In truth, all of them failed to spot the massive asset bubble that had deformed the British economy by 2007, a bubble blown by dangerously underpriced debt. Yet even now there is a worrying reluctance (on all sides) to admit that a bubble ever existed. The decision to blame the banks is not just lazy, but dangerous — because it means that the profound errors of the Labour years are neither diagnosed nor corrected. And so the factors which led us to the crash remain in place, primed to explode again.
The problem here wasn’t light-touch regulation, but wrong-touch regulation. If this crisis was global, why do Sweden, Canada and Australia not have any collapsed banks? Because they had their banking blow-up 20 years ago, and responded with proper regulation. Under George Osborne, Britain finally looks ready to join the club of countries with properly regulated banks – but, crucially, this will not fix the problem.
Yes, bankers behaved abominably — like teenagers at an unsupervised party with free alcohol. But when a responsible adult comes home to find the place wrecked, the questions are simple: who organised the party? Who supplied the booze? The answer, in the case of the British economy, is simple: Mervyn King and the Monetary Policy Committee.
When Gordon Brown redrew Britain’s financial regulatory architecture in 1997, he not only wrecked banking regulation but rigged the system for setting interest rates. King would be granted independence, in theory, but asked to set rates by taking a vote from a committee, most of whom were chosen by the Treasury. They went on to pump the British economy with the steroid of cheap debt. Brown loved all this. He changed the inflation target from RPI to CPI; he took a bow for all this ‘prosperity’, which we now know to have been a dent-fuelled illusion. Prosperity was the Teflon coating which covered New Labour. People felt rich because the asset bubble pushed their house price up. People then borrowed against the new value of their house and the phrase ‘equity withdrawal’ was commonplace. The very phrase means that people used their homes as a cash dispenser doling out borrowed money. The UK Treasury became Europe’s leader in debt concealment, with PFI deals and even Brown’s Enron-for-Africa scheme, the International Finance Facility: he’d worked out that if three countries share a pool of debt, it doesn’t show up on any of their national accounts due to a Eurostat loophole.
Before the crash, this was the UK economy. A pyramid of debt, built upon debt. Everyone was taking out cheap loans, and either spending it – or speculating with it, in the housing market or (in the case of banks) dodgy Russian deals. Rather than being unpredictable, it conformed perfectly to the classic bubble. Including that age-old claim that ‘this time, it’s different’ – globalization, we told ourselves, means a one-off adjustment to a new era of low debt. Greenspan spoke about a ‘great moderation’ and Brown spoke about an ‘end to boom and bust’. Thus the pattern of bubbles repeats itself. Mankind is prone to become hubristic.
Gordon Brown loves to say that ‘it started in America’ but, in many ways, London was the source of the contagion. It was the Nevada of the globalized world, the most ineptly-regulated financial centre out there. It was Lehman’s London division that ran up the worst liabilities. It was AIG’s team in London that were its worst offenders. No wonder the Icelandics don’t want to repay their British debt: their maniac bankers were rampaging around London, not Rekjavik. Brown didn’t really care: his government took a 40 per cent cut in every bonus paid. As I wrote for the News of the World, Brown governed in coalition with the banks. Britain was a bankocracy.
The Queen’s famous question — why did no one see it coming? — has a clear answer. Because everyone was looking in the wrong place. They were fixated with keeping consumer inflation in check, and didn’t notice the signs of a debt bubble. Savings had collapsed, the prices of assets — from fine wine to penthouses — were soaring. Yet all this was described as stability and prosperity because inflation stayed around the 2 per cent level. Common sense was supplanted with a statistical fixation, and the results were calamitous.
This matters because this same failed system remains in place. The difference is that King and his committee are now presiding over a new type of instability.
Britain has the worst inflation in western Europe, bar Greece, and the cost of living is not only making life miserable but slowing the recovery. King speaks with an academic’s detachment about rampant inflation, as if it were just another statistic. Those on low wages will know that inflation is, as Reagan once put it, ‘as violent as a mugger, as frightening as an armed robber and as deadly as a hit man’. It shows how things are in Britain when news that inflation has fallen back to 4 per cent — twice the target level — is celebrated.
This is not stability. The people who brought you the credit bubble will now create Greek-style inflation. Osborne cannot simply shrug and blame King. When the standard of living falls, governments follow. Osborne gives the Bank its orders, and will take the blame at the ballot box. Sooner or later, he will have to recognise that the Monetary Policy Committee, like so much that Brown set up, is dysfunctional and needs to be replaced.
Brown’s economic failure was total, and extends far beyond bad banking regulation. Of the new jobs created over the Labour years, 99 per cent can be accounted for by extra immigration — mainly because Britain’s welfare state paid so many millions not to work. Welfare is at last being reformed. But many of Brown’s other disastrous policies remain in place. The notion that tax cuts are unaffordable remains hardwired into the Treasury’s thinking. But look at Sweden, which cut payroll taxes to stimulate its economy during recession and is now celebrating the strongest growth in Europe.
This is not to belittle the progress Osborne has made. Cameron's speech yesterday (flagged up by Pete) mentions a housing bubble. But there's no talk about the overall asset bubble, no analysis that this bubble arose because debt was too cheap for too long. There's a Financial Stability Committee being bolted on to the Bank of England, with a wide-ranging remit. But power rests with the MPC and its inflation-only remit. Osborne deserves credit for fixing bank regulation, but the MPC system is still in place. In monetary policy, the root cause of the crash, there has been no change. Osborne should have torn up Brown's system, and started again.
Throughout history, moneylenders have always been an easy target. Osborne has played to the gallery, making sharp attacks on banking profits and defending other Brownite policies such as the 50p tax on high-earners. He would argue that being seen to hit the rich and the bankers is necessary; it’s the sugar that makes the fiscal medicine go down. Maybe so, but it carries a greater risk. Every voter who blames banks for the financial mess is a voter who is not blaming Gordon Brown’s government and is more relaxed about Labour’s return. For Osborne and for the country, this is the far greater danger.