Who do you blame for the credit crunch? Is it the fault of remuneration packages at banks, which reward management for their successes but do not penalise them for their failures? Maybe George Soros is right, and central banks have been too willing to bail out banks every time things go wrong – it’s what’s known as moral hazard – banks have not been made to pay for their mistakes, therefore they have kept making them. Maybe the problem is that interest rates were allowed to fall too low.
Maybe the crisis isn’t anyone’s fault – it’s just one of those things, and the global economy has become a victim of its own success – there will be a mild correction before the forces of globalisation and advancing technology start driving the economy forward again.
But here is another possible explanation for what has gone wrong. It appears that many of the economies that face crisis right now have one characteristic in common – a characteristic that has no sign of going away unless governments and central banks take deliberate concerted action to manipulate the financial markets.
The credit crunch creates a once-in-a-generation opportunity for governments to take that appropriate action – and, in the process, build the foundations for more-sustainable booms in the future.
What is that action? Well, read on.
Gordon Brown and Alan Greenspan appear to respect each other. Mr Brown is presented in glowing terms in Greenspan’s book the Age of Turbulence, while Mr Brown often quotes Alan Greenspan as if the former chairman of the Fed is somehow the modern day equivalent of the Oracle. Yet, a few years ago, the two men’s views seemed to differ starkly in one respect.
The then British chancellor tried to promote the idea of long-term mortgages with fixed interest rates, that’s to say mortgages that have fixed interest payments not for a year or two, but for ten years, or even longer. It used to be the American way, and it still is the German way – but in the UK, variable-rate mortgages have long been the norm, and when we do take out fixed rate mortgages, the rates are fixed for a mere two years or so. As you know, it is the resetting of 1.4 million of these mortgages in the UK this year that is raising alarm bells.
Okay, Mr Brown was not successful – but that was not his fault. Attitudes were so entrenched that even the most-powerful chancellor the UK has had in over a century appeared impotent in that respect.
By contrast, Alan Greenspan appeared to be a fan of American’s taking out variable rate mortgages – at one time the US rate of interest was just 1 per cent, and the so-called maestro seemed keen to encourage as many Americans as possible to take advantage of this.
That was Greenspan’s greatest error; Brown’s failure to have his view accepted: his most serious failure as chancellor. If it had been the other way round, then it seems likely today’s credit crunch would not be so serious – maybe it would be non-existent.
Right now, though, central banks and governments have more power over the credit markets than in a very long time. In the US, the Fed has taken to taking over mortgage securities from banks. In the UK, as the mortgage market dries up, it seems probable the Bank of England will be forced to mirror the Fed’s action.
It can use this position to start enforcing more long-term fixed rate mortgages – via its retail arm, Northern Rock, it could even proactively enter this market.
Now is a unique opportunity to promote this more-stable form of mortgage lending, and to establish it so that when the recovery occurs, attitudes towards it won’t be so ambivalent.
It seems unlikely the Government will take this action – but here’s hoping.
Doesn’t this lose an important lever of monetary policy. If the Authorities want to stimulate the economy by reducing interest rates, this will have no effect at all on the indebted consumer. No effect if they want to slow things down either !
Maybe the answer is to sell a hedging product to the borrower who is exposed to interest rate movements. Perhaps the answer is to prevent people buying houses when they can’t afford them - sell this one to the Politicians !!
The only way back to sustainable growth is to allow the current level of borrowing to fall and accept that recessionary pressures are inevitable if we are to return to a healthy economy. Any short term solutions are likely to prolong the process of recovery because if the public has borrowed beyond what is prudent the only solution is to ultimately allow borrowing to fall.