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 £25 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.