concerns that the government has little clue how to solve it. I also have the view that Labour politicians do not apprecaite how to run a free market economy for varius reasons which are now becoming obvious.

    My main concern is the reaction to the bail out with the government flinging vast amounts of cash around will impact badly in other areas. It will be very difficult for any government (including the Conservatives) to cut expenditure in the future when seamingly at the drop of the hat they can find £400 billion pounds. I am worried as signs of social unrest is stiring in France in particular but also in this country with the strikes about “British Jobs for British workers”. It was the last depression (not recession) that gave rise everntually to the rise of the far right and far left which took over fifty years to solve.

    I hope I am wrong but I am fearful of a bigger problem approaching.

    Please get them to listen and act on your logic!

  10. Adrian Peirson
    Posted February 6, 2009 at 3:46 pm | Permalink

    It’s because Westminster Borrows hundreds of millions of £50 notes from banks ( that only cost them 1p to Print ) AT FULL FACE value, then forces us to Pay back this ‘loan’ With interest, that is why the British people are skint.

  11. Sue
    Posted February 6, 2009 at 5:17 pm | Permalink

    I thought credit unions were a good idea before the credit bubble burst. Perhaps extending such a scheme would have been better for private businesses and individuals.

    We should have just let the bad banks go bust, it was no more than they deserved!

  12. oldrightie
    Posted February 6, 2009 at 5:23 pm | Permalink

    Excellent and well presented argument. However, we do so need a change of Government ASAP, before any hope of common sense returning, can happen.

  13. Johnny Norfolk
    Posted February 6, 2009 at 5:36 pm | Permalink

    I think the whole thing is clear to see. labour have no idea at all. They are just making propaganda all the time.
    all labour can ever do is spend they are unable to manage anything.

    They could not run a whelk stall

  14. Bernard Palmer
    Posted February 6, 2009 at 6:13 pm | Permalink

    Reading all the comments gave me the vivid picture of JR standing in the middle of a room full of very complimentary mirrors.

    ‘Oh you are so wonderful John to have the same views as me. You really are awfully smart’.

    Wake up all of you heavy thinkers. What we are seeing here is the inevitable death of Socialism and everyone sounds like they are trying to find ways to revive it.

    “Don’t die on us old friend, come on wake up, please wake up”.

    Let it die. Can’t you see that the malaise you are all so keen to resuscitate was cancerous right from the beginning?

    You all swoon over the words ‘Margaret Thatcher’ but in truth she helped bring you to this point just as much as George Brown and Tony Blair did with her adoration of the high priest of Monetarism Milton Friedman and all his now defunct ideas. Having Keynesian thoughts now can only lead to Orwell’s Nightmare. The system in place is going to crash. The real problem facing all of the westernised world is low birth rates. And only gold can solve that because only gold restricts the size of governments which is why all Socialist governments hate gold.

    All westernized governments are behemoths that are consuming the essential wealth needed to allow countries to grow. Fiat paper money is NOT money. It is PAPER. Only gold and silver is MONEY. Stop trying to revive the paper currency. Jump out of the box, look around you. You have been so hemmed in for so long you have forgotten what freedom is. Only gold allows freedom from oppressive obese governments.

    Simple fact. What is crashing is the fiat currency system. No fiat currency system in history has ever survived. Only gold and silver can last forever.

    The influx of 3rd world migrants into the UK, Australia, Canada, the US, New Zealand, Europe since 1971 is because of dwindling population growth of the British/European gene pools of those countries due to the abandonment of the gold based Bretton Woods Agreement and the introduction of a world wide fiat currency system which has caused a 95% reduction in the value of most paper currencies. This in simple terms means the wife has to work to help pay the mortgage because money isn’t worth as much any more. No longer can she stay home and have lots of babies because government theft by inflation silently eats her money. Consequently cheap labour immigration increases as does migration to lesser evils.

    So forget about looking for paper currencies based answers. They will all eventual fail again anyway. Only gold combined with Adam Smith’s Real Bills Doctrine can get us all out of this mess.

    Read Professor Antal Feketes writings if you want to see what happens next.

  15. David Belchamber
    Posted February 6, 2009 at 6:27 pm | Permalink

    Dear Mr Redwood
    You are one of the few people in my estimation to reveal a proper understanding of our current problems and to suggest solutions.
    If asked, would you agree to be part of the conservative Treasury team?
    I personally hope that you will be asked and that you will accept.

    Reply: I am willing to help in any sensible way.

    • David Belchamber
      Posted February 7, 2009 at 12:41 pm | Permalink

      Thank you very much.

  16. Bernard Palmer
    Posted February 6, 2009 at 6:32 pm | Permalink

    complementary

  17. Atlas shrugged
    Posted February 6, 2009 at 10:56 pm | Permalink

    We will continue to be hobbled by Brown until we can change leader at a general election and remove politics form our management of the economy.

    We cant remove politics from our management of the economy, because those that really control our economy also control our party politics. They may not control John Redwoods, but then, he is not even in the shadow cabinet. Which may go some way in explaining why he is not, and never will be, especially for a department anywhere near the treasury.

    John, I know whats going on, as do an increasing amount of people. We really are not up to another bout of Thatcherism.. We have done that, been there, and very much bought the T-shirt.

    This country has had its chance, and it has well and truly blown it. Even Conservatives are not going to sacrifice another generation for this boom and bust criminals charter yet again.

    This is the end for this country without doubt. As it is surly the end for this our theatrical scam that goes by the name, of western style liberal democracy.

    Nazi Fascist corporate socialism and Marxist Communist corporate socialism are bankster created ideologies, designed only to destroy without conscience the lives of countless millions, while creating a world only good for themselves to exist in. Themselves being slave owners and extremely power crazed and criminal bankers.

    • Bernard Palmer
      Posted February 7, 2009 at 10:32 am | Permalink

      Good one Atlas shrugged.

      “This is the end for this country without doubt. As it is surely the end for this our theatrical scam that goes by the name, of western style liberal democracy.”

      No, it’s not the end of the country I don’t think but definitely the end of Socialism Democracy and the banking system as we know it. Now’s the time to look forward to a true Capitalism Democracy which we’ve never tried in modern times contrary to popular belief. Capitalism only works with gold and silver, not bits of coloured paper.

      At some point John Redwood needs to quit the Tories and start up a new party that calls for a return to a gold standard and the Real Bills Doctrine and stops the majority from interfering in the lives of the minority by constitutionally accepting the Primary Fundamental Right which means everyone legally owns their own body and can do what they like TO that body thereby making everyone legally responsible for themselves. No more government schooling, medicine, social insurance, drug wars, transport, fiat currencies, taking children from their parents and giving them to strangers, huge bureaucracies, war games in far away lands, swat teams etc etc. Let government be run by real successful business men such as JR and receive a monetary pittance for their efforts. That would keep out the bottom feeders.

      I reckon John Redwood could do it if he would just read up on Antal Fekete and grasp the concept of the Primary Fundamental Right.

      • chris southern
        Posted February 7, 2009 at 2:51 pm | Permalink

        whilst the gold standard was extremely stable, it fell apart due to goverments meddling with extra printed/minted currency being put into the system which devalued it too much.

        restricting goverments from introducing extra currency (limit them by only allowing x amount based on population every so many years, an agreed amount of currency and time by all countries)
        combined with getting rid of fractional reserve banking (say good by to paper notes, it’s either coins of value or a debit card) will give us back the stable system that lasted for the longest period we know (the restriction on minting extra coins would stop the spanish silver minting incident)

        no bank would implement a system like this though, nor would any of the high fliers support it, why, because they wouldn’t be able to make a fortune at the flick of a pen from out of no where.
        they would have to invest in physical assets or labour, and that takes real business skills, something that many people lack nowadays.

  18. Hanfgeist
    Posted March 5, 2009 at 5:38 pm | Permalink

    I think we are basically witnessing the end of western industrial civillisation, this was predicted by Ayn Rand back in the nineteen fifties and the current incumbent would do well to read and act on the lessons and ideas contained in her great work ‘Atlas Shrugged’ . You cannot run an economy just by flipping real estate and shuffling money around the city and Wall street and creating cash out of thin air to lend to people who are totally unable to or incapable of paying it back, at some point you have to actually produce things which have real intrinsic value, which make peoples lives easier and better, products from scientific and industrial research which can be sold and exported, that’s how we used to generate real wealth in this country……

  • 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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