Easy money

“Neither a borrower nor a lender be; For loan oft loses both itself and friend;

And borrowing dulls the edge of husbandry.” – William Shakespeare.

 

Time was when all that was needed to rectify banking problems was a raised eyebrow from the Bank of England Governor. Now it is the actions of that same Governor that are causing eyebrows to be raised throughout the markets.

 

At the 20 September Treasury Committee, Mr. King’s defence began with acknowledging, albeit with some prolixity, that “the impact on the confidence that people have in the banking system generally could have been shaken by the scenes that were seen on television”. From personal observation, the queues of Northern Rock depositors in North London last week threatened to be outnumbered by TV cameras. Reporting on the crisis was of course wholly legitimate; but the media treads a fine line between reportage and fuelling panic when the subject matter is as sensitive as this.

 

Part Two of the King defence amounted to attack: “the interaction between four apparently unconnected pieces of legislation prevented us from carrying out the operation that we wanted to do”. The (widespread and often vicious) criticism of Mervyn King for his role in the Northern Rock debacle looks unbalanced by comparison to the roles played by the FSA and the Treasury. What is now clear to all is that a tripartite system of banking regulation, oversight and support amounts, in extremis, to costly confusion and an even more costly environment of unaccountability. And we may never know the true degree to which a nominally independent Mr. King was leant on by politicians. But the Bank of England is not a lawmaker, whereas the members of the Treasury Committee are. As Mr. King pointed out, an old-style banking bailout of Northern Rock was made impossible by recent legislation: the Takeover Code prevented a rapid change in ownership, while the 2005 Market Abuses Directive prevented covert action on the part of the Bank as lender of last resort. The Bank of England was cowed by a tangle of New Labour-introduced red tape.

 

What does the Bank of England require to ensure that history doesn’t repeat itself ? “We now require a serious reform of deposit insurance, of the administration of banks, of the clash between the wish for transparency of companies to their shareholders, the tension between that and how it applies to banks when in difficulty, and the length of time it takes to deal with transfer of ownership of banks. Those four things are fundamental. If any one of those had not been there, there would not have been the problem with the lender of last resort operation.”

 

Chancellor Alistair Darling has already exceeded his authority in “guaranteeing” bank deposits with money that, underwritten by taxpayers, was never his to begin with. Evidently the Financial Services Compensation Scheme is going to be overhauled; the figure of £100,000 as a maximum level of deposit guarantees keeps floating about. Logic suggests that the banking regulator and lender of last resort should be one and the same entity. And when flawed business models run into the buffers, politicians should be forcibly reminded to be less eager to throw public money at the problem – what amounts to socialism for the rich, if you will.

 

But knee jerk reactions to otherwise unprecedented events have been remarkably commonplace over recent months. And when it comes to knee jerk reactions and a craven capitulation to powerful lobby groups, Pavlov’s dogs have nothing on Wall Street faced with the ringing of an easier money dinner gong. The response by equity markets to last week’s 50 basis points cut in Fed Funds was shockingly predictable: off to the races, again. An indiscriminate relief rally like this deserves to end in tears for at least some of its members. For the prosecution, see the house price data published in the September 15 issue of ‘The Economist’. Between 1997 and 2007, US house prices (the Case-Shiller national index) rose by 120% (OFHEO data suggest a 103% rise). Only an optimist could foresee anything other than disappointment ahead for existing US homeowners. But consider the rises experienced in other countries over the same period: Denmark 121%; Belgium 131%; Sweden 138%; France 139%; Australia 149%; Spain 189%; Britain 211%; Ireland 251%. There are obviously differing factors that moderate the rises: the role of rising real incomes and population; declines in real interest rates, and the pace of homebuilding. But the essential indication seems stark: a “bubble” in US property has triggered, one way or another, a crisis in international financial markets. There will be other national housing market shoes to drop. And lower rates on their own may do very little to boost both sectors – we have seen first hand the impact of a sharp decline in confidence on the savings system. Tighter lending standards, the reversal of 'teaser' rates and wider credit spreads may see many borrowers perversely watching their costs increase even as headline interest rates fall - let's see politicians explain that. Equity markets are in denial. Not everybody gets out of this room alive.

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