We are now entering the second phase of the Credit Crunch, the time when the crisis has a direct impact on the rest of the economy. The first phase was a problem for the bankers and brokers. The second phase is a problem for all of us.
In the early days of the Crunch there was some pleasure by many in the US and the UK to see rich financiers finding their share options and bonuses wiped out. The years of plenty and easy money for bankers had produced plenty of jealousy and anger outside their privileged banking halls. The feeling that the bankers should be made to pay was still there when the Bush administration came up with its $700 billion package to buy distressed debt from the banks.
The political establishment who wants to “bail out” the banks argues correctly that crisis on Wall Street will also hit Main Street. They try to persuade their electors that they must spend all this money, otherwise the banks will be unable to lend sufficient to American borrowers to run their businesses, buy their homes and carry out their normal transactions. The public seeks guarantees that any bail out will not leach public money into shareholders dividends or bankers pay.
The revised version of the American bailout plan attempted to deal with these very reasonable concerns. It offered the US taxpayer a stake in banks that sell their loans to the government. It provided for controls over executive pay. It implied a new level of state control over US banking we have not seen before, on the very reasonable argument that if the taxpayer has to pay so much money then they deserve a say and a stake in the future business of any participating bank. The danger is that the terms may become too unattractive to banks, and knowledge that a bank has to participate in the scheme may not be as good for confidence as the Administration hopes. There are no easy answers.
There can be no doubt that the banking system is in trouble. Given the run of news on both sides of the Atlantic you would need to have avoided all media programmes and newspapers for a year not to understand that. There can be no doubt that weak banks unable to lend much will undermine the general economy. US and UK voters are beginning to accept that. The issue should be, what combination of actions by the banks, the rest of the private sector, the Central Banks and governments can get the banking markets working again sufficiently to avoid deep recession? That may include some spending of public money, but it may revolve rather more around the spending of private money to recapitalise the banks and around actions by the Regulators to move their rules into a shape which help fight deflation rather than inflation.
The sad truth is that even if you did want the taxpayer to take on the banking black hole and fill it with taxpayers money, it is too big to do that comfortably. Governments have been part of the problem. They have borrowed too much, and certainly in the UK have themselves used the modern off balance sheet techniques of finance which they are now criticising others for doing. Both the US and the UK governments have to accept there are limits to how much money they can borrow and commit to sorting out banks, otherwise the credit worthiness of government will become the issue. Governments must keep people believing in their financial management, so government guarantees when offered are things of value and mean something. The banking crisis will only be resolved when banks believe each other major bank has adequate capital, and a sensibly structured balance sheet. What we need is a debate about what kind of a package will have most chance of success, rather than a debate about whether there is any need for action.