Storm, The (5 page)

There has been more controversy over whether it is also necessary to stimulate the economy by running a larger budget deficit.
This is already happening automatically, since as the economy slows there will be weaker tax receipts from personal and corporate
income, VAT and stamp duty. But there is anxiety that, even without the impact of recession, the government has been running
an excessive, structural, deficit. The OECD, among others, was very critical of the British government’s gradual drift into
larger, unplanned deficits, even before the problem of the recession arose. In December 2008 there was an increasingly polarized
debate about whether Britain’s public finances were strong enough to permit a small fiscal stimulus, of around 1 per cent
of GDP, on top of a current (that is, excluding public investment) deficit of 9 per cent of GDP, expected in any event. Critics
argue that if the
government’s borrowing requirement spirals out of control, then the cost of borrowing in international markets will rise on
the fear of sovereign default, perhaps in a dramatic way.

The issue of managing the public sector deficit is emerging as a central issue in economic policy, and in politics. As it
happens, the government is experiencing no serious difficulty in marketing government gilts, despite very low interest rates
(less than 2 per cent in real terms). And the current, outstanding, UK public debt is moderate in comparison with those of
other countries, or with much of the last two centuries. The overwhelming consensus among economic analysts and policy makers
is that the government (and other governments) has been right to maintain expansionary policies and to run large fiscal deficits
throughout the crisis (which is not yet over), and that conservative critics have been wrong. The point may, however, be approaching
at which it is necessary to signal to the markets that, as the threat of a major slump recedes and recession is abating, the
government has clear plans to cut its borrowing, which is now, at 13–14 per cent of GDP, at a level that would be seen as
absolutely extraordinary in normal times.

Because so much of the uncertainty and worry besetting the UK economy has centred on the housing market, there has also been
an argument to the effect that any attempt to rescue the economy from a downward spiral of declining confidence, declining
spending, and declining activity should centre on shoring up house prices. The banks, as well as builders and property owners,
are, unsurprisingly, proponents of this approach. Various ideas have been canvassed, including direct or indirect state guarantees
for new loans, stamp duty suspension or reduction, or the state funding of mortgage arrears through the benefits system. A
moderate reduction in stamp duty was attempted in September 2008 and sank without trace. There has also been a modest programme
to assist people who are out of work to pay their mortgages. But the government and the Bank of England have essentially declined
any suggestions that they should stop the
housing market adjusting through a substantial fall in prices. This adjustment is now taking place, although there is the
danger of a premature and artificial recovery.

The most dramatic and far-reaching interventions in the UK economy have not been in monetary or fiscal policy, nor in the
housing market, but in the banking system. In that respect Britain was caught up in a wider international banking crisis.
But this is not to minimize the specific shock to the British economy of having several banks nationalized, others partly
nationalized, and others still dependent for their survival on government guarantees. Britain also pioneered what became a
collective response to the crisis in the form of recapitalizing banks through government capital.

The global nature of the crisis has left in its wake a somewhat confusing and unsatisfactory political debate, in which the
government claims that the financial crisis and its aftermath of recession are problems whose origins lie exclusively overseas,
while its critics, notably the Conservative opposition, simply blame the government for mismanagement. A balanced assessment
has to be that there is both an international and a domestic dimension. Without diminishing in any way the global origins
and nature of the crisis it is also necessary to debunk the self-serving myth that Britain has, in Gordon Brown’s words, created
an economic environment of ‘no more boom and bust’, and that the country was uniquely well placed to ride out the global storm.
On the contrary, Britain’s housing and debt bubbles have been larger than elsewhere; the government has relatively limited
freedom of manoeuvre in fiscal policy because of structural deficits; and a large financial services sector, centred on the
City of London, has exposed the UK to the full force of the gale that is blowing through international financial markets.

These failings are not just technical, but reflect deep social currents. The extremity of Britain’s housing bubble stems ultimately
from a national obsession with property and property values. Those who feel that they must ‘have a foot on the property ladder’
are not just making a calculated assessment about the future value of a capital asset, but are buying into the notion that
‘an Englishman’s home is his castle’ and into the concept of a ‘property owning democracy’. Mrs Thatcher’s brilliantly populist
‘right to buy’ policy – under which council tenants could buy their homes, usually at a hefty discount to the market price
– contributed mightily to the idea of the ‘first-time buyer’ as an essential pillar of society, an iconic figure on a par
with the self-sacrificing, saintly NHS nurse or the self-made entrepreneur. New Labour understood perfectly the importance
of the icon: the sense of self-esteem and security that came from discovering that one’s own bricks and mortar were worth
more and more; the economic value and personal satisfaction derived from home and garden improvements. The plethora of TV
property programmes and the domination of national newspapers by property supplements and house price stories reflected our
national mania. It is not in the least surprising that a bubble in property prices was allowed to run out of control. The
government now faces the anger of voters whose dreams of a property-based nirvana are now being dashed.

There was another set of British illusions that have played powerfully into the current crisis: the glamour of the City and
the lure of Big Money. After the demise of much of Britain’s manufacturing industry, the City emerged as a national success
story. The banks and finance houses whose offices now define the skyline of London may be owned by foreigners, but they have
chosen to operate here. Lots of Dick Whittingtons have discovered that the streets of London really are paved with gold. The
City has sedulously cultivated an image of buccaneering, innovative entrepreneurship. Britain has been projected as a place
with the cleverest, most hard-working and attractive financiers. A generation of brilliant young graduates with advanced numeracy
has been persuaded, by lavish incentives, to devote their intelligence
to financial inventiveness, rather than the more tedious and less lucrative alternatives of the laboratory or the classroom.
There was a role, too, for the proles: smart young men with Estuary English, who could make a killing and accumulate previously
unheard-of wealth on the dealing-floor.

All those bonuses may have financed the champagne and cocaine markets, but they percolated through too to the Treasury and
the wider economy. Governments were seduced by this narrative, and politicians brought up on Trotsky and
The Ragged-Trousered Philanthropists
fought for the honour to be champions of the City.

There is now a brutal reappraisal taking place. Aspiring Dick Whittingtons are discovering that much of the gold was iron
pyrites: ‘fool’s gold’. Brilliant financial innovators have been recognized as greedy or reckless or incompetent, or all three.
Self-proclaimed, buccaneering entrepreneurs in the banking industry have been reduced to rattling a begging bowl and are dependent
on the government bailing them out. Though the City remains an important industry, there are fewer illusions now that it has
generated financial and wider economic instability, as well as wealth. As the financial sector stabilized in the middle of
2009, top bankers’ confidence started to return and a debate started to emerge about whether a return to ‘business as usual’
was either desirable or possible. It is clear that the radical reforms necessary to stabilize the banking system will be fiercely
resisted in parts of the City.

The impact of the simultaneous battering given to the ideal of owner-occupation and the reputation of financiers will only
be fully understood with the passage of time, and much will depend on how much damage the storm has caused. The challenge
for the UK will be to manage a very painful correction and to achieve some rebalancing, between private- and public-sector
housing, and between the regulation and deregulation of financial services.

What started as minor trouble on the Tyne has grown and turned into a major crisis for the UK economy. But the UK is
merely one, modest, part of the global economy: barely 2 per cent of it. The collapse of confidence in financial markets and
in what were, until recently, seen as stable institutions is a much wider phenomenon. To that bigger context, I now turn.

For many Americans, hurricanes are a regular hazard. They happen frequently and are generally well prepared for. So it is
with financial crises. In recent decades there have been episodes of extreme volatility in the prices of securities, property
and commodities. There is usually a trail of damage, but it is temporary and superficial. But occasionally, as in nature,
there is a financial super-storm of great destructive power. The biggest and most destructive within living memory (at least
for the very old) was the Great Crash of 1929–32, which caused mass unemployment and a fall of one third in US GDP. It did
not recover to 1929 levels for a decade. The experience shaped US policy, and politics, for a generation, perhaps two. Institutional
memory of that event has been kept alive, not least by the Chairman of the Federal Reserve, Ben Bernanke, who studied it for
his PhD thesis.

The question that has dominated those charged with responsibility for policy has been whether the tropical storm proceeding
through the global banking system was developing into a full-blown hurricane, or merely a violent storm like the savings and
loans crisis of the 1980s. The latter resulted in cumulative losses of $500 billion, but was contained, albeit at a substantial
cost to the US taxpayer, without affecting the economy of the USA in a significant way, let alone that of the world. Another
potentially destructive storm in 1999 centred on the collapse of the hedge fund Long Term Capital Management. Then there were,
around
the millennium, a bursting bubble in ‘dot.com’ shares in the USA and Europe, and financial crises in Asia – Thailand, South
Korea, Malaysia and Taiwan – followed by a default on Russian debt. While these individual crises inflicted considerable damage
on the countries concerned – a loss of over 30 per cent of GDP in Thailand, for example – there was no significant impact
on the USA or the rest of the world economy.

It has become increasingly clear that the storm is not one of those lesser events, but one of the most destructive ever known:
the equivalent of a Force 12 hurricane. The earlier storms blew over. The attitude of the US authorities, however, in each
case, was that a major potential disaster could only be averted by applying the central lesson of the 1929–32 crash, which
was the need to counter the deflationary effect of a financial crash by pursuing expansionary monetary policies. Faced, for
example, with a potential systemic crash at the turn of the century, the authorities cut interest rates dramatically, from
6.5 per cent in 2000 to 1 per cent in 2003. It is a matter for conjecture whether dramatic intervention was necessary or desirable
and whether it contributed to later, damaging, inflation in markets. But the apparent success of that strategy – albeit with
three quarters of recession over the years 2000–1 – helped to elevate the then Chairman of the Federal Reserve, Alan Greenspan,
to a status akin to beatification. It is just as well that beatification did not proceed to sainthood, since his freewheeling
approach to financial regulation is now seen as a major cause of the more complex and deeper financial crisis that we are
facing – perhaps a bigger crisis in scale and scope than has ever been seen before.