Wednesday, 4 February 2009

Sustainable debt, the only practical course

Far more regularly than we might like to admit, we all face problems we have not encountered before. The first illness of the first child, the first time something arrives on our desk at work and we look at it thinking "oh dear, I don't know where to start", the first dripping tap or rotting window sill encountered as a homeowner with no landlord to call on for free help, the first time we exit Madam Fifi's Sauna and Hanky Panky Parlour to see our dearly beloved looking in the window of the shop next door. We have to decide what to do. We can try to tackle it ourselves (usually more in hope than expectation that we will find the right solution) or we can call for help from those who know more about the subject than us (or, in the last example, we can go back inside Madam Fifi's establishment until the risk has passed). What would have us committed to the local asylum, if such a thing still existed, would be denouncing other people's suggestions and then announcing publicly that we haven't got a clue what to do.

Welcome to the world of Gordon Brown. He has now admitted that he is stumbling around in the dark and simply guessing at how to deal with the current banking crisis.

Now let's go back about a year. At that time it had become clear that big banks in the UK and America had been making a lot of very bad loans and off-loading the risk to others, then buying the risk taken by other big banks. It was plainly a complete dog's breakfast. No one knew how much each bank was likely to lose by the time all the bad loans clucked home to roost, so each bank at risk manned the barricades and sought to limit their new business to very safe and secure transactions. While all this was going on, a few big banks had not engaged in the risky stuff and a lot of small banks, with shareholders who keep them on their toes, carried on as they had for decades lending only to good risks and keeping a perpetually beady eye on how each loan was performing. These prudent lenders have carried on much as before and are in just as sound a position today as they were before Mr and Mrs Ordinary first heard the term "Credit Default Swap".

The real problem with the international banker's beano in Davos is that it was an international bankers' beano. They are big wigs, grand fromages, doyens and doyennes with medals of all colours and nationalities to confirm their position as the banking creme de la creme. The politicians are scared of them because they have real power whether or not they deserve it. They can make or break their customers and they can make or break national economies. That necessarily means they can make or break political careers. It would take a true statesman to stand up to them and say "you made a right balls-up of this and now you must pay". Yet the only real power they have over politicians is the power of blackmail and that is diluted by the banks' current parlous states.

I have been hoping to hear a leading politician call their bluff and say to the banking aristocracy: "we are prepared to help you out to a limited degree but we require every penny of that help repaid with interest and you must cut your suit to match your cloth". You see, these banks are not doing us any favours by staying in business. They are not doing so because they think it is in the long term interests of Mr and Mrs Ordinary in Stoke Poges. They are staying in business because they think they will make a stonking great profit a few years down the line. If they thought they were irredeemably bust they would not stay in business, they would fold and let the losses lie where they fall regardless of how that affected any particular country's economy. In fact they know that a well run bank is a steady source of decent profits and a speculatively run bank can deliver massive short-term profits but only at the risk of long-term losses. That is the position they are in now. They speculated and appeared to win for a while but in doing so they build up a catalogue of debt which has proved to be corrosive. It is no surprise that it is corrosive, that has been proved time and again in the past and that is precisely why prudent bankers have never chased speculative short-term profits.

The reason they are fighting to stay in business is the very reason why taxpayers should not take on any of the risk that currently lies on their books. Either the banks will make profits from the business they are doing now or they will not. The business they did in the past has been done and cannot be reversed. It is tolerably clear that there are substantial losses in the system from that business, some of it has already surfaced and a lot more is waiting in the wings. Those losses have to fall somewhere they will not just disappear. There are only four possibilities. First, the losses are kept on the banks' books and are made good out of future profits. Second, the losses prove too heavy for the banks to bear and they fold, in which case investors in those banks lose the value of their investment (be it as shareholder or depositor, but subject to the £50,000 taxpayer-funded guarantee or personal deposits). Third, the banks are relieved of the debts by the government taking them on, in which case they still do not disappear they have to be made good from future taxes. Fourth, the government takes on the losses subject to a right of reimbursement from the banks' future profits.

None of these options is attractive, but that is unavoidable because vast losses are unattractive. The only difference between the first and second options is the future profitability of the banks concerned. Either they make it through the mess they have made or they don't, if they do the first option applies if not the second comes into play. I am attracted to these options because it will mean the gamblers have to take the risk inherent in their gambling. But there is a problem in piling all the loss on just one link in the chain of responsibility. The banks are not the only party to blame in this awful situation. Their activities were subject to supervision by the Financial Services Authority acting on the instructions laid down by poor Gordon when he was Chancellor of the Exchequer. Those of us with a bee in our bonnet about banks lending money to people who cannot afford to repay it get rather miffed to hear the government condemning irresponsible lending. The government was responsible for supervising the banks and, one might think, part of responsible supervision is to prevent irresponsible lending. So, why should the loss all fall on the banks and their investors when government is also to blame?

If we are to be fair about these things we have to accept not only that government was partly to blame but also that we, the electorate, put the government in place. I certainly didn't do so but I am bound by the decision of a general election, and long may that be the case whether or not I agree with the particular outcome. So, if we are to be fair, part of the loss should be borne by the great British public because the incompetent shower they placed in office are also to blame.

How much, then, should the taxpayer have to bear? This is not a matter for an arithmetical formula, it is a matter for looking at the thing in the round any trying to reach a balanced view. Already the taxpayer has taken out massive debts to help the banks restore their capital position and now we are in a recession hitting the little man hardest. It will be a long time before graphs start to turn north and by that time the taxpayer will have been landed with previously unimaginable amounts of debt. That seems a pretty fair price to me. From now on let the banks sink or swim. The level of business they do will determine not only their ability to make good losses on bad loans but also the extent of borrowing the people of this country can sustain.

Forget credit-funded stimulation of the economy, concentrate on what can actually be afforded. There is no point pretending we can live on credit to the level we did in 2005, 6 or 7 and seeking to boost lending back to those levels. If we can't afford it, we can't afford it. If we can afford it, that amount of credit will be advanced. That is not a decision for government it is a decision for individuals, businesses and prudent bankers. If the banks need a further kick-start by some of their losses being guaranteed with an obligation on the banks to repay anything the taxpayer has to fork out, then it can be considered as and when that position is reached. As I said above, they are not in business because they think they will continue to make losses, they know that they can make good profits if only they make good loans rather than bad loans; so any further financial assistance should come with protection for the taxpayer.

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