…Further thoughts on the “credit crunch”.

I have described the orthodoxy around the credit crunch: that it was essentially caused by problems starting in the US housing market and spread around the world through interconnected financial institutions, the uncertainty of the assets owned by those institutions and how this stopped them lending to each other, resulting in the pricking of asset bubbles.

I don’t doubt this; but I think that contrary to what Gordon Brown keeps saying, it isn’t just a global problem: a lot of the problems faced in the UK are homegrown, and the solutions proposed and acted on by the Government don’t seem to be likely to help solve them.

The first bank that needed rescuing as a result of the credit crunch was British – Northern Rock, which failed because it was using short term borrowing from other banks to fund long term lending to customers: once the interbank lending markets dried up, Northern Rock became insolvent. Failing to match the assets and liabilities is a classic mistake, and both management and regulators should have spotted the risks.

Northern Rock – and other banks – lent much more than the value of the property securing the loan with 125% mortgages, which are no longer available. The other lenders providing more cash than the value of the property have also been taken over or nationalised – Alliance & Leicester and Bradford & Bingley’s retail operation (both former building societies) becoming part of Banco Santander, and HBOS (which owns Birmingham & Midshires, another former building society promoting 125% mortgages) taken over by Lloyds TSB. Lending more than the value of the security is another obvious mistake: we really should have seen this coming.

The other large bank to be taken over by the Government, RBS, needed capital because its takeover of ABN Amro at the height of the boom – just months before the credit crunch bit – left it vulnerable to the financial crisis. The ABN deal appears to have been spurred by Fred Goodwin’s hubris – he seemed resolved to buy ABN at any cost, breaking the bank to do so.

Gordon Brown repeatedly said he had ended boom and bust. He didn’t: “boom and bust” is a feature of markets generally (indeed, the book I am reading at them moment – Critical Mass by Philip Ball – describes the random chaotic patterns that give rise to this behaviour): you can’t just legislate it away.

Gordon Brown greatly expanded public spending from 2000, stretching public finances and limiting his and Alistair Darling’s options now.

So: a lot of the current problems stem from things that happened over here, not in the USA or elsewhere: from the expansion of the UK economy, from poor business models, and from a belief that the Government had managed to change the fundamental ways market works. Doh!

What the UK government and the Bank of England have done is reduce interest rates to their lowest ever, reduced VAT from 17.5% to 15%, reduce stamp duty and effectively nationalise three large retail banks.

I doubt reducing interest rates is going to help much: the recession we are now in is a result of a lack of credit rather than high interest rates. Companies can’t get the finance they need because banks are not lending – instead, they are guarding their cash as they restore their balance sheets. Plus, fundamentally, it was low interest rates – caused by the high volume of cash looking for a home – that started this whole thing off: so we could just be storing up problems for the future by making money cheaper than it has ever been.

Reducing VAT isn’t really helping anyone other than retailers. Those “hard working families” so beloved by politicians are not likely to start spending again because something that cost £117.50 now costs £115 – all of 2% cheaper. Those who really need help paying their bills spend their money on food, clothing, rent and energy: and only energy is subject to VAT, so they will hardly be helped at all.

Cutting stamp duty on properties costing less than £175,000 seemed like a desperate effort to prop up the housing market – one which clearly hasn’t worked. Should the Government be interfering in the housing market in the first place?

The nationalisation of the banks is a hard one. According to the BBC, RBS and HBoS were close to collapse before the Government injected more capital; letting that happened would have caused a great deal of financial hardship, bankrupted many, many businesses, and damaged the UK’s financial system. Not a good idea – so probably the Government didn’t have choice over this one.

Thing is, I believe Government has a tendency to meddle in businesses and markets. There are calls for a bailout of the UK motor industry; they have already interfered in the housing market by removing stamp duty on cheaper properties (true, the imposition of stamp duty might be seen as an interference in the first place); and the CBI is lobbying for support for its members (although that is what it is there to do).

Instead, they should set the parameters for a healthy economy and let those markets and businesses get on with it. There is clearly a need for great regulation of financial institutions, lest they forget the damage they have wrought over the past eighteen months. And politicians should realise that they shouldn’t believe their own words.


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