Let it Fail, Let it Fail, Let it Fail

Sing the title of this entry to the tune of the Christmas song, 'Let it Snow' and we have a natty little anthem for the day.

I was pondering, at the beginning of all this banking fiasco, that had the Government stepped in at Northern Rock and just picked up the mortgage book and guaranteed all depositors, just what might have happened.

This was not my idea, no less an economist as Nobel Laureate, Joseph Stiglitz, suggested this some time ago. He was fixed on the fact that a contract for a Credit Default Swap or Collateralized Debt Obligation was in fact a two way contract or bargain jointly entered into by two companies fully aware of the consequences if something went wrong like part of the debt was toxic. Indeed, if they had had any sense, just prior to signing the deal they might have embarked on a bit of 'Due Diligence', that long lost phrase which went out of the window during the Enron scandal to have avoided such a calamity.

Stiglitz was of the opinion that if we had allowed the consequences of that failure to play out, only then could we have teased out what the true underlying liabilities were - not just at Northern Rock but in the entire banking system. True, many banks would have failed but he claimed that we could have used the shell of those old banks to build new ones with more secure procedures and tighter regulations to focus them on their core functions of providing credit and capital.

Further, Stiglitz asserted that the overall cost to the taxpayers would have been less in the long run as at least we would have known exactly what we were paying out for. His claim is that in the current scenario, we are propping up an already failed system, that part of the guarantees and loans that we have paid for will actually underwrite part of the 'good books' because no one is encouraged to itemise the toxic debt as it is being all paid for so why not ask for more and cover current good debt.

Sound wrong? Just look at the Enterprise Loan Guarantee Scheme from the Government meant to cover and encourage new lending - banks are taking existing loans, handing out small increments to qualify for the scheme and then getting 75% of the original debt covered. The amount of net new lending is trivial.

My view, which is with Stiglitz, is that banks should have played this all out. I dare say there would have been more sad cases like Mr. Kellerman in the US as bank executives were troubled with the terrible burdens of their greed, but I doubt it would have troubled them that much. There would have been a terrible loss of confidence in the banking system, have no doubt. That is what has been most protected in all this - banks must never fail, according to all Governments. The fact is that some banks do fail. Lehmans were left to fall and the repercussions were not that huge.

The problem we have bought for ourselves, as Stiglitz has pointed out, is that if all we do is reset the sail to catch the wind again, then all we have done is hidden the problems to manifest themselves again in the future. He now predicts we have set ourselves a course which will commit us to ever shortening cycles of peaks and terrible troughs in our economies with no chance of any kind of sustainable stability. There is no doubt that the alternative would have meant a period of recession possibly depression but we are in a different age now. No more the '30s where people could not eat, the majority would still have had some way of providing for themselves. It would have been a different kind of austerity that would have curtailed our wanton materialism - and would that have been such a bad thing? Besides, it could argued that this is exactly what we are going to get anyway.

As Stiglitz does, I think we have missed a massive opportunity to put this all right and start again, properly.

Am I Missing Something Here?

I don't normally agree with Robert Peston - he looks for the sensational in everything about this crisis. In fact, without it, he would just be the bouncy hack who did the occasional TV spot. Now he's a household name and the guru of the financial collapse, with some even crediting him with the whole misery we are in.

I dare say in Downing Street there are those who are looking to see how they could actually blame it on him - after all they are doing a great job in making us believe that the present set of ministers had absolutely nothing to do with it.

So having heard the fairly obvious news yesterday that unemployment shot past 2m with a very serious burst of new claimants which seemed to surprise everyone but those who had read the papers, we also heard that the country's deficit rose another £8.9bn to £75bn for the year and rather ominously tax revenues collected dropped 10%. These were not unexpected but I suppose we were all praying that somehow all this incredible amount of money that has been pumped into the financial system would have actually started to do something by now.

No, not really. And that doesn't seem to surprise me either.

More News

In between finding out that the mystery illness at the Fat Duck in Bray was in fact the noravirus, which I presume gets its name from having rolled down stockings and a Yorkshire accent when viewed under the microscope, we also heard that the National Audit Office has spotted that Northern Rock was allowed to lend £800m in risky mortgages for a further 6 months AFTER it was taken into ownership by the generous taxpayer. In fact the Rock was still handing out 125% mortgages in early 2008.

At that time, the Government was at the helm, attending to the detail of running a bank. The PM had told us that sub-prime had triggered the Credit Crunch and was nothing to do with us and here was the bank he had rescued handing out mortgages worth 125% of the value of the property in a FALLING house market. Gross incompetence springs to mind as just recently the same lot actually approved bonuses for staff at the Rock just for paying back some of the money it owes us and then allowing it to unilaterally change the terms of the rest of the loan so it can go back and do some more daft lending. So it's our property - which one of you allowed them to continue like that? Go on, own up.

We must be all barking mad.

Banking and The Future

But I digress. My eyes alighted on Peston's latest blog and for once I was intrigued. He harps back to being a junior in the 1980s and watching how Old Fart bankers seemed to lend to Third World Banana Republics and lose the lot, or to fat, oily businessmen like Robert Maxwell who stole it - Polly Peck springs to mind too. They were suckers for men in suits with big talk and very aggressive to plebs in the street like you or I. Peston yearned for flash, confident bankers who would think creatively and modernise banking.

Be careful what you wish for, is the adage, as indeed we got some new bankers alright. The fast-buck merchants came to town and off they went 'collateralised debt obligating' and 'credit default swapping' (CDO and CDS) their way to being extremely rich. And we became far better off because of it. Our personal earnings had gone down but because the trickery and sleight of hand of the new style of banking, more credit was made available to us and, thanks to a generous Central Bank, at cheaper prices than ever before.

And we spent and spent - like there was no tomorrow.

Peston looks at the essays of Sir Jeremy Morse, former head of the now defunct Lloyds Bank which he is credited for saving (how does he feel about its situation now, I wonder?), who says that we have two choices on the road ahead. 1) we rein back banking to something like the 1980s and focus on using deposits rather than wholesale money markets to finance lending and so severely restricting the debt people can have going forward - which would definitely shrink the economy for some years to come - or 2) we reconstruct the banking system largely as before but with the worst excesses removed. He claims this would plunge us back into the 19th century world of harsh troughs and periodic peaks but less inflation for some reason beyond me.

This latter course of action has been the only one considered - there is a massive obsession with politicians to maintain growth as it has been the sure fire vote winner at the last two elections and the only hope in the next. So the current policy is to increase the money supply with Quantitative Easing, and this money will arrive with us in the form of more credit for us to run up more debts.

As our PM constantly reminds us, he wants credit levels to get back to the mid-2007 level and so we fuel our addiction to credit and debt.

The Road To Ruin

Peston's piece is a sharp reminder of where the combined genius of Government and finance are wanting to take us. If debt was a primary cause of the financial mess we are in, the answer to solve the issue is for us have more of the same.

It is logical at one level, i.e. the theory, and downright stupid in terms of common sense - at some point we must reduce our indebtedness, it simply cannot just go on. The timer to the next financial crash seems to have been started and we haven't finished this one yet. Jeremy Morse is right - we will go through cycles of rapid growth and then massive and very hard crashes.

This crash has not been fun - we must be crazy to think this is the way ahead.

If you turn the clock back 12 years when the smiley-faced Tony Blair took over with his jowly, grumpy Chancellor in tow, the graphs looked lovely for a good while. Unemployment went down, we all used our properties to create more money, interest rates fell. Now, 12 years on, unemployment has gone back to the same levels, our houses have lost all the gains we spent, and we are in an economic crisis which we will all pay for in taxes for the next 20 to 30 years. Oh, and several of the banks are largely nationalised.

How the mighty fall.

Brown says that the politics of the Centre Left are the only way forward. That would be the economy with one forward gear and 3 for reverse, I assume? We all had such high hopes for these guys but you only have to look around at the mess the world and our country is in to know they got it horribly wrong and their way forward will only compound the error - massively.

At some point, we are going to have to clear up this mess and pay the true price of the excess of the last 12 years. Just to remind us of those whizz-kid instruments of mass destruction, the CDO stood for an 'obligation' and CDS a 'swap'. These kids struck the bargains - like the rest of us they should have been prepared to honour them.

Why should we pay and let them all rise again? We must be all truly mad.