Is the Credit Crunch over?

The “independent” Bank of England allowed its Financial Stability Report to be published just before the local elections, and allowed the spin to be placed on it that the losses in the financial sector will prove to overstated, that the Credit Crunch has not reached its worst point, and that from here we should expect some improvement. It is difficult to make up such a story.

A truly “independent” Bank should have left such a publication for the day after the elections, to avoid being dragged into the political argument. It would also have insisted on a balanced presentation of what the long and serious underlying Report actually says.

The report shows just how persistent and deep seated the liquidity and valuation problems in the banking market have become. The Bank’s own measures of liquidity are summed up in an Index. This has fallen off a cliff, and is at its weakest level since the dives of 1998 and 2000. It goes on to explain why market participants have to mark to market (use market prices to value the financial assets they own), why markets are reluctant to value more risky paper at higher prices, and states that there could be more bad news to come.

Indeed, it says that tight credit conditions can be expected “to lead to a pick-up in defaults among vulnerable borrowers, including a subset of households, parts of the commercial property sector, and some highly leveraged non financial companies”. In addition “Financial difficulties could emerge in some emerging markets, including countries in Central and western Europe with large current account deficits”. In other words, some of the losses have not been overstated, but will materialise.

The report goes on to recommend actions that banks and regulators should take to improve the position. It recommends better risk management by the banks themselves – an unexceptional request.

It proposes “Strengthened regulatory standards for liquidity”. This is more contentious. It would be odd to require tougher cash requirements today, in the middle of a credit squeeze which the Bank seems to want to end, than they sought in the inflationary credit bubble days of 2006. The Bank itself sees the dangers of “pro-cyclicality” in regulatory rules – regulators relaxing the amount of capital needed in good times, fuelling the boom, and then demanding more regulatory capital in bad times, tightening the squeeze. It concedes that the new Basel II rules coming in could well make just this mistake, and confines itself to wise words suggesting something might be done about this. It should be cause for immediate action.

It seeks “differentiated ratings for structured products” which is code for saying it wants Rating Agencies to be more cautious about they evaluate the credit worthiness of some of these packages of debt that have caused problems in the last few months. That too makes sense.

It wants “sharper regulatory incentives for banks to control risks through the credit cycle”. That presumably means they want banks to lend less and lend to fewer people than they did in the last few years. One way they could achieve that is by keeping interest rates higher. There is a reluctance to blame the Monetary Policy Committee, yet their low rates underpinned the credit boom of recent years. This approach needs careful control, lest they lurch from the boom of 2006-7 to a bust, by being too tough.

They also seek “strengthened UK and cross border crisis management arrangements”. A good place to start would be to recommend to the UK government strengthened arrangements for the Bank to supervise the UK markets, instead of relying on the tripartite approach which let us down so badly over Northern Rock. We have not, fortunately, had a bank crash recently that fell owing to errors in cross border surveillance – we have had a run on a domestic bank owing to errors in UK surveillance. The priority should be for UK regulators to get together to re-establish a framework in which the Bank of England can influence money markets decisively, restore the importance of base rate, and monitor bank liquidity day by day.

The body of the Report is more interesting and more realistic than the glib spin placed on it when it was released to the press. It does not make comfortable reading, showing as it does persistent problems with liquidity in banking markets. The government should take the initiative, recognise that the tripartite system got Northern Rock wrong, and reinstate the Bank as chief controller of commercial banks and manager of money markets. The two jobs go together. It is difficult to do the one without doing the other.


  1. Tony Makara
    May 2, 2008

    Interesting article John, would a Conservative government end the 'clause' written into Gordon Brown's open letter to the governor in May 1997 which states that government has the right to intervene in BOE policy? The Bank of England can't operate objectively if it is constantly on a leash and having to check that its policy is in line with government policy. The Bank of England carries out government policy by proxy, there is no independence, only compliance. Will the Conservatives look at the issue of the 'clause'?

  2. Deborah
    May 2, 2008

    The number of political press releases made by govt and supposedly independent bodies during purdah has been a real cause of concern.
    I had hoped for better from the BoE but it just goes to show how much damage Labour has done.

  3. mikestallard
    May 2, 2008

    I quite agree – one of the most disgusting things which Tony Blair did was to make all the previously independent agencies – Bank of England, Civil Service, Secret Services, A Levels, the Times and Sun – members of the Labour Party.
    Without independent bodies who know what is going on, the government is bound to get into real difficulties.
    Did you hear Polly Toynbee on Question Time last night, by the way? Complacent or what!

  4. Steve
    May 2, 2008

    Well, congratulations are in order on the showing today. The issue with the BOE is just part of an ongoing pattern of the Labour Party spinning and manipulating every bit of information. They really look at their most vacuous now.

    Gordon Brown's comment this morning was priceless. "My job is to listen and to lead." And I thought he was the Prime Minister. Where's Maggie when you need her?

    Harriet Harman's reaction was to say that Labour's poor showing was effectively turning the spotlight on the Tories lack of policies. Well, let's hope David Cameron continues to play a measured long game – don't want Gordenron taking any more policies.

    Something that puzzles me is the lack of challenge to New Labour on their economic record. When they boast of 48 quarters of stability I can't understand why the riposte is not rammed down their throat … "Yes, growth based on a doubling of tax revenues and a doubling of personal debt. We have an economy and a government that now relies on debt expansion."

    After all, look at what is happening now. A bit of a credit squeeze and we seem to be facing armageddon. After 10 years of prudence? No, after 10 years of wasting the best opportunity this country will ever have to re-group after losing a lot of old manufacturing capacity. We should have been developing new industries and technologies instead fo which we have 'developed' a million more public sector jobs and PFI initiatives our children will be paying decades hence. The man has really ruined this country and it will take a generation to fix.

  5. Al Nightingale
    May 2, 2008

    Surely, it's just a report, and if the conservative party thought the picture painted was inappropriately positive, it should have immediately taken steps to clarify what the report said. A strange comment.

  6. Mark Wadsworth
    May 2, 2008

    The Bank of England is totally independent and free of any sort of political interference. Everybody knows that. We also know that Gordon Brown and Ed Balls have a crystal ball that has enabled them to call every single base rate change correctly a few days in advance.

    It's really reassuring to know that this country has a truly independent central bank and a couple of financial geniuses running things.

  7. Robert
    May 3, 2008

    This confirms comments I have heard today. John Moulton from Alchemy, in my view one of the few people who really understand the credit crunch and the possible fall-out, was on CNBC this morning. To papaphrase – 'It's a whitewash!'

    And our company had a meeting today with a large UK retail fund manager today. Very similar reponse to Moulton – the spin is to try to improve confidence, the facts are something completely different.

    The last thing Tories need right now is a General Election. Let Brown take the caning he deserves over the next couple of years – it's too late and too big for politicians to sort the mess, they can only try to smooth the edges. The money's spent and he has absolutely no room for manouevre.

  8. APL
    May 3, 2008

    Mikestallard: "Did you hear Polly Toynbee on Question Time last night, by the way? "

    The best bit was when Littlejohn asked her if she thought about global warming during her flights to her villa in France or where – ever. Her response was not to say, yes I agonize over it, or no I never give it a second thought, but to say, don't try to make this personal!!

    Mikestallard: "Complacent or what!"

    If I were feeling uncharitable today of all days when we have seen the newt-man given his marching orders (well done Boris). I would say something like, she is complacent, because she knows she has Cameron's ear.

    But I am feeling charitable, so I won't say such a thing.

    JR: "Is the Credit crunch over?"

    No, I think it has barely begun.

  9. Matt
    May 3, 2008

    I believe this report as much as I do Brown & Bush's glassy-eyed delusional nonsense that "prices are stable, the economy is strong and inflation is low."

    These people should be forced to live on their own cleaner's wages for three months to see what utter garbage they try to get us to believe.


    See for a more realistic assessment

  10. David Jensen
    May 3, 2008

    Dear Mr Redwood,

    Your party and the nation as a whole benefited from this report and it was right for the bank to release it before a vote rather than after it. Independant does not mean retrospective information, and in this instance labour, conservative and liberal deserved available information. I don't want to sound rude but I am sure that your party welcomed the report and its timing.
    As for all of the ideals on control and containment in the context of this credit crisis, there is a simpler way of managing financial risk at the top. Stop chasing growth for growths sake and return to a form of gold standard and stiffen the reserves of this fractional banking system

    Reply: The issue was the spin placed on it – compare what the Report said with what the media told us it said!

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