It’s five years since the “sub-prime crisis” began in earnest. Lehman Brothers filed for bankruptcy on 15th September 2008. The resulting financial meltdown lead to the first global recession in living memory, so causing countless job losses and widespread human misery.
Questions such as “what have we learnt?” and “could it happen again?” are of sufficient importance and complexity to fill thousands of columns inches, running to millions of words. I offer here, then, a necessarily brief explanation of why I believe the Western world’s policy response to sub-prime has been deeply flawed, and why we’re now even more vulnerable to another debilitating systemic collapse.
Since late 2008, our leaders have implemented a twin-tracked policy reaction to the credit crunch. First and foremost, we’ve expanded our base money supply at a pace that has no precedent – whether in times of war or peace. Under the pseudo-scientific label of quantitative easing, the Bank of England’s “balance sheet” has grown more than 350pc since March 2009. The equivalent US figure is 220pc. The European Central Bank, initially slow due to German objections but now catching up, has increased its base money supply by around 100pc over the last five years.
This column has long argued that QE, while necessary to a limited degree after the Lehman collapse, has been used to far too great an extent and is now deeply counter-productive. These “extraordinary measures” always were, and still are, a tawdry way of recapitalizing bombed-out banks by the backdoor. By propping up asset prices, QE has allowing many such banks to avoid necessary write-downs on their catastrophic investments, so dodging the forced restructurings – and even criminal convictions – that would then result.
QE “proceeds”, meanwhile, have found their way into non-financial markets, so putting upward pressure on oil prices over the last five years and helping to stymie Western recovery. By pushing up global food prices, QE has also further entrench poverty across the developed world, while providing the spark for the “Arab Spring”.
Inflation, although broadly under control, has still been stubbornly high in recent years, despite the Western world remaining on go-slow. When the QE funds currently squirreled away by the banks start to be spun-out, I truly believe we’ll face a serious inflation problem. In the here and now, of course, QE has also pushed down annuities, so condemning endless retirees to denuded pension incomes, while related low interest rates have imposed negative real returns on working-age savers too.
Initially a necessary post-crisis emergency measure, QE has since become the policy equivalent of crack cocaine. Western governments are addicted to it too. By debasing the pound, dollar and euro against the big Asian currencies, QE has slowed down our loss of export competitiveness, while reducing the value of the debts we owe foreign governments. That’s generated anti-Western resentment among the emerging giants of the East, doing nothing to foster the trading links with the fast-growing markets of tomorrow upon which our economic future depends.
Even more fundamentally, on the home front, QE has facilitated circular financing, with a high proportion of the virtually created money (particularly in the UK) being used to buy government debt. That mighty combination of vested interests – governments and the banking sector – has spawned the conventional wisdom that QE is a good thing, in the face of all historic evidence, to say nothing of common sense.
By allowing the state to borrow from the state, QE has meant politicians, for now, have been able to dodge the really big fiscal decisions, so facilitating the second pillar of our post-crisis policy response. This I can only describe as “masked Keynesianism” – talking tough on austerity, while anyway rapidly expanding the national debt. While some areas of public spending have been cut, the overall Western picture remains one of mind-boggling fiscal profligacy.
Since 2008, America’s national debt has grown by 80pc. Obama has overseen the biggest Keynesian boost in US history. In the UK, we’ve spent beyond our means to an even greater degree. For all the Coalition’s “austerity” rhetoric, and Labour’s “anti-austerity” retorts, our public sector liabilities have more than doubled since the Lehman collapse, reaching £1,200bn and now fast-approaching 100pc of national income. Year-in, year-out, interest must be paid on that debt stock, so sucking revenues away from vital public services.
Yes, the Coalition has lowered the deficit – the annual increase in our national debt – by a quarter. So our national debt last year grew less slowly than it did the year before. But we still borrowed in excess of £80bn – which remains huge by historic standards. And even these ghastly debt numbers don’t include financial interventions (bank bail-outs), public sector pensions and other off-balance-sheet whizz-bangs. Include them and the UK’s national debt is north of 250pc of annual GDP.
So the Western world has responded to a problem of too much debt, by taking on even more debt, not least here in the UK. While some households have “deleveraged”, this country’s overall private sector indebtedness remains higher than at the start of the sub-prime crisis. As such, with our government fiscally hobbled, and our gilts market reliant on printed money, we’re even more vulnerable in the event of another market-driven “Minsky moment” than we were in 2008.
Which brings me to the area of post-Lehman reform where, in my view, the UK has most seriously erred. No-one could argue that the current government, when it took office in 2010, faced an easy task. Given our bloated state, and engrained entitlement culture, getting our already diabolical public finances under control was always going to be tough. What I find unforgiveable, though, is the on-going bungling of financial services reform – not least the failure to tame our still rapacious banking sector.
“We know that truly sustainable growth depend on sound public finances, well-capitalized banks, healthy balance sheets, and a system of financial regulation that’s alert to broader risks like asset bubbles and excessive debt,” said George Osborne in a speech last week. What the Chancellor didn’t say is that, five years on from Lehman, the UK’s big banks are still characterized by balance sheets close to 5 times the size of the entire economy and 33-times leverage. In other words, despite sharply contracting credit in recent years, our big banks are still holding just £1 of reserve capital for every £33 on loan. That is insane.
Banks resist holding reserves, of course, because low “provisioning” means they make more profits, which are then channelled into executive pay. Yet despite widespread calls for a much lower leverage ratio, from the likes of the Parliamentary Commission on banking and former Bank of England Governor Mervyn King, the government’s ears our closed.
Ministers are pushing ahead, instead, with the deeply-flawed “Basel” rules that allow capital adequacy measures to be declared as a function of “risk-weighted assets”, meaning banks can keep making wildly optimistic (deeply dishonest) assumptions about current and future losses. That allows them to hold less capital, so increasing the chances of another disastrous collapse.
Back in 2010, it was clear the Anglo-Saxon banks warranted root and branch reform. Yet, on both sides of the Atlantic, while there have been some policy tweaks, the big structural changes have been delayed and fatally diluted. Policy momentum is ultimately shaped not by ideas, but by money and political power. It doesn’t have to be that way. But in the current post-Lehman age of voter apathy and intellectual cowardice, that seems to be the way it is.