Common responses to the crisis

Last night I travelled to Hatfield to speak at a dinner. The roads were eerily emptier on a Friday night – a sign of things to come. I am grateful to the audience – and to all of you bloggers – for your thoughts on the crisis. I would like to comment on some of the most common responses.

“Too much deregulation caused this mess” – showing the eternal power of Labour spin. The extreme version blames Margaret Thatcher for this “crisis of capitalism”!
The great difficulties in banking have occured in the most regulated of industries. Regulation of banks and other financial institutions has expanded greatly in recent years. This is a failure of regulation as well as a failure of banking. It is not that we had too little regulation – we had the wrong type of regulation regulating the wrong things, allied to weak regulation of what matters, capital and liquidity.

“People like you called for deregulation, so you caused the problem”!
This is the fatuous BBC line. It ignores the fact that I issued warnings about the dangers of the Bank of England have too little power to regulate banks and other financial institutions. It also is a muddled proposal in its own terms, as an Opposition MP calling for something does not mean that something happens! I thought Labour was in government and calling the shots on how much regulation we needed.

“Banks should not be allowed to lend more than they get in deposits, so they would be stable.”
The run on the Rock which brought the Rock down shows that deposits are not a stable source of cash if confidence goes. There is a lot to be said for a model where a bank draws its money from a wide range of sources, to reduce risk.

“Banks should not borrow short and lend long”
Borrowing short and lending long is a normal banking approach to making money and helping the economy. Done in moderation it makes sense. The interest rate is usually higher for longer term loans than for short terms. Intelligent exploitation of this difference can earn a return for bank shareholders. Of course, taking it to extremes can jeopardise confidence. The problem in the summer of 2007 was the Central banks, especially the Bank of England, left markets so short of short term funds a crisis was likely.

“It’s not fair of you to call for lower interest rates – this means savers will be hit”
In this crisis we are all going to be hit. Savers can only enjoy high rates of interest if people and companies can afford to pay even higher rates of interest to borrow the money. If rates are too high too little money is borrowed, and too high a proportion of exisitng borrowings are not repaid. Savers and borrowers depend on each other. At the moment it is too difficult for borrowers, so the savings rates have to come down to prevent the system breaking down completely. I would have thought the experience in the Icelandic banks might start to show savers the dangers of wanting too high a rate of interest for current conditions.

“We should limit people to borrowing just 3 times their income again, as they used to do, when taking on a mortgage”
I agree banks and Regulators need to look again at how much they are prepared to lend against any individual property, and how big a multiple of income they will allow. Today, however, the problem is not limiting the amount banks will lend, but getting them to lend enough. This is a something for the future when banks do want to lend more. Many of us were warning against the extreme deals we saw being advertised in 2006-7 before the crunch.

“Nationalising the banks would sort all this out – why don’t they just do it?”
Transferring problems from the shareholders to the taxpayers sorts out nothing. The day after you still have the same underperforming loans and the same need for extra cash and capital. The banking sector is too big as a whole for the UK state to take on. Why should the UK taxpayer have to pick up the losses, when we did not enjoy the bumper years for banking profits and bonuses?


  1. Bazman
    October 11, 2008

    Which word best completes the sentence kids?
    We are all…………………?
    A: British.
    B: Creditors.
    C: Debtors.
    D: Socialists.
    E: Suckers.

    Maybe if the British and other governments had not allowed a banking system to exist next to the real banking system we would not be in this position.
    When Lehman Brothers boss Dick Fuld was asked if it was right that he should receive $480 million in bonuses when everyone else has to pay higher mortgage rates and maybe lose their jobs replied "That number is not correct" This is what you are dealing with.
    Any chance of regulating these basic points John?

    1. mikestallard
      October 11, 2008

      And when the Clinton administration was forcing the banks to give out mortgages to unemployed people at 3%, then more or less for nothing or allowing mortgage banks to trade in derivatives throughout the world, where was the "real government"?
      How about
      We are all in this together……..

  2. Kit
    October 11, 2008

    Labour is offering more regulations and the Conservatives are promising better regulations. Politicians and regulators need accept that they are the problem.
    And if the BBC call the banking system "laissez faire" one more time I'll scream!

  3. anon
    October 11, 2008

    Incredible. Being watching the reporting (particularly on the BBC) of this shambles like a hawk. Throughout there has been no mention, let alone explanation and discussion, of:-

    1) Fiat Currency

    2) Fractional Reserve Banking

    3) Disintermediation

    With respect to the points above:

    1) Whether or not the basis of such is good or bad law (in my opinion it is bad law see the Case of Mixed Money). The morality of point (1); the result of which is that peoples' livelihoods and savings are used as ballast so ignorant parasitic banksters can sail more and more towards capsize.

    2) A mechanism of inherent instability made worse by ignoring moral hazard.

    3) A parasitic banking system is simply not needed with our current level of communications. Things such as Ricardo contracts are already in place and could be activated. The only reason this doesn't happen is that govs would loose control of their subjects – see point 1.

    Overall the media are stuck in a horizontal dialectic so deep that they cannot see beyond the edges. Are you in the same trench?

    1. mikestallard
      October 11, 2008

      One of the characteristics of the modern age is gobbledegook. In morality it is disastrous because it gives permission for all sorts of perversions to be taken as right. I imagine the same is true in banking.
      As a school governor, if I am honest, the trouble was, for me, that I simply could not understand what the Headmaster was saying – let alone the Council Officials who eventually closed the school.
      Fiat Currency – does that mean inflation?
      Fractional reserve banking – does that mean trading without proper capital?
      Dis-inter-medi-ation ?????????
      It is important, in a democracy, that people know what is going on in simple English. We were duped all through the past decade.
      Let's stop now.

  4. figurewizard
    October 11, 2008

    During the weekend before Monday 6th October there had been a confidential meeting between 'senior officials' of three of our biggest banks and the Treasury. However in the wake of this the fact of it was leaked by someone, as yet unknown to Robert Peston of the BBC who duly reported it on the morning news. By the end of the day the share price in the banks concerned had tanked over concerns that they were about to go bust. Because the consequences of a second day's trading like this didn't bear thinking about Gordon Brown and Alistair Darling were then forced to spend most of the day and all of that night with their own officials, putting a package together to remedy the situation which as we now know has committed £500 billion of our cash to the problem. Had there been no story to report would there have been such a problem however and would this £500 billion been necessary? In other words was it the fact of a depressingly familiar Downing Street leak that was solely responsible for this crisis in the first place?

  5. Acorn
    October 11, 2008

    All good points JR. Actual intervention mechanisms by central banks and government treasuries have yet to kick in; but, if this was just a confidence thing, you might assume that the announcement of such plans, would have done something for that confidence; but it did not.

    The financial system has been founded on rising property prices; hence, when those prices dropped, the foundation crumbled. It will not respond to any medicine until property prices start rising again. How should we make that happen?

    A model where the eastern world, with too many savers, exports two to three billion dollars every day, to the western world with too many debtors; simpletons like me start to think, how the hell is this mechanism sustaining itself.

    The macroeconomic text books tell you "savings – investment = exports – imports" and "this equation must balance over the long term; in a free market, global currency exchange rates will seek to correct imbalance". The US and the UK to a lesser extent – net importers of capital – have tested this theory in spades.

    Perhaps you have to add addition terms to the equation to allow for governments printing money; too difficult for me to work out.

    They also say that governments don't go broke, I am having trouble with that statement as well (Iceland).

    In defence of local government treasury managers. They are not allowed to use any hedging instruments and the rules are dictated by central government, even when they use external fund managers. There is a lot of cash washing through the "collection fund" if it is a council that collects tax on behalf of other preceptors. A lot of capital they can only use the interest from (council house sales for instance, but I think the rules have changed recently). I have never met an LG Treasury manager that was not ultra cautious; CIPFA set out rules for the way they work.

    1. mikestallard
      October 11, 2008

      Abut the Eastern world. My son works there (Bangkok and South East Asia). He tells me that business is actually booming and he is worked off his feet. This is in advertising which, I am told, is a sort of mining canary: it croaks as soon as the economy weakens.

  6. Derek
    October 11, 2008

    I think the problem the government has now is that whatever actions it takes there'll be further unpleasant ramifications down the line. What can't be got away from is that many companies weren't viable and aren't now viable after ever expanding lines of revolving credit, at low rates, have disappeared. Too many companies were not founded on a market leading product or excellent value proposition, but rather the carry trade. Bye bye Iceland equals bye bye UK retail sector.

    This argument can be modified slightly and applied to the residential and commercial property sectors also.

    I would say as far as regulation goes it wasn't quite the problem that received wisdom now thinks. A big problem was that people weren't rewarded for building solid businesses from scratch and creating jobs. The big rewards came in areas like private equity, where companies were acquired, property was sold off and leased back and the company then flipped on to another eager participant in the pyramid scheme. Those involved profited handsomely ad paid very little tax. The fault for this lies squarely with Gordon Brown.

    1. Puncheon
      October 11, 2008

      Exactly. For years the western world has undervalued those who found and grow good businesses, whilst hero worshipping dealmakers. Of course, the latter always look good in a rising bull market – any fool would. As Mr Morrison knew and Mr Green knows, the secret of a sound business is keep the bankers out and the accountants under your thumb.

  7. Man in a Shed
    October 11, 2008

    John – what is really worrying is that Labour is getting its spin accepted as fact, with the willing help of the usual suspects (ahem BBC ).

    Some are even rewriting history to blame all economic crisis on various Conservative administrations. ( The BBC is forever comparing to black Weds )

    There is a danger of being right, but losing the argument with the electorate.

    I sometimes think Conservative spokespeople, knowing in their own minds they are right, think the facts will do the talking for them. It is very clear Spin Labour is back setting its web of narratives, with the tacit cooperation of its sympathisers in the media.

    The Conservative message needs to be clear, repeated often and fought for.

  8. Gordon Riby
    October 11, 2008

    A key contributor to this crisis, and also to the downfall of Enron and Worldcom, was the lack of tranparency of company accounts. I refer specifically to the decision taken by governments and regulators globally to allow firms set up "Special Purpose Vehicles" (SPV's) to keep toxic assets off their balance sheets.

  9. Derek W. Buxton
    October 11, 2008

    Nice article as usual, just one small point, mark to market as we have to do courtesy of EU rules reduced solvent banks to problem banks overnight. The USA can suspend this, we cannot. Mind you, although they have, I believe, suspended it they have not stopped the Urban Re-investment programme which had much to do with the sudden crisis.

    1. DBC Reed
      October 11, 2008

      Is the latter a reference to the Community Reinvestment Act, which was a piece of Carter legislation? Action to increase home-ownership among American minorities seems to go back even further to the 60's when Civil Rights protests focused on the red-lining of property maps which meant minorities had to pay more for mortgages over shorter periods.A large number of presidents revisited this problem,particularly Clinton,but George W Bush has a Fact Sheet America's Ownership Society still on the Net accessible by Google as such which proudly declaims his intention to make homeownership easier for minorities.
      Of course in the UK the Conservative Party has sought to identify itself as the home-owners' party,starting by the populist abolition of Schedule A of income tax on owner-occupation in 1963, though particularly in the last ten years,the other parties have competed for that popular recognition.
      However none of them can claim,as can the American politicians, that their actions were meant to extirpate institutional racism.
      Both in the States and here non-socialist parties would have been better off concentrating on increasing the incomes of marginalised people so that in the US especially they could have afforded to pay for the mortgages that so much reform of the system made possible.
      A Land Value Tax to stop the properties increasing in value all the time would have helped.

  10. mikestallard
    October 11, 2008

    Kark Marx is now so unfashionable that I think it is fine to quote him.
    "The essential condition for the existence and the sway of the bourgeois class (ie us here in the USA and Europe), is the formation and augmentation of capital (our banking system??)
    "The condition for capital is wage labour (China/India/Africa??). Wage labour rests exclusively on competition between labourers. (Hence the very low prices of Chinese clothes and African/Indian foods?)
    What the bourgeoisie therefore produces (that's us, folks), above all, are its own grave diggers. Its fall and the victory of the proletariat (that's them) are equally inevitable." (Communist Manifesto.)
    Or, in very simple language: The Chinese and Indians graft. We don't. Therefore we are bound to go down before them. They own the means of production, we just own lots of capital which you can not eat or wear.
    Maybe, now we have been given, and are about to be given, a huge shock, our previous strong, workmanlike and honest character will be revealed?

  11. Puncheon
    October 11, 2008

    The Government must not be allowed to spin their way out of this and blame the usual left-wing hate figures – the USA and Mrs Thatcher. The fact is that is one of the (few) Government jobs is to to regulate markets. Light or heavy is irrelevant – it should be effective in delivering an efficient and fair market economy. The old BoE system was light – we'd like you to pop round for a chat old boy – but effective. The old Midland Bank (got into trouble -ed) because of (the actions of the-ed) board of directors (remember the Crocker Bank purchase), and so the BoE arranged, quietly and without fuss, for Hong Kong and Shanghai to take them over. This Government set up the huge FSA and look what has happened. That is because an army of regulators will nearly always comprise those not bright enough to earn a living in the industry they are regulating, and they will almost always be headed by Government toadies and time servers. This is not a new phenomenon. The Labour Party loves regulatory bodies and they almost alway fail. But hell. why aren't Her Majesty's opposition making these points? Yes the BBC is hopelessly biased and must be abolished at the earliest opportunity, but they aren't the only media outlet. John – tell DC to get off his backside.

  12. Matthew
    October 11, 2008

    One issue that needs to be raised is in your last sentence 'we did not enjoy the bumper years of banking profits and bonuses'. Well we did a bit, thanks to the higher rate of income tax. I'm pretty sure most commenters here would like to scrap it, but I would suggest it has served a useful purpose.

    On the other hand I've noticed that fairness is not a guiding light of many Conservative's views on taxation. I've argued on this blog that it seems bizarre to me that Conservatives would rather an indivual who inherits £2m of property pays no tax (compared with about £0.5m under Labour's proposals) rather than reduce the tax on a hard-working fireman or small businessman, but that is indeed their current policy.

    1. Puncheon
      October 12, 2008

      Matthew – I agree. This has worried me for some time. Given the shift from direct to indirect taxation in recent years and the fact that tis hits the poorest hardest, the lowest earnets must be taken out of the direct tax bracket. The argument that they will thereby not be contributing to society no longer hold good. For those on or near minimum wage paying income tax is simply cruelty. The Conservatives should make this a priority area in the next election.

  13. londonerr
    October 12, 2008

    John, I appreciate your analysis in these confusing times.

    I find 2 things worry me. The story about bonuses is a red herring. If we don't pay bonuses our brightest will go to those who will pay them. I feel that some people's anger is being focused in this direction – wrongly in my opinion.

    Second, like Man In A Shed I am concerned that the Conservative story isn't getting coverage. Thus allowing stories about bonuses and this govt's analysis and approach to intervention to prevail.
    Reply: The media refuse to run my approach to the crisis – they just want me in their story as a "deregulator", refusing to accept I was calling long before the crash for proper banking control from the Bank of England. I just shows the power of Labour spin control again.

  14. Pete Chown
    October 12, 2008

    "It's not fair of you to call for lower interest rates – this means savers will be hit"

    Up to a point I agree with you. The aim of monetary policy should be stable prices (of consumer goods and of assets such as housing). It should not aim to give a fixed return to savers. It might be that savers' returns will even be negative at times.

    What the government may be tempted to do, though, is inflate its way out of the crisis. If the economy is mired in debt, why not make the debt smaller with a bit of inflation? That is where it gets unfair: the government is simply transferring resources from savers to borrowers, in effect taxing the prudent to bail out the profligate. Many savers are pensioners who have put money by for their old age. Are we really reduced to bailing out the City with the savings of the nation's pensioners?

    We should also consider that inflation discourages saving. By world standards, Britain has a very low savings rate. Is that left over from the days of 20% inflation, when saving must have been pretty pointless?

    Finally, it's worth noting that I could transfer my own modest savings into gold with a few mouse clicks, and I'm not on my own. If the government thinks a run on the banks is bad, try a run on the currency, as the country's savers look for something safer.

    1. APL
      October 12, 2008

      JR: "In this crisis we are all going to be hit. Savers can only enjoy high rates of interest if people and companies can afford to pay even higher rates of interest to borrow the money."

      A good point. But I also agree with Pete Chown, inflation has since the end of the war been an instrument of government policy.

      It discourages saving, which if coupled with tax on interest paid, it is a wonder anyone bothers to save at all.

      Oh! in the UK we have the lowest savings rate ever. So government policy has arrived at it's logical conclusion.

      Lowest personal savings coupled with what appears to be the mother of all financial crisis. And now Gordon Brown has crippled the UK balance sheet.

      Pete Chown: "Finally, it’s worth noting that I could transfer my own modest savings into gold .."

      How long before the government re-imposes tax on gold purchases?

  15. Rugfish
    October 12, 2008

    Given this piece yesterday in the Financial Times by Damian Reece :-


    "This is the price we’re paying for creating the illusion of wealth when in fact we were creating nothing more than a huge pile of debt. We’ve borrowed to buy houses; we’ve borrowed to buy cars, clothes and every other consumable conceived by man.
    Banks, such as Lehman, were so keen that no one in the great new debt democracy should be left out that they started borrowing from each other. They used that debt to create sub prime loans and turned these riskiest of debts into apparently safe investments.

    They traded these back and forth amongst themselves, even finding insurance for them in murky derivatives few people understand, called credit default swaps.

    Many of the world’s biggest banks from Iceland to Japan now find themselves caught in this toxic mesh where they no longer know who’s holding what and who can repay, so they’ve turned the taps off and are hoarding cash.

    In this environment confidence evaporates, banks can’t meet their short term liabilities so go bust and companies can’t raise credit, even for cash to pay the wage bill, and recession very quickly ensues. Faced with these prospects, investor sentiment collapses bringing down the price of shares with it. Panic selling was stoked even more yesterday by a fear over who’s been left holding Lehman’s liabilities"………….. continues….

    It seems to me that liquidity within the banking system could be restored if a global bank such as the IMF just took over the toxic assets. Surely this would allow banks to pass them on to restore their capital assets and could be a way to give confidence back to the markets along with promoting lending between banks again?

    If there was any diferential in the value of those assets then any loss could be offset by placing a levy on banking industry profits as a whole over a realistic period through what would in essence be a loan of the real loss but spread over a period which didn't harm capability to trade ?

    Rather, it would allow banks to trade openly with confidence and place sums aside from profits in order to wash toxicity out of our system in a way it had less immediate impact on people, their homes and their economies ?

    Would there be a problem with this Mr Redwood ?

    Reply: The problem is, where would the IMF get so much capital from to do this?

    1. Rugfish
      October 13, 2008

      By the issuance of non-marketable securities such as government bonds. i.e. national debt as is the case now but only it's happening on an ad hoc basis. The levy placed against the banking industry would be picking up the cost of the debt rather than the taxpayer but the debt would be diminishing gradually like a mortgage paid to the taxpayer.

      If the levy calculated a profitable return to the taxpayer ( like a mortgage lender ), then everyone would win and the banks and the markets would be free to operate again. Home values and the markets would stabalise, jobs would stabalise and the economy could go on much as it did before but with some constraints which would be laid down by IMF conditionalities as is the case now.

      I also feel, given this injection of confidence to the system, that the assets we describe currently as 'toxic', may actually turn out to be good assets again and would likely be redeemed far quicker than 20 years if banks were trading again normally ?

    October 13, 2008

    Global crisis is not only about companies of financial services. It is about common people as well. The ones with loans, credits, mortgages. The ones with jobs to preserve, houses to retain, families to maintain, relatives to support, children to send to colleges. The ones with budgets, where every cent has its destination. How many of the people lose jobs, cars, homes? How many have to cut out the spendings, which they considered a normal part of their lives? –

  17. Adrian Peirson
    October 13, 2008

    Banks operate a system called Fractional Reserve Banking.
    IE they lend out 10 times more money than they actyually hold on reserve.
    This si why, when confidence falls, and everybody rushed back to withdraw their money the scam has to be hidden.
    there is no way Banks can give depositors their money back because they have lent it out to TEN other people.
    this is why govt and Banks do whatever it takes to stop a run on the Banks, so the sheeple will not realise what is actually goin on.
    Not only that, but these loans and credit, based on assets that banks simply do not have are issues at interest, essentially we pay interest on thin air.

  18. rugfish
    October 14, 2008

    Okay Mr Redwood, I asked what I thought was a perfectly good question, you gave a perfectly good reply, and I went away and watched Newsnight last night and was dumfounded by the number of zero's on the back of that capital figure to fit my query.

    You're answer is clear and understood and I thank you for pointing me in the right direction to see how utterly ludicrous it was of me to suggest it as in hindsight it appears there is more debt wrapped up in those instrument bundles than the entire globe could pay back in little shorter than the next 100 years.

    My God !
    Who actually owns the "real assets" for this or is that another stupid question as my hunch is that much of it is 'imaginary' ?

    P.S. I didn't try to write a note of the trillions out there as I don't have a big enough piece of paper.

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