The house that Gordon wrecked
Bubble — By Michael Jones on October 9, 2009 6:00 am
Going, going... the economy's fallen off a cliff, and it all began in the housing market
PLENTY of people have already argued convincingly that Gordon Brown is the worst Prime Minister in modern British history.
At least £3 trillion – that’s £3,000,000,000,000 – of our national wealth may have magically disappeared since the Labour Party took power over 12 ½ years ago. This deficit includes borrowing (£560 billion) and bailouts (£200 billion), public sector profligacy (£1,000 billion), public sector pension increases (£520 billion), spending on quasi-governmental organisations (£500 billion) and the erosion of private savings and pensions (£470 billion). To describe Gordon Brown as irresponsible would be almost to promote that term to the level of respectability.
On Labour’s analysis, Britain’s economy has grown under Brown’s stewardship. Our national wealth has apparently more doubled from £3.2 trillion in 1997 to £7 trillion in 2007. This would count as an incredible achievement for this government and its Prime Minister if that number had been based on something real, like manufactured goods and exports. As it happens, about £3 trillion came from rising house prices; another £1 trillion or so is due to inflation; and the rest was artificially inflated by large-scale immigration and the expansion of the public sector. Once you take these out, you actually find that our national wealth experienced a decline of close to £1 trillion.
Gordon Brown also said he had ended boom and bust and, in those innocent days before the collapse of the banking sector, we believed him. The only person to question this mantra was the Liberal Democrat MP Vince Cable. He asked Gordon Brown: “Is it not true that…the growth of the British economy is sustained by consumer spending pinned against record levels of personal debt, which is secured, if at all, against house prices that the Bank of England describes as well above equilibrium level?” Brown replied: “The Honourable Gentleman has been writing articles in the newspapers, as reflected in his contribution, that spread alarm, without substance, about the state of the economy…” We all know what happened next.
Predictably but disappointingly, politicians are blaming everyone but themselves. Rhodri Morgan’s proclamation – that “the free market ideology of Margaret Thatcher and Ronald Reagan is dead” – sounds like a weak parody of Friedrich Nietzsche’s proclamation that ‘God is dead… God remains dead… And we have killed him.”
Financial markets do indeed experience corrections. That’s in the nature of a market system: that people will try new things and some of them will fail. In the last 100 years there have been only four occasions when stock markets failed. The credit crisis, however, lies squarely at the doors of governments, beginning in the 1970s with the Community Reinvestment Act and culminating in the mid-2000s with the American Dream Downpayment Initiative. President Clinton wanted to raise home ownership among black Americans from 50 to 75%. President Bush wanted the same for Hispanics. Laws and regulations were introduced to punish lenders who refused to make loans to poor people in poor neighbourhoods – so-called redlining.
Of course, this racial equality stuff was just a cover story for debauching credit standards. White people with poor credit histories were just as entitled to subprime mortgages, the riskiest category of consumer lending. Profits in banking and insurance, mortgage lending, housebuilding, construction and retail boomed. Property prices ballooned. Confidence in this guarantee grew, and as it did, more and more speculators took advantage of it. The Federal Reserve (a central bank run by the government to control all the private banks) simply added to the frenzy by keeping interest rates low for years.
But, of course, no boom lasts forever. As the economy grew, the Federal Reserve began to tighten, to raise interest rates. Mortgage terms became tougher, and house prices stabilised. From this point, a chain reaction of panic started. Sub-prime borrowers found themselves in a situation where they couldn’t pay back their loans (such as credit cards and mortgages) and the companies that were depending on getting that money back (with interest) got into trouble.
It is not painting an overly rosy picture of the banking system by blaming the boom-bust cycle entirely on government intervention. Unscrupulous lenders contaminated the global economy by taking the subprime debt, slicing it into smaller pieces and selling it on to foreign investors, who were desperate for securities in America’s housing market but were too lazy to inspect the rotten paper on their books. As house prices stabilised, foreign investors awoke to the reality that all that this paper, spread right across the world, is overvalued. This is the so-called toxic debt that has caused banks to stop lending to each other, or to businesses and first-time buyers.
There are other complications that still remain difficult to fully comprehend. Fannie Mae and Freddie Mac, for example. But all the complexities hid a very simple fact: there weren’t enough people with the earning power to pay for all the new homes which were being built to prop-up America’s flailing economy. Riskier mortgage lending practices, heavily encouraged by government, empowered the most indolent investors and unscrupulous bankers. Traders were free to gamble with other people’s money, but faced almost no meaningful sanction if they failed, leaving the mess to be cleaned up by taxpayers, through direct bailouts, and savers, through inflation eating away their capital.
In his article The Good Prime Minister, Duncan Higgitt makes a prescient observation: “In truth, everyone had a hand in the recession.” The usual categories of conventional thinking – Tory vs Labour, business vs government, libertarian vs Keynesian – aren’t very useful here because it was a total systemic screw-up. Shareholders had little control over fund managers; fund managers had little control over chief executives; and chief executives had little control over trading desks, partly because they just didn’t understand the complexities of mortgage derivatives.
However, I disagree with Duncan’s claim that “we are all to blame”. When things are booming, consumption is perfectly rational: when nearly all customers are getting richer, it follows that they will grab as much as they can. Ultimately, the most reasonable attribution of blame falls foremost on our government’s most sacred mindset – affordable housing. Politicians created the bubble that encouraged us all to borrow too much. The old and trite saying, “No Boom lasts forever,” is old and trite precisely because this has been a common experience for a very long time. Decades of demonising realistic thought about markets has come back to bite us.
Tags: Economy, George Bush, Gordon Brown, Government, Labour, recession, subprime
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6 Comments
So free markets can’t be blamed, this is caused by a US government intervening.
So why have a go at Gordon Brown for not doing anything? That’s exactly what this article has been advocating, or I think so anyway, because that’s the key question that isn’t answered directly, what should he have done?
The derivatives market is too complicated for financial CEOs to understand but apparently the chancellor and PM should, we either have low demands of the people running our banks there or very high ones of our politicians. The blame falls foremost on the government’s sacred affordable housing but that was a policy in another continent before Brown was even in office.
Great piece, Mike. Thanks for writing it for us.
I guess that, at the end of the day, there’s only limited benefit in looking backwards and apportioning blame. The SEC is working hard to find grounds for prosecuting some of the (former) Masters of the Universe and there’s frustration here that the FSA doesn’t seem to be moving the same way. However, it’s difficult to decide if or how we should punish our bankers. It doesn’t seem even remotely possible that Sir Fred Goodwin or Adam Applegarth will ever feel the hot breath of retribution on the back of their necks, so perhaps our efforts could be more constructively aimed at creating the framework that preventsthose contributing factors from coming together in the same way again. Admittedly, this is the devil’s own task.
Gareth raises an interesting point about what we expect from our politicians. We are now in a culture where we want it both ways. We decry the mountain of legislation and resultant red tape, yet expect the Government to step in on matters where it should have absolutely no say. However, it’s worth pointing out that it was Labour created this mindset, having promoted since before it came to power the idea that it alone had – has – the panacea for all our woes. Of such promises are high expectations made.
David Cameron yesterday spoke of smaller government. Yet the Conservatives will get nowhere with this unless they realise that it is attitudes that must change first. Government interference – expected or uninvited – in our every day life has led on to the widely-held view that individual rights come before collective responsibility. Reversing that mindset should be the ultimate goal of smaller government.
@Gareth. I hope I can answer a few of your questions:
> ‘So free markets can’t be blamed, this is caused by a US government intervening.’
Even a free marketer like me appreciates that markets are imperfect. But market failure is not a magic phrase that automatically justifies government intervention, because the government can make things worse. Yes, there was dishonesty and greed in the global financial system, but this was the result of the bubble, not its cause. The particular problem isn’t the market per se, but a lack of counterbalancing fear.
> ‘So why have a go at Gordon Brown for not doing anything? That’s exactly what this article has been advocating, or I think so anyway.’
My article advocates nothing of the sort. The PM mistook a boom for stability, and never prepared Britain for the bust. According to the IMF, our recession will be more severe than America’s, Germany’s, France’s, Italy’s, Japan’s, Spain’s and every other major economy in the developed world.
> ‘The blame falls foremost on the government’s sacred affordable housing but that was a policy in another continent before Brown was even in office.’
The PM discreetly encouraged Britain’s banking sector to follow Bush’s lead and take their loans and mortgages into run-down areas. (The Government wanted them to form a ‘universal bank’ to provide a service for customers with poor credit.) It was Brown’s anxiety, in other words, to keep customers safe that made him introduce more and more exhaustive regulation. To quote Eamonn Butler: “The only banks that can afford to deal with this bureaucracy are the big ones. Regulation has made the banks fat – and their customers complacent. It would be much healthier if the banks were competitive and customers eyed them up more carefully before trusting them with their savings.” This ‘Too Big to Fail’ mentality is one of the reasons why banks are able to privatise their profits and nationalise their losses.
Let me be clear, I’m not clearing Brown of blame either, I agree entirely with your statement that he shouldn’t have increased deficit spending based on a bubble, but this article does seem to give a pass to virtually everyone else apart from him.
I mean I could turn one argument on its head:
Even a pro government man like me appreciates that governments are imperfect. But their failure is not a magic phrase that automatically justifies free market collapse, because corporations can make things worse.
I worked in the financial industry from 1997 – 2006 and Brown’s pressure on us to lend was certainly discrete, to the extent of being invisible. We were asked to open basic bank accounts, which had no credit facilities, but certainly not lend mortgages.Trying to tie a US policy of forcing increased lending and rampant expansion in the housing sector onto the UK doesn’t scan. It’s long been reported that we have an acute housing shortage (for which you can justifiably blame Brown as that doesn’t seem to have changed under his watch and also part of the driver for the housing boom, demand outstrips supply).
Regulation is a red herring in being a major cause of “too big to fail”, the UK banking sector has forever been based around 4 large clearing banks, without which the other banks cannot clear a cheque. All deposits from building societies are then deposited again in the big 4 clearing banks. It is, by design (and I have no issues with it being called a faulty design), built around organisations that cannot fail without taking everyone with them. That’s been true since any of us can remember, regardless of who was in power and before the FSA existed.
Maybe this will be addressed Mr Ramsay and colleagues in a future Conservative government. Hopefully we can see that in a future article as I agree with Duncan that there is limited benefit in looking back and apportioning blame, as enetertaining as it may be sometimes
)
@Gareth. We’re going round in circles here:
> “Even a pro government man like me appreciates that governments are imperfect.”
The imperfections of a free market economy are miniscule compared to the imperfections of government intervention. To say ‘the market decides’ is only to say that millions of people decide. It brings 99 percent of knowledge into play, and generates new knowledge. That is why free markets (individual free choice + the guidance provided by prices which result from millions of people interacting with one another), rather than the groupthink of the elite few, are so important.
> “But their failure is not a magic phrase that automatically justifies free market collapse.”
Instead of a bailout, creditors should have been made to recapitalise the banks. A debt for equity swap – supervised by the Bank of England – would reduce banks’ over-borrowing at the same time as it increases banks’ equity.
> “Brown’s pressure on us to lend was certainly discrete, to the extent of being invisible.”
Gordon Brown was by no means a passive bystander. In 1997 he transferred the responsibility for bank regulation from the Bank of England to the feeble FSA. He also curbed the central bank’s ability to keep asset inflation in check by removing housing costs from the price index.
If it is all Gordon Brown’s fault then why is a GLOBAL economic crisis and why is have other Country such as the United States bailed out their banks and injected government money into their economies?
America Japan and France and Germany are more indebted than the U.K.