On Wednesday I was asked to write an article on how we got into the current economic mess by the Daily telegraph. They told me they wanted it for Monday’s paper. On Friday after I had written it they changed their minds and said they did not want a piece about that after all. I thought I would share it with you here:
A couple of years ago many people thought all was well with the world. The economy was no longer an issue. Even some Conservatives would tell me they thought Gordon Brown had done a pretty good job, and that Bank of England “independence” was excellent. Endless repetition of the propaganda, ”We have abolished boom and bust”, lulled many into false security.
Two years on and how different it all looks. Even the government has given up repeating the boom and bust mantra, realising hubris came before a tumble. Gordon Brown did not make the Bank of England “independent”. He gutted and filleted it, taking away its duty to manage the government’s own debt, and removing the responsibility to supervise the banks.
He put his own people on the Monetary Policy Committee. He changed its target in 2003 so it kept interest rates down prior to the 2005 election. The MPC failed to hit the inflation target, allowing some prices to soar. It ignored the sharp rises in house and property prices, the fall in the pound and the commodity cycle.
We have lived through a colossal debt binge. The UK’s growth rate was flattered because the authorities helped turbo charge the debt. Our economy created hundreds of thousands of jobs for new migrants, because they opened our borders at the same time as opening the debt taps. We sucked in new people, hot money, and lots of financial business based on more and more leverage.
Monetary policy lurched from too hot to too cold. Just like a person in an unfamiliar shower, the authorities hurled the controls from hot to cold and now back to super hot again without waiting for the water temperature to settle down. They never found the happy mean.
Today the government wishes to blame the bankers. The Prime Minister tells us he wanted an international clampdown on too much credit, but unfortunately other world leaders did not share his foresight. This is difficult to believe, when we consider just how big a contribution the government made to excessive debt.
In the glory years the government was not more cautious than the banks. It was egging them on. The Treasury decided to finance ever more projects they could not afford, by ever dearer never never schemes. We had various types of Private Finance Initiative, and then moved on to Public Private Partnerships. The government flexed the national plastic, took out the biggest mortgage possible, drew down a personal loan and topped it all up with additional credit cards. That was all before the downturn and the reflationary packages.
It never warned the banks to lend less. It wanted to promote home ownership, so it encouraged banks to lend to people on lower incomes who might find paying the mortgage more difficult. It was a keen advocate of debt based major investment projects. The Chancellor, the Head of the cumbersome tripartite regulatory structure, never called the regulators in for a review. He did not ask them to require more bank capital and cash to cool things down a bit. Far from controlling the fire, the government was busily stoking it up.
The crisis that struck was easy to forecast. In the Economic Policy Review I helped write in the summer of 2007, we underlined the weakness of the financial regulatory system and said it would not be able to handle a crisis. I warned that monetary policy had lurched from too easy to tight. There was bound to be a crash.
Things got worse as the authorities displayed monumental incompetence in the face of gravely weakened banks. In the late summer of 2007 they kept the markets starved of cash as the wholesale money markets seized up. Banks like Northern Rock were bound to come to grief in such circumstances. Some of us told the authorities to loosen money so these banks could survive. Instead Chancellor and Governor lectured the banks on “moral hazard” and refused to ease the markets.
The run on the Rock was the result. A ÂŁ25 billion limited term loan against security was all it needed to prevent the run on the Rock. Alternatively modest sums by modern standards supplied to the money markets may well have stabilised the mortgage banks at risk. Instead the authorities opted for disaster, and ended up guaranteeing all the deposits of the entire banking system. In addition they nationalised the Rock, putting the taxpayer at risk for much more than they needed, and ensuring big taxpayer losses from their new bank.
You might have thought that the Rock experience would have led them to take urgent and private action to sort out the other and larger banks in the system. Instead the authorities wasted the next year. They should have invited in each of the big banks in turn for a private review. They should have told them they wanted them to strengthen their balance sheets. They could have given them a period of months to do so. In 2007 all the main banks had options. They could have sold assets and subsidiaries to raise money. They could have made major issues of shares to raise new capital. They could have cut their bloated costs. They could still have securitised more of their loans, passing the risks to more patient holders.
Instead the authorities let matters drift, until the autumn of 2008. Then, inexplicably, they demanded more capital for each of the banks. They did so in public, creating a loss of confidence and facing banks with an impossible timetable to meet the new capital requirements. The catastrophic result was to put the taxpayer at risk for both RBS and HBOS. Worse still, the authorities helped broker the disastrous merger of Lloyds with HBOS, undermining a relatively strong bank needlessly, and putting the taxpayer behind Lloyds as well.
It would be difficult to imagine more blunders. It was almost as if they wanted to end up nationalising most of the banks. Barclays was spun against for daring to find private sector solutions to the new capital requirements. We are living through a nightmare.
Today the authorities are still making several major errors. They seem to believe the credit of the state is inexhaustible. They have been going around trying to find more liabilities to take on. “We will do whatever it takes” includes more borrowing to pay for the IMF, for eastern Europe, the developing world and for the ailing UK economy. They have chosen to ignore the warnings of those of us who think there are limits to how much a state can borrow at sensible interest rates. The little wobble in the government bond market last week should be a warning to them.
They seem to think that transferring problem loans and other bad investments from banks to the taxpayer will solve the problem. It doesn’t. It means the taxpayer has to pay the losses. You still need to manage each and every bad loan and dodgy investment, with a view to getting back what you can.
They seem to believe that the answer to excessive credit in the private sector, is to indulge in excessive credit in the public sector. Surely the lesson from 2003-7 is that borrowing too much cannot be sustained. Why therefore should we borrow more? Of course we need to look after people thrown out of work, but we cannot afford to subsidise the banks to keep them in bonuses.
They also seem to believe that spending more in the public sector is “reflationary”. It may not be as reflationary as they hope. If the extra spending is paid for by higher taxes, as with the 45p income tax increase, it means less spending in the private sector which offsets some of the extra public spending . If it leads to fewer people staying in the UK and running businesses here, that too reduces demand. If the extra spending is paid for by borrowing more, that cuts private spending. If they issue more National Savings the people who buy them cannot then spend that money. They might opt for the security of a savings bond instead of the pleasure of a new car.
They need to control their deficit and to get much tougher with the banks. The state’s banks are cuckoos in the public spending nest. They need to be slimmed down and sorted out quickly, or else they will topple the public finances.
March 30, 2009
My personal opinion is that how we got into this mess is not the issue – crisis’s come and go. The question is “Was the government prepared?” The answer was no and even worse they knew they it and still did nothing.
March 30, 2009
You seem to be having your time wasted recently by both the BBC and the Telegraph but don’t be deterred, you have an important message to deliver and must continue to do it.
March 30, 2009
The BBC hiding the truth about Daniel Hannan came as no surprise, the Daily not printing your excellent article does..
Thank you for sharing it with us.
March 30, 2009
This is an excellent article and I’m very surprised the Telegraph couldn’t find room for it. Never mind, though – it’s their loss.
March 30, 2009
“They should have invited in each of the big banks in turn for a private review.”
On the one hand the big banks, if remotely competently run, should have known how exposed they were. On the other I suppose, because they are in competition, none of them wanted to be the first to reing in & that is where government can act as referee.
“Barclays was spun against for daring to find private sector solutions to the new capital requirements”
Saint Vince Cable, whose party is supposed to believe in the free market deserves particular oprobrium for the attacks he made on Barclays over this.
March 30, 2009
Keep plugging away, John. Churchill also had to spend years stating the obvious before anyone, including within his own party, had the wit to listen!
March 30, 2009
John:
I agree with you. The two causes of our current problem is an huge increase in overall debt (private, public and personal), probably caused by incorrect control of interest rates, and a slowing in the productiveness of the UK economy as more pointless jobs were added. If we had not been able to borrow so much this ecomonomic slowdown would have shown much sooner.
Indeed if you look back at 2004/2005 there was a slowdown in the economy and houseprices but as there was an election coming up, the government increased the debt level, raised spending and achieved a temporary rebound. Perhaps this earlier ‘succesful’ fiscal stimulus is what makes Brown think he can do it again.
What I am interested in, is why the private sector was so caught out by all of this? We say that in a free market, the alignment of ownership, risk and reward should lead to more careful thought about invesment decisions. Surely it was of no interest for any of the bank shareholders (the ultimate owners) to have their shareholdings trashed in this way.
Why were they so careless with their responsibilities? Is it because the bank employees forgot about their responsibility to the shareholders and simply took the short term bonuses? e.g. Even after the collapse of their banks the employees still got their bonus, yet the shareholders lost most of their wealth.
Also, John, it would be good if you could do an article on the use of interest rates to regulate the economy? From my view al that seems to have happened lately is that interest rates have been used to defer problems rather than solve them, e.g. 2001-2003, economy slows so lower interest rates and take on more debt storing up problems so that in 2007- interest rates need to be crashed again. How do we know that we are not going to have the same issues again in a few years?
Thanks very much
March 30, 2009
One reason is that the dominant shareholders are the institutional investors, and they very often operate the same kind of short term bonus schemes. If the investment manager is rewarded for the short term performance of his funds, then of course he’ll be much more inclined to tolerate short term attitudes at the senior levels of the companies in which he invests.
March 30, 2009
You need to do a ‘Hannan’ with that. Get someone to give you a platform, present it well, and have it videod and published on youtube.
Do it now.
March 30, 2009
Lola, Forget it. You can take a horse to water but you can’t make it drink.
March 31, 2009
I wouldn’t worry too much about getting JR in youtube – Brown looks pretty much finished to me. From where I’m sitting it looks like one by one the final nails are being hammered in his coffin, I’ll bet you he’s gone before the Labour conference.
March 30, 2009
Please continue writing articles like this one. For many of us this site is the only media outlet which makes any serious attempt to explain the crisis, without insulting our intelligence or being proved spectacularly wrong as events unfold.
March 30, 2009
As usual, you’ve stated your case clearly and correctly.
It’s a shame the government aren’t listening. But I suspect it’s too late anyway. The damage is mostly done.
The only question in my mind is, how much worse can the situation get?
March 30, 2009
Brilliant! I’m not an economist and I feel I’ve had to endure so much gobbledygook over the last few months – clear, consise and gloriously unpatronising – sod the MSM – more folks will read you here anyway!
March 30, 2009
Thankyou for this, John. Succinct and to the point as usual. Don’t worry if the MSM ignores you – there are very many more people who get their information from sites like yours than there used to be.
I noticed Jonathan’s comment above about why the private sector was caught out by this – it would be more accurate to ask the question why parts of the private sector did not spot this coming. I worked in the City in the run up to the downturn and can say that some areas did see this coming – in 2006 some of us started planning for the downturn. Recruitment in many firms stopped in autumn 2007, and firms began to actively plan their actions for the point the bull market turned bear.
Why didn’t the financial sector see it? Probably because they didn’t want to or were unable to. If you sit in a coffee bar in the square mile and estimate ages of the people passing by (I did this!) you would be hard pressed to find anyone over the age of 45. A lot of these financial vehicles were dreamt up by whizz kids straight out of university, supported by questionable accounting practices which had as their aim the desire to avoid the increasing burden of taxation. Many firms did not have experienced heads in the position of decision makers and those who were more experienced often didn’t understand it but took the view that everyone else was doing it, so it must be ok. There was a complete lack of experience of crashes and recession in a large number of staff in the city, so no concept of what could happen if any part of the chain went bad.
Shareholders are toothless and exert no effective control, the questionable practices mentioned above had the effect of making balance sheets look great, so why worry? I’m sure there are more views on this, but that was my perspective at the time…
March 30, 2009
Ruth, thanks for the answer, that does make sense.
If shareholders are toothless, I guess the question then is whether it is best to have bank ownership structured this way. If the failure of a bank is more damaging to the economy than the failure of another, similar sized company then perhaps we need owners who are alot more engaged?
I remember reading something a while back about how when Goldman Sachs were a partnership, any investment decision was carefully considered but once they became a shareholder owned company, decisions were much quicker and money thrown around
Thanks
March 30, 2009
Jonathan
I think you are right. Most shareholders do not understand the company accounts they see, and cannot see the numbers underlying the numbers anyway. I have done enough due diligence work to know that the published accounts hide a multitude of sins and a company which looks profitable may be anything but.
On the Huffington Post last week, a writer made the statement “if a bank is too big to fail, it is too big” and I think this is right. Over the last 10-15 years companies have grown and grown through acquisitions and unwise credit to a size which I personally believe is unsustainable. I saw it myself, as my own company absorbed others – beyond a certain point senior managers cannot keep effective control and that is when bad decisions are made with other people’s money.
In my view, what we need are more, smaller companies because when the economic climate changes, smaller companies are quicker to adjust. I have a very tiny business but I’m on the first page of google, competing with the big boys. I’m increasingly winning business from them, yet they have far more resources than I do. Why? I have no bank loans, no expensive infrastructure and no hordes of staff to be paid. And I know where every penny goes – big companies cannot possibly know that. I’m at one extreme of the spectrum, but you are right that other models of mangement, i.e partnership, tend to be much more cautious and hence safer in the long term. I take an increasingly dim view of the management of listed companies, given what I saw of them over the years.
Maybe I’m just a cynic or maybe a realist?
March 30, 2009
Nice article John 🙂
Sometimes people take a long time before they realise that the truth has been openly told to them, time and time again. More and more politicians are starting to slowly wake up, thanks to those individuals such as your self (maybe democracy can be rescued and parliment become a respected place once again.)
March 30, 2009
No mention of Basle II. I only say that because there is a case to be made ahead of the G20, that the banking crisis was caused by hamfisted international efforts to tighten banking regulatition…. beyond that my thoughts largely dovetail but I would guess these concerns could be mirrored throughtout the world.
Why agree to share a platform with Mr Draper, I grasp that he may be in financianal straits with a new baby on the way and to a certain extent the media may be looking after their own (his wife). But his acumen in this field is limited at best.
March 30, 2009
John
Keep plugging away.
You WILL get there in the end.
Then you could use properly the well known phrases
“I told you so”
“Its the economy stupid”.
(No) “end to Boom and Bust”
“The pound in your pocket” (is now worth less)
Although aware that you are far too modest and sensible to say so.
Those who do not take on your vision of the situation are the loosers.
April 1, 2009
We got in to this mess for one reason only: the Monetary System is 100% FRAUDULENT ! It has been swindling people for decades, unchecked, and now has reached critical mass and is spewing the effect of this everywhere. It has created a giant ‘credit bubble’ which is the tangible effects of the World Bank’s ILLUSIONS, made manifest!
The ONLY solution is to disband the World Bank, issue a parliamentary claim for ÂŁ100 trillion or more back from ( a named banker who is clearly not the main beneficiary -ed)who is the ultimate benefactor of this organised stealth over the past decades, and after claiming back these stolen funds, to re-distirbute them back to the people. Oh, and we also need to urgently disband the ‘spawn’ of this hierarchical and highly corrupt set up: namely, to do away with the Federal Reserve, abolish the IMF, abolish the Council on Foreign Relations & Trilateral Commission, and bar them from owning the ‘printing rights’ for the world’s money supply. this G-20 summit is a complete waste of money, playing in to these idiots hands, and they need to get the message that the world does not WANT the G-20 nor anything it has to offer, and we know their GAME. It’s time for urgently Monetary reform, also regulatory reform and Judicial reform. It’s time to clean up the widespread corruption and raise the bar across the board. Questions, anyone ?