The thing that is really worrying me most at the moment is the absence of any clear thinking by anyone on what we need to do to get through the credit crisis. Politicians and regulators look like frightened rabbits staring into car headlights as they deal with one immediate crisis after another. None seem to have developed an understanding of their required direction of travel. Developing that is essential if we are to get through this situation.
What I hope to over the next day or so is suggest what a strategy might look like. I will start with the short term.
For too long it seems that the only priority of economic management has been growth. That is at the core of the current problem in the UK and USA. The pursuit of growth on the assumption that this would, wherever and with whomsoever located, keep an electorate happy has been the only apparent economic strategy of governments both sides of the Atlantic for more than a decade. The consequence has been unlimited house price increases, massive expansion of the financial sector - fuelled by debt, and an increase in government expenditure.
It is now painfully apparent that this was a mistaken strategy. Of course, governments can lay the blame on the bankers and economists who asked them to deregulate the economy and then proceeded to abuse that deregulation. Nothing, though, can deflect from the fact that the strategy was itself inherently flawed, and politicians who adopted it, of all parties, have to accept their share of blame.
Since that adoption was almost universal the issue we face now is one of redefining priorities. Since time is not on our side these have, for the time being to be expressed in somewhat basic terms. I suggest, contrary to the assumptions made in the past that growth is the aim, that the current active of most people is security. By that I mean that people want to know that they can:
1. Feed themselves and their families;
2. Have a roof over their heads;
3. Be warm;
4. Have access to health care;
5. Be protected from abuse (whether to their person or property).
These are immediate issues. In the longer term they want:
1. Job security;
2. Education and prospects for their children;
3. Knowledge that they can avoid poverty in retirement.
If they can have some fun on the way this will be a bonus of course. But for most people I suspect the above, rather basic issues, are paramount.
They should be guiding us right now. We have to be clear that our economy has been brought to its knees by the banking practice of the last thirty years. The time for recrimination and reflection on that will occur. This is not it. What we have to do now is ensure that the above needs can be met.
What to do now
If the above list is anything like a reasonable reflection of people's current strategies, which are, I suggest based on a desire for security (without which little else in terms of a 'good life' is possible) then the immediate needs that we face in the next few weeks are as follows:
1. Make sure that the bank payments system keeps going.
Savings, investments, mortgages and all else will need consideration, but if people cannot be paid to work and do not have the means to buy the goods and services they need then everything else is entirely academic. Our society will fail without having that means of exchange.
When we last saw an economic crisis of this scale, in the 1930s, the vast majority of people were paid in cash. The vast majority of transactions were settled in cash. 97% of all money is now electronic. Cash is peripheral to our every day economic transactions. It's almost possible to survive without it. But it is banks that provide that 97% of cash, and banks that own the mechanisms of exchange. We suddenly appreciate that an absolutely fundamental mechanism that is essential to our basic economic well-being is outside our control. We have to ensure we can make the essential payments that will keep our economy going.
There are two threats to this at present. The first is that banks fail, possibly consecutively, as has been the case of late. Second, there may be runs on banks which will create much the same effect. We have already answers to these problems. Banks have to be bailed out by governments: even the takeovers have been subject to guarantees and government underwriting. Runs on banks are stopped by government guarantees to depositors.
So, rather than wait for further crises to arrive we have to do two things. The first is to guarantee all deposits. The second is to recognise that in any meaningful sense that destroys the concept of risk for shareholders in banks located in the UK. As such they must be forced to cooperate with the Bank of England to ensure three things.
The first is to ensure that the clearing system will work. If this cannot be achieved without taking control of the banks then that control must be taken.
The second is that they will lend to each other, if necessary by an enforcement mechanism requiring deposits to placed with the Bank of England. Again, if this cannot be made to happen without taking control of the banks this must happen.
The third is that in the longer term the right of banks to both create cash without limit and to own the effective mechanisms for the means of exchange must be curtailed. But this not for the next couple of weeks. The first two are and if any bank does not cooperate then they should be required to issue their own equity in exchange for the support they are now receiving from the Bank of England. Effective nationalisation would happen overnight. This is an issue for the next few weeks.
2. Ensure that sufficient cash has been printed to ensure any run on the banks can be met with cash settlements.
It may be a desperate short term measure, but if it is not done then the chaos that would ensue if cash were unavailable would be catastrophic. And cash can always be pulped if it is never needed.
3. Mechanisms to ensure law and order must be in place, as must mechanisms to ensure that food and basic services continue to operate.
It cannot be assumed this will happen.
4. Interest rates must be cut.
This is essential. I fully accept that such a cut may have long term inflationary impact. I accept it may shift the distribution of wealth in the economy in the long term. Neither matter. We have a short term crisis.
An immediate cut of 3% in bank base rates is possible: it must be mandatory that this be passed on in mortgage lending rates.
The effect will be simple. The cost of a repayment mortgage of £180,000 would reduce from about £1,290 a month to about £960 a month. If the latter were paid interest only (and in the short term this does not matter) the rate would be £600 a month. The vast majority of non-performing 'toxic loans' that the government might have otherwise to bail out in UK banks would suddenly become affordable again. That is the sole current objective that we should have of interest rate policy. People would not have to be foreclosed upon: banks would not need to make provisions against their loans. Nothing could stabilise the economy more effectively at this moment, even though as I note below the long term consequences are significant.
5. The government must take steps to protect itself and banks from inappropriate claims upon their capital.
If the government is, in effect, to underwrite all banks and guarantee the deposits held in them then it clearly has to protect itself and those banks from inappropriate claims.
Large numbers of those claims will arise from offshore and from the special purpose vehicles of various sorts that have been created to move their liabilities off balance sheet. These debts are real: they cannot be reneged upon without serious consequence, but a priority in determining the claims upon the good resources of a bank have to be established to protect the state and depositors. All claims from special purpose vehicles and from recognised tax havens have therefore to be treated as secondary claims on banks at this time: if anything goes wrong they should not be considered to have first claim on assets, whatever their contracts might say. The state and depositors must have that.
6. Immediate steps to ensure that further deterioration in the housing market is prevented must be taken.
In the short term this is simple. Repossessions from owner occupiers must be put on hold. In the case of repossessions of buy-to-let properties ownership of the property should be transferred from the bank that has the mortgage on the property to a new Social Housing Corporation. This will have the task of taking ownership of these properties, ensuring they continue to be let (making use of the army of near redundant estate agents to fulfil local management responsibilities) and compensating the banks for the mortgages that have defaulted in accordance with a formula. The formula for this transfer is relatively straightforward. I explain it below in the section on housing.
Unless action is taken now though three things will happen. The first is that property prices will continue declining and with it bank's balance sheets will deteriorate. Second, people will be forced out of their homes and become dependent upon the state that will not have the resources to house them. Thirdly benefit claims will increase markedly. None is desirable in the short or long term. Increased availability of social housing is desirable.
I do not suggest that this will stop all the problems that will arise, but the main aim is to take control of the situation, stop contagion of risk, stabilise asset prices, protect taxpayers whilst doing so, and ensure that the mechanisms of authority required to effect long term change are created during this short term crisis: that is why the passing of significant degrees of control is essential at this moment to ensure that it is available to enforce reform in due course.
This then provides a platform on which to build.