Every ten years or so, any capitalist democracy can expect to have its
economic system and governing institutions severely tested. For Britain, the
last such occasion was Black Wednesday, 15 years ago, and before then the
Winter of Discontent in 1979 and the sterling devaluation of 1967.
In each of those episodes the test result was comprehensive failure leading to
political and economic upheaval. It may be hard to believe that the
near-collapse of Northern Rock was an event of comparable importance but
that is only because, for the first time in two generations, our country’s
economic and political institutions survived a severe test.
As things have turned out, this week’s events will merit no more than a
footnote in tomorrow’s history books. But if Monday’s rescue had failed and
millions of depositors had lost tens of billions in savings, Black Wednesday
would have become just a brief introductory chapter to the learned
monographs of the future on the long-term consequences of Northern Rock.
To say that this was the first time in 50 years that Britain’s institutions
have survived a threat of such epic proportions is not to suggest that
everyone has emerged with flying colours from this affair. However, you
should disregard sensationalist headlines about collapsing consumer
confidence, recriminations in Whitehall and heads rolling at the Bank of
England. The reality is that all the most important actors in this drama
have ended up with their positions solidified, if not with their reputations
enhanced.
Let me begin with the most important actors of all – the millions of British
homeowners, savers and consumers, whose economic future was briefly balanced
on a knife-edge this weekend. Far from behaving over-emotionally, in a sort
of economic re-enactment of the Princess Diana outburst, they merely took a
rational economic analysis to its logical conclusion. But once the
Government offered its unambiguous guarantee, the stampede to withdraw
deposits ended. The British public’s surprisingly clear intuitive grasp of
finance is reassuring in terms of the broader consequences of this affair.
Even before Northern Rock, the outlook for the British economy had
deteriorated because the global financial turmoil that began in August. This
was bound to shut down for a while the gusher of wealth from the City of
London that fuels the British economy. A domestic bank run – with the
consequent collapse of mortgage and consumer lending, even by the strongest
banks – would have transformed growth slowdown into a disastrous recession.
Such a breakdown in the supply of credit has been averted, but the risk still
remains that the demand for credit – the willingness of consumers and
homeowners to keep borrowing – could be seriously reduced by the slowdown
and the weakening of the property market that almost certainly now lies
ahead. Luckily, the rational behaviour of British savers through the
Northern Rock episode makes such a collapse of borrowing, and therefore
consumer spending, less likely than it seemed a few days ago.
Despite all the vituperation in the media about the “madness” of a company
such as Northern Rock aggressively increasing its mortgage lending, the
British public seem to understand that there is nothing imprudent about
mortgage lending. They also seem to understand that the housing market,
while it may well fall slightly in the next year or two, is not going to
collapse to a point where it endangers big financial institutions or
seriously disrupts the national lifestyle – a lifestyle that is not
“addicted to borrowing”, but simply takes advantage of the universal
availability of new financial mechanisms.
When finance is viewed as an innovative, dynamic service industry, rather than
a mysterious offshoot of psychiatry, then the levels of borrowing today in
the British economy are no more evidence of “addiction” than the
unprecedented levels of computer ownership. Until the Tories and the Liberal
Democrats begin to understand this, they will remain disqualified from any
serious role in modern British life – and that was the message that voters
sent in the polls, which showed confidence in the Tories sharply falling
this week.
So much for the big picture; but what about the institutional implications of
these events? Surely the Bank of England’s reputation has been tainted,
while our system of financial regulation, with its dizzying whirl of
directives between the Bank, the Treasury and the Financial Services
Authority, has been exposed as a Feydeau farce?
Some parts of the system will need to be reformed – and quickly. Britain needs
a modern system of deposit insurance comparable to those in America and most
of Europe. The nonsense of offering only 90 per cent insurance to deposits
up to £35,000, with a repayment period stretching into months, must be
replaced with a guarantee of instant repayment in full, with the limit
raised to at least £100,000. This is a reform that the Bank of England has
long demanded, because it understands that nothing less than a cast-iron
full guarantee will work in a genuine crisis, as was demonstrated this week.
The only serious opposition to such as scheme has come from the big clearing
banks, which are known to be “too big to fail” and therefore benefit from
the present half-baked arrangements. Now their self-interested lobbying will
surely be overcome.
The urgent need for this reform was at the heart of the arcane argument
between the Bank and the Treasury about what type of guarantee should be
provided to Northern Rock and by whom.
The Bank anticipated that the line of credit announced on Friday might be
insufficient to restore confidence and pressed from the start for a private
commitment from the Treasury to offer its 100 per cent guarantee as a
backstop, only to be announced if the first line of defence failed to work.
The Treasury, naturally reluctant to sign blank cheques, argued the
opposite: that the Bank should offer an implicit guarantee, in the form of
its line of credit, not just to Northern Rock, but to any potential bidder
for its business, such as Lloyds TSB.
The Bank refused to do this because it believed, probably correctly, that a
forced takeover of a publicly quoted bank, never before attempted in
Britain, would take weeks to consummate and could be resisted by lawsuits
from dissident shareholders in either bank. During the period of uncertainty
Northern Rock depositors would remain in limbo, knowing their savings were
in danger and unable to rely on the takeover going ahead. Their most
rational course would be to withdraw their deposits, making the takeover
harder to complete.
In the worst case, a legally messy takeover without the all-important Treasury
guarantee could even have set off the ultimate catastrophe – a run not only
on Northern Rock but also on Britain’s biggest retail bank.
Why did other participants in the rescue talks resist this seemingly logical
argument until Monday evening? Why do some still apparently believe that a
takeover of Northern Rock could have gone ahead without the backstop of a
100 per cent Treasury guarantee? Furthermore, should there be some
streamlining of institutional arrangements for future crises? And why did
the Bank of England suddenly change its mechanism for dealing with the money
market?
Luckily, these are second-order questions that can now be consigned to dull
committees. They will be of little interest to historians of the future
because this week Britain’s institutions were severely tested – and for once
they passed.
How about this for euphemism:
''They (the public) also seem to understand that the housing market, while it may well fall slightly in the next year or two, is not going to collapse to a point where it endangers big financial institutions or seriously disrupts the national lifestyle – a lifestyle that is not “addicted to borrowingâ€, but simply takes advantage of the universal availability of new financial mechanisms''
You see we are not simply leveraged up to the eyeballs so that household debt is now larger than GDP it's just that we are 'taking advantage of the universal availability of new financial mechanisms.'
Don't you just love it!
Vintage AK. One Fed interest rate cut and it is a return to business as usual. Carry on borrowing chaps. You can't have too much liquidity. Until the next chapter in an unfolding crisis that is.
This man is both dangerous and incorrigible.
F.V.Lee, London, UK
Far from saving New Labour, the British consumer's intuitive grasp of finance is what will destroy the government. This article's irrational analysis smacks of the desperation that I'm sure can be smelt in the corridors of the Treasury. Time for The Times to give up on a morally and soon to be financially bankrupt administration and rejoin the grown ups.
Brian Merston, London, UK
So after a few days to develop his macroeconomic contect, Mr Kaletsky feels the urge to write a historical perspective on what is occuring in the capital markets. Lets have a small wager that the dramas to follow will allow him to announce , within the next few months, how the authorities made a huge mistake by issuing an implicit PUT on rabid risk taking.
I feel extremely reassured that he is not managing my money.
Karl, London, UK
So we are to understand that the government and the associated executive have played a blinder by giving the impression that ALL deposit-taking financial institutions (or, at least, those capable of generating a bit of media coverage) are now too big to fail. Hmmm, let's see what interest rate is on offer at the Bank of Moral Hazard.
Eric Murray, Auckland,
Why is Mr Kaletsky being so kind to the government over the banking crisis? Five days of muddle and confusion over Northern Rock, not to mention the U-turn of the BoE of providing 3-month funding , have indeed proved costly to the reputation of the authorities including Mr Brown where the ultimate responsibility must lie: as the FT points out, 'The man who created this system of banking regulation is Gordon Brown, Britain’s chancellor in 1997 and now its prime minister. His responsibility for the mess, and that of his government, is considerable'.
Mr Kaletsky shows considerable bias towards New Labour in giving them such an easy ride in contrast to his lambasting of the Major government over the ERM debacle, even though the longer-term outcome of that shambles was in fact a very favourable one. Mr Kaletsky is already exculpating the present government even though it is far to soon to call the eventual outcome of days of muddle and cofusion.
Robert Cookson, Milton Keynes, UK
An interesting post by Ludwig (whether he is of Austria itself or just of the Austrian School - either is good).
The three Cs that I am more preoccupied with as a professional investor are Complacency, Caution and Capitulation. Back in August I thought we had healthily entered Caution but I fear we have since backtracked to Complacency once again - helped by invertebrate policymakers and cowed institutions.
A fourth C, Crash (meaning a comprehensive 20%+ equity market decline in less than a week), is perhaps now the only healthy thing that can happen to avoid protracted economic malaise. Without it I think we are in real trouble.
Ashok , Chelmsford, Essex
"nothing imprudent about mortgage lending."
Even 125%, 40 years terms, interest only and a combination of all three? Stop trying to kid yourself Anatole. It's wreckless mortgage lending that has distorted the market and created this bubble. If the lenders had been prudent, the a credit crunch would have likely been averted, we wouldn't have over a trillion pounds of debt and homes would be affordable and not viewed as an investment. In other words, we'd have a stable, productive and fair economy.
PT, Tynemouth, UK
What a shame this article isn't on the front page as the headline in all the rags of this country.
It is so refreshing to read good, clear, rational and supportive reporting. I believe a dose of real truth, such as this, on a regular basis for the population of Britain would do more good for us than anything, both personally and commercially.
Melissa Mailer-Yates, Hereford, UK
As I understand it the financial system was saved from severe damage because in effect the British Government and the independent Bank of England guaranteed depositors` money on the basis that if need be the British taxpayer would pay and the Bank would print any money necessary. It would therefore be interesting if Anatole Kaletsy would tell us what he thinks would have happened if Britain had been in the Euro
S Monkcom
S Monkcom, London, England
Can we trust the government? We could not if we were Equitable or Company pension scheme members. What has changed for the better if anything? Even if we could trust them, is the solution beyond their competence? Well you can judge by their management of the rest of government affairs such as Education, Health, Farming, Fishing, Justice, Migration and Defence?
Brian Gilbert, HAMPTON, Middx
A little early to be ringing out the 'All Clear' I think.
The 'House of Cards' had a wobble shored up in desperation by the autonomous (cough cough) BoE.
Paul Sullivan, Chester, Cheshire
The three U-turns from the Bank of England (on support for Northern Rock, lending three month maturity, and acceptance of mortgages as collateral) are not second-order questions in any way.
The tough talking of Alistair Darling and Marvyn King about 'old fashinoned banking' and moral hazard while they allowed confidence in Northern Rock to evaporate demonstrated incompetence of a level last seen in the weeks prior to Black Wednesday. Like Major and Lamont, Darling and King were eventually forced to eat their words and do the very thing(s) that they had previously declared impossible.
Unlike Lamont, who was defending a government policy that he inherited, King was the very architect of the collapse of Northern Rock.
A Clarke, London,
Just a couple of days ago the summer swoon in credit markets was just a storm in a teacup, overblown by irrational behavior on the side of speculators. Then Northern Rock, a classic run on a bank, a 180Uturn of BoE governor and an unprecedented 100pc guarantee of all bank deposits. Which is it Mr. Kaletsky a storm in a teacup or is the eye of the hurricane already over Treadneedle Street? The question we all should ask is what does Northern Rock have on its books that no bank whatsoever was willing to lend it short term money. In the case of the German banks IKB and Sachsen LB we now know that their conduits were filled with toxic US subprime CDOs. No such thing for Northern Rock if we believe the messengers. But then we learned just now that at least a dozen large money center banks have refused to buy out the bank and speculative HF have to come to the rescue and scoop up an allegedly healthy 200B mortgage book for cents on the Dollar. It would be nice to get some an answers.
Alfred, New york City, NY, USA
So mortgages of 115% are healthy and not 'imprudent' lending, the Fed pumping yet more dollars into the world economy is just fine. (Saudi Arabia want no more though !)
Is this the level of The Times analysis ?
Reminds me of the broker last week who advised the goldfish to buy Northern Rock stock.
Tim, Shanghai, China
All banks borrow short and lend long. That's what banking is.
jon livesey, Sunnyvale, CA/US
Mr Kaletsky has put the whole thing into perspective. It may not be to the liking of merchants of doom but being an economist myself I fully agree with his analysis. Worse is over, although rules and regulations regarding banking industry and financial wizardry would need to be examined at least Northern Rock has not collapsed.
The world economic conditions are benign, US has passed through its lowest points and falling interest rates (or the perception of them) will keep the British economy ticking along barring any other economic shocks.
Shahid Rashid, London,
100% Ludwig, Austria.
Mr. K. writes his usual incomprehensible twaddle, implying that NR is/was the beginning and end of the 'crisis'. It was simply the tip of the iceberg and the rest is yet to follow. How many other 'banks' out there are borrowing short to lend long?NB: fast rising repossessions and personal debt in the stratosphere and oil now way over $80 a barrel - even the Saudis don't want dollars.
Perhaps Mr. K would personally like to take over NR today he could get it cheap!
Victor Cowen, Malaga, Spain
J.P. Morgan said that finance must be based upon three Cs: character, cash flow, and collateral, in that order. For all the talk of financial "innovation", finance is still the same game that Morgan was playing over a century ago: the forging of contracts between lenders and borrowers. The most powerful effect of financial "innovation" has been to obscure this contract, in effect leveraging faith on both sides. Today, securitisation has almost completely obscured the first two of Morgan's Cs and the third (and in Morgan's view least important) C has become so overinflated that when it is finally called upon because borrowers are unable to refinance the finance on their finance then lenders are faced with the stark realisation that borrowers and lenders have both been exhausted and there is no market left to sell to! The end is not nigh. It is here
ludwig, austria,