Another bubble?

Alan Greenspan became a popular figure. Everytime there was the threat of a downturn or a suggestion the US should draw in its belt, he slashed interest rates, created more money and allowed the good times to go on rolling.

More recently he has become less popular. His successor, fighting to deflate the bubble his policies helped create, has attracted some support for the view that Mr Greenspan overdid the bubbles It was Mr Bernanke’s decision with colleagues to deflate the bubble and restore some balance in the US economy that helped create current conditions. In the UK the Bank of England followed a similar course with its interest rate strategy over the last ten years, preferring always to inflate the housing bubble than to correct the imbalances until they became so gross around three years ago.

When governments saw the results of their monetary authorities new austerity they moved from “teach them a lesson” to “let’s panic”. They now want the authorities to try to puff up a bubble again. In the UK the governemnt thinks one more puff will enable them to emerge from the electral hole of the opinion polls, and in the US Mr Obama, only used to being popular, thinks one more bubble could make him a hero just as Mr Greenspan used to be.

That’s why they want to support rather than mend the banks. That’s why they are committing unbelievable sums of money to underwriting business that has gone wrong, more large sums to “reflationary packages” and still more money to what they hope will be new lending. They are gambling the credit worthiness of the state on the hope that short term it will spark things back into life.

I have news for them. The way out of this mess is not another bubble, but working through all the past excess and winding it up, paying it off or netting it out with as little loss as possible. The private sector banks should take the hits, not the taxpayer. The Central banks should stand behind the banks that have a solvent future, and should force the pace of making the larger banks solvent in the long term by insisting they raise more of their own capital by asset sales, cost reductions and other marks of better management. We can neither afford to lose a major bank, nor afford to feather bed it with state capital. If in need the authorities should lend short term money against promises of better management and against what security they can find.

The loss of most of the £37 billion the UK government foolishly tipped into three banks here in just two months should be a warning to them. The rate of loss is too high. They should have blocked the LLoyds/HBOS deal, as advised here, so LLoyds was untainted by all this. They should have required substantial change at HBOS for any loans they asked for from the state to tide them over. They should have demanded that RBS wind up, sell or otherwise reduce the extent of its risks in the investment banking side of its activities. We have a large bank attached to a medium sized government. The bank is in danger of capsizing the public finances.


  1. DBC Reed
    February 14, 2009

    Darling was on Newsnight yesterday,saying they did n’t really have time for due diligence: it was nationalisation or bust. Lloyds were probably conned ,though no doubt with assurances of last resort help from the Gov.
    John Redwood’s analysis that Brown is frantically trying to reinflate the collapsed housing market is surely correct. But the banks don’t want to know, insisting on 23% deposits because they have factored in a 23% drop in house prices and want the public to take the loss.
    It would appear that the long post 1970’s era of keeping the populus quiet with regular unearned ,untaxed capital gains in house prices is over (or at least should be). Inflating property values ,basically land values, beyond the rate of increase of production was bound to overwhelm the economy as Henry George
    said years ago.
    Politicians of all parties have got to wake up to the fact that there is more to political life than keeping homeowners on side.

  2. Brigham
    February 14, 2009

    With all this talk of printing more money, bubbles, and boom and bust, a non financial expert like me is a bit out of his depth. In my mind none of the above matters unless we have the manufacturing base, or the financial services that other people are willing to pay for. What we now need is, a truthful, ie non government, assessment of all our assets and liabilities, to see if UK plc is financially viable and where we stand in relation to the rest of the world. I would think that the more we bail out the banks the more our money becomes devalued. As someone recently said,”Welcome to Harare. Incidentally, I am one of the pensioners that now has virtually no interest coming in on my savings.

    1. jim
      February 15, 2009

      You need to buy gold coins with your savings and quickly, otherwise they will be evaporated away.

  3. Waramess
    February 14, 2009

    And John, you too might be wrong. The interesting thing about these developments is that the end game will show who got it right and who got it wrong.

    It might be worth pause for thought that the shareholders are not jumping in with a suggestion of a rights issue in order to save their bacon. Could it be that the shareholders are ready to cut and run in the same way as they have done with RBS?

    The banks are too big to save and their problems are too big to warrant resolving: their shareholders know this; public opinion knows this, why are the politicians having problems with the concept?

    Think again; allow the banks to go bust in a nice orderly fashion and concern yourselves with saving the banking system.

  4. roger parkin
    February 14, 2009

    Couldn’t agree more with your assessment. The Tories have this ‘label’ of being the do nothing party. Why isn,t this message being hammered home by the shadow cabinet?

  5. Alan Phillips
    February 14, 2009

    John, is it just me, or is Gordon Brown et al seeing Obama as a Jesus Christ type figure waiting for him to raise his hands and deliver a miracle?

    It would seem that Nu Labour are staking everything they have on the G20 meeting in April. Sadly for the country, they are in my opinion committing acts of treason, for which we’ll pay dearly for.

  6. oldtimer
    February 14, 2009

    I would be interested to get your reaction to the speech released yesterday, Friday 13th February, by the Bank of England:

    It reveals that the Bank and the FSA were aware of the inadequcies of the commercial banks own internal stress testing some years ago. Precisely when is not revealed. It raises several questions: What was done about it? Were the Treasury informed? If not, why not? Were the Bank and FSA officials as worried about their jobs as the commercial banking representatives said they were about theirs?

    The comment that got my attention was this (foot of p12):
    “There was absolutely no incentive for individuals or teams to run severe stress tests and show these to management. First, because if there were such a severe shock, they
    would very likely lose their bonus and possibly their jobs. Second, because in that event the authorities would have to step-in anyway to save a bank and others suffering
    a similar plight.

    All of the other assembled bankers began subjecting their shoes to intense scrutiny. The unspoken words had been spoken. The officials in the room were aghast. Did
    banks not understand that the official sector would not underwrite banks mismanaging their risks?”

    Over to you – everyone else appears to have ignored it.

    February 14, 2009

    Amongst the well-reasoned, common sense proposals we have seen argued here this rates very highly.

    In much the same way that politicians prefer to dwell on ‘policy’ and ‘eye-catching’, vote-chasing initiatives (rather than the sheer nitty-gritty of implementation), they have no stomach for mucking out the stables when they can instead move on to their next song and dance performance!

    The old adage of “10% inspiration/90% perspiration” would go a long way towards creating a government that works in the public interest.

  8. Acorn
    February 14, 2009

    The consensus appears to be that between forty and fifty percent of the credit bubble has been created by the process of securitisation. The willingness of people to buy other peoples loans in various derivative forms that they did not understand, but the yield looked good at the time.

    No individual could hope to work out the risk level on any particular product, so they depended on the rating agencies to tell them; they didn’t know either and may have had reasons for not wanting to know.

    There is little point in trying to keep afloat insolvent Banks. Better to liquidate them; let them die. Insure the retail depositors to stop the runs; and just get back what you can for the taxpayer. Some of the toxics may work out not to be that toxic down the road. And, there is always a price for the rest that some private speculators will take a chance on. Plus, there will be lumps of cash provisioned and reserved in various places.

    Shareholders at all levels in these banks should get out their dictionaries and understand the meaning of “risk capital” and the importance of “cash flow” when reading the accounts of any business.

  9. oldrightie
    February 14, 2009

    The bank is in danger of capsizing the public finances.

    My only disagreement, they are already deep under the waves.

  10. Michael, Islington
    February 14, 2009

    Ah hah.

    I see you’re moving closer to the view of Prof. Buiter, of the FT’s Mavercon blog, of the necessity for the creation of good and bad banks.

    Surely, your current position will leave us with an array of zombies – crippled by loss and debt, unable to borrow, unable to lend?

    Incidentally, I wonder whether banks are interested in “netting out” their positions, as you would say, or crystallising their losses, as I would.

    The status quo offers them a semblance of dignity from the true disaster lurking on their balance sheets. Integrity has long ceased to be part of the banking code;.

  11. Blank Xavier
    February 14, 2009

    The Government does not set the price of food, petrol, cars or any one of a million different goods and services.

    Why does the Government set the price for money?

    The upshot of not permitting private individuals – who’s money it is that is being lent and who are far more careful than the Government to ensure the rate charged is appropriate – to decide between themselves how much they wish to charge for money has been catastrophe – not to mention, naturally, a pure denial of individual freedom to those people whos money it is.

    Firstly, the Government *cannot* know what the correct price for money is – it is simply impossible. The correct rate varies with a fine granuality over time and situation, such that a single global rate is never correctly set.

    Secondly, there are times when an economy needs to slow down and/or retrench. Governments, wishing to remain popular, always want the economy to be growing or booming. In their selfish, short-term interest, Governments price money too cheaply, causing a boom – and the inevitable bust.

    So not only can Governments *not* know what the correct price is, even when they *can* see the price *is* wrong, they have strong incentives *not* to correctly price money – and the country pays the cost.

    Can we not see from all these years of failure in that which the Government controls that giving these powers to the State is a massive and fundamental mistake? one that we are now in this very moment with legions of newly unemployed paying the price?

  12. Michael Taylor
    February 14, 2009

    This is absolutely the correct approach. Not just that, it’s what must and therefore will happen in the end.

    But time is money, lots and lots of it. In the monthly of January alone, the DTCC figures show banks netted out US$1.75 trillion CDSs. At that pace (which can go on all year), all the ‘bailout’ and ‘stimulus’ money gets eaten straight away, which is why US banks and credit markets actually shrank by cUS$250 billion in January!

    The truth of the matter is this: the banks are squeezing the real economy relentlessly to try to recoup the capital/liquidity they are losing on their CDSs writedowns. On an individual bank basis this is inevitable and ‘correct’ behaviour. But collectively it’s both ruinous and impossible, because the CDS problem is approximately 1.8x the amount ‘real’ bank credit in the system.

    If governments don’t grasp the message, they won’t grasp the nettle. And if they don’t grasp the nettle, the result will be / must be economic devastation.

    Is there no way of explaining this to the people in charge, John? Every week that passes, is more damaged and wasted lives now, and more debt for our children and grand-children.

  13. Lola
    February 14, 2009

    You have just got to stop the banks doing their usual trick of rebuilding their balance sheets at the expense of their customers balance sheets. I fo one will not tolerate this yet again.

  14. Mark Wadsworth
    February 14, 2009

    Yup, agreed.

    Cutting the banks loose is nowhere near as radical as you think. Sure, the government has guaranteed the first £50,000 of each deposit, and it should stick to that, but as to the rest, that’s what the concepts ‘risk’ and ‘reward’ are all about. if pension fund trustees end up being sued to death for investing in all this rubbish, then so be it.

    But you are still only looking at one half of the equation, being the credit bubble. You can’t have a credit bubble without an asset price bubble – in this case, property prices. And what would keep property prices low and stable – well, liberalising planning laws (the areas of hte USA with liberal planning laws didn’t have house price rises over the last ten years) and Land Value Tax instead of Council Tax, Business Rates, Stamp Duty Land Tax, Inheritance Tax and so on.

    I don’t kid myself for one minute that any of this will happen under the Tories as they are in thrall to this idea that you can get rich by owning your own home (a fanciful notion that has been disproven, yet again) and that somehow ‘land’ = ‘property’ that can’t be taxed (and by reverse logic, wages and incomes are NOT property, and so it’s perfectly OK to tax them).

  15. Adam Collyer
    February 14, 2009

    I agree they should have stopped the Lloyds/ HBOS deal. In actual fact not only did they not stop it, but they effectively ordered Lloyds to do the deal. (Remember Gordon calling them into Downing Street to broker the deal?)

    So now one of the most conservative, sensible, solid British banks (Lloyds) has now been poisoned by Mr Brown’s idiocy.

  16. DennisA
    February 14, 2009

    01 February 2006
    Dr Greenspan to become honorary adviser to Chancellor Gordon Brown

    The Treasury today announces that Dr Alan Greenspan KBE has agreed to be Honorary Adviser to the Chancellor of the Exchequer Gordon Brown.

    Dr Greenspan will advise the Chancellor on issues relating to global economic change.

    Gordon Brown said:

    “I am delighted that Dr Greenspan has agreed to be Honorary Adviser. His advice on issues relating to global economic change will be much appreciated.”

    Mr Brown has spoken of Dr Greenspan as “not only one of the world’s most outstanding economic policymakers but the greatest economist of his generation” (The Times, Saturday 29 January).

    Nuff said….

  17. mike stallard
    February 14, 2009

    On holiday, I have managed to read Robert Peston’s book which gives a very fair picture of UK PLC. The general idea is that Gordon Brown cossets the banks and uses the money forthcoming to support the people who live in areas far away from London. Once the banking system falls down, therefore, the whole Northern economy, gifts, pensions, wages falls down too.
    Obviously what needs to happen on this analysis (he does not say this) is a radical reduction in State expenditure, some urgent attempt at earning some income by the State and immediate action, as our host suggests, to make sure that the banks do not lose their position at the centre of the financial world.
    At the moment there are rumours that both UK and the PIGS will all lose their three star credit rating. And, do you know what? I do not think that this government, broke and tired, has a clue what to do – or even realises how serious things are.
    PS I notice that the FSA is completely absent in our host’s analysis of the problem with the banks. Why not get rid of that first off?

  18. Bernard Palmer
    February 15, 2009

    “Q.: What are the main roots of the present economic and financial crisis?
    A.: There is only one main root, the same as that for the Great Depression in the
    1930’s: destruction of capital. Erosion or consumption of capital has been going
    on unnoticed for decades. The process ends when there is no more capital left to
    consume. After the seven fat years, a period of seven lean years must commence.
    Capital erosion is not natural nor is it inevitable. Rather, it has been
    inflicted upon the world economy by the unmindful and irresponsible monetary
    policy of the United States in deliberately driving the rate of interest to zero.
    Falling interest rates, which are lethal, must be carefully distinguished
    from low but stable interest rates, which are salutary. A falling interest rate
    structure, foisted upon the world by the Americans obsessed with the idea of
    preserving the hegemony of the dollar, works insidiously and unobserved. As the
    rate of interest falls, the liquidation value of debt rises. Far from decreasing it,
    falling interest rates increase the burden of debt. Economists, chartered
    accountants, and bank examiners do not recognize the concept of liquidation
    value of debt, let alone its inverse relationship to the rate of interest, although it
    is exactly the same inverse relationship that is well-recognized to exist between
    the market value of a bond and the rate of interest. As the interest rate falls,
    creditors refuse to accept the face value of the bond in settlement of debt. At the
    lower rate the income stream of coupons falls short of amortizing the face value
    of the bond. To compensate for the shortfall the market value of the bond must
    be increased. Accordingly, creditors bid up the market price of the bond. If
    debtors want to get out of debt before it matures, then they will have to pay the
    market price exceeding the face value of the bond. This conclusively proves that
    the fall in the rate of interest increases the liquidation value of debt.
    As soon as the liquidation value of liabilities less assets surpasses capital,
    the firm becomes insolvent. Its capital is gone. It can no longer attract credit.
    This is what has happened to the banks in the U.S. and the U.K. This is what has
    also happened to the American auto industry, and all the other American
    industries now extinct.
    Those who dismiss my analysis of the present crisis in terms of capital
    destruction as an improbable single-cause explanation of a complex
    phenomenon must answer the following question. What are the statistical odds
    that the banks, financial institutions, as well as the three big automakers go
    bankrupt all at the same time? Well, the odds are virtually zero, unless they fail
    due to a single cause.”

  19. Brigham
    February 15, 2009

    I have just seen Lord Turner on the Andrew Marr show. He is a clone of Brown. He never answered a question, everything was somebodies fault other than his, he wasn’t there at the time, and the usual implied arrogance, “I’m too important to be here answering questions from some low life.” I wouldn’t buy a second hand car from this man.

  20. Bazman
    February 15, 2009

    Another Bubble? Look John! You have had the result of unregulated banking and here it is. We have believed enough. LOL!

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