I’ve restrained from posting on World Depression II so far, rather feeling that I’d covered most of the main points in my earlier series of posts on the Northern Rock fiasco. But now thankfully the US Congress has agreed to George Bush’s plan to save capitalism by sending every US citizen a very large tax bill. There will be many who will be thinking that at least he’s good for something, but I’m afraid that I’m not among them.
The one thing on which everyone is agreed is that far too many financial institutions have made far too many reckless loans (on which there are likely to be defaults), and that this is the cause of the problem. Certainly savers with the Bradford & Bingley will feel they’ve had a narrow escape now they’ve realised that their money was being advanced on mortgages where the bank wasn’t even taking the basic step of confirming the applicants incomes.
What worries me is that there is still a failure by the politicians on both sides of the Atlantic to grasp quite how our economies have become dependent on this false credit. Indeed the argument being put forward goes something like this: If we don’t let people carry on using their credit cards, sales will slump. That is of course quite right, but they forget the other side of the coin: If we let people carry on using their credit cards they’re going to owe even more money that they haven’t a hope in hell of repaying.
Excessive credit (of which there has been far too much for the last twenty-five years) overheats an economy and produces a false illusion of wealth. In this country it has manifested itself particularly in sustained property price inflation, with all the negative effects on society that entails. Our Government (and for that matter the one that preceded it) is quite as guilty as that of the US for presiding over an economy financed to such an extent on false credit, and for claiming the economic credit for doing so. Economies are pretty much like credit cards in that sooner or later the bill arrives, and you can only put off paying it for so long. We've had the boom, we've reached the bust, and now it's time to pay. The economic price is recession, and painful as it will be we will need to go through it if we are to emerge with a restructured economy fit for the 21st Century.
As individuals and as a country we have been living far beyond our means and we are going to have to learn to do otherwise.
The most interesting commentary on this crisis can be found on the ever reliable John Redwood’s blog (far too many posts to link individually). He is now struggling to maintain his normal ideological consistency, but I suspect that he was always in something approaching a minority of one with his conviction that much of our current problems have been caused by excessive banking regulation.
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From the eminent US lawyer and economist Richard A Posner:
"I believe that the basic causes of the crisis were six factors internal to the market system. The first was abundant and therefore cheap global capital--the result of private economic activity--and, consequently, low interest rates, which encouraged borrowing. The second factor was a housing bubble caused in part by those low interest rates and in part by aggressive marketing of mortgages. The third was new financial instruments that businessmen believed reduced borrowing risks and so increased optimal leverage. The fourth was the difficulty of "selling" a conservative business strategy to shareholders in a bubble environment. Borrowing more and more at low interest rates while home or other asset values are rising enables financial institutions to make higher profits, and a firm that refuses to jump on the bandwagon will as a result experience lower profits and will have difficulty convincing shareholders that they really are better off because the higher profits of the competing firms are unsustainable.
The fifth factor was sheer uncertainty--was it a bubble? If so, when would it end? Would the new financial instruments assure a safe landing if it was a bubble and it burst? And the sixth factor was that the downside risk to highly leveraged financial institutions was truncated by generous severance provisions for their executives, authorized by boards of directors that were not effective monitors of executive decisions."
I can't really disagree with that.
I've commented over on Fora about the link between the 1980s decision to sell off heavily discounted public housing stock as a factor specific to the UK's inflation spiral for property prices. There were other factors (in the broader problem of private debt) over here; these were the privatisation of public utilities (again at heavily discounted prices) and the de-mutualisation of the building societies. All three of these encouraged the 'something for nothing' mentality, and the economic policies of the Thatcher Government (particularly that of privatisation) were widely admired and copied. It is interesting to see that the main banking casualties here so far are the de-mutualised 'banks' who have had little other activity than trading in mortgages, while their initial shareholder base was of necessity made up of small and mainly unsophisticated shareholders who had little grasp of their responsibilities.
It is worth bearing in mind that not all banks bought into the enthusiasm for crazy lending; HSBC for one stuck to a more traditional conservative business model and this was certainly not to their detriment.
If I were to suggest one policy that might encourage more sensible lending without requiring excessive regulation, it would be that where loans are secured against property the repossession of the property would end all debt secured against it. This would transfer much of the risk deriving from negative equity to the financial institutions and (hopefully) make them somewhat more cautious.
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