“There are two kinds of chancellor”, said Gordon Brown famously,”failures, and those who get out in time”. No surprises for guessing which category Gordon fits into. And what is French for “apres moi le deluge” by the way?
Poor Alistair Darling (I still can’t get used yet to calling him the Chancellor) has been left to cope with the consequences of a decade of Gordonomics. The air is ringing to the sound of stable doors slamming as the livestock disappears over the hill.
Last week, Darling gave the City a stern lecture on how it wasn’t the government’s job to bail out banks which had indulged in irresponsible lending and borrowing. It was time to get back, he said, to “good old-fashioned banking”. The very next day, Darling began the bail-out out Northern Rock, a byword for irrational exuberance in the mortgage market. It had been financing its too-good-to-miss mortgages by dabbling in American sub prime. Borrowing short to lend long - the defining characteristic of irresponsible banking through the ages.
Reassuring words didnt' work, and after the first run on a bank in over a century, the government has been forced to guarantee the savings of every depositor in Northern Crock at a cost to the taxpayer of around £22bn. This was, indeed, Labour's 'Black Monday', when it was driven by events into taking an extraordinary gamble with the nation's finances. Never before has any government given a cast iron guarantee to honour the losses of a bank, indeed all banks, because Alistair Darling was forced to agree that 100% of all bank deposits are now guaranteed by the Bank of England. No wonder shares rocketed - it's now the bank of you and me.
It’s very nice of Mr Darling to use our money to bail out this company and its managers. I’m sure Northern Rock will be equally eager to help those low income home owners who will be unable to pay the increased mortgages rates that Northern Rock will be charging in future as it tries to rebuild its finances. Of course, everyone insists that NR is a “very sound, solvent business” with “solid assets and good prospects”. Everyone, that is, except investors, who have been dumping Northern Rock shares as if they were radioactive. If the FSA is right, and this is such a good business, why does it need to fall on the mercy of the Bank of England to avoid going bust? After all the banking scandals of recent years, it’s hardly surprising that people are queuing up to get their money out of Northern Rock’s few outlets. I would.
But, at least we don’t have any sub prime to worry about here do we? Good old British banks have been prudent lenders, ensuring that mortgages have only been given to people who have the ability to pay and on the basis of rock solid assets. Have they heck. In fact, the British banks have been throwing money at home-buyers without a thought for the consequences for most of the last decade. Just ring up one of the websites. You don’t even have to prove your earnings.
Even at the height of the ruinous US housing boom, American banks weren’t offering125% mortgages or six times earnings to people earning as little as £18,000 a year. Yet that is what British high rollers like Alliance and Leicester and Northern Rock have been doing. They have been “helping” first time buyers get onto the “housing ladder” by offering interest-only mortgages over forty years - mortgages which are so good you don’t even get to own the house after you’ve paid for it!
Irresponsible lending in Britain has prolonged the craziest housing bubble in the world. In America, house prices peaked eighteen months ago at average $267,000 dollars, that's only about £140,000 for a pretty substantial house. Here, that sum wouldn’t even buy you a basement in Edinburgh. Yet somehow we are told that the British housing market is more solid and values here are more reliable; that British house prices can only go up. Well, the laws of economic gravity can only be suspended for so long.
Politicians and central bankers are now beginning to realise the danger of having let the housing market get out of control. Prices have tripled in the ten years since Brown promised he would keep them stable in 1997. But Gordon’s bargain with the devil was that as long as house prices kept going up, the economy would appear to be booming. Cheap credit and house price inflation made everyone feel rich, even though we were building up £1.3 trillion in debts - debts which will now have to be paid now at higher rates.
Actually, if Northern Rock had been allowed to go under it might have brought some sanity into the housing market by precipitating the long-delayed fall in house prices. But following this rescue, political pressure is now mounting on the Bank of England to cut interest rates in order to keep the party going a little longer. With cheaper money, mortgages would become more “affordable” again and people will continue buying houses they, er, can’t afford.
To give him credit, Mervyn King, the governor of the Bank of England, realises that this would only defer the pain for another few years, and so far he has resisted because he has a sense of history. Central banks cut interest rates in 1998 after the Asian stock market crash; they cut them again after the dot.com crash of 2000; and they cut them again after the last housing wobble in 2004/5. The cheap credit unleashed by these actions is the real cause of the American financial crisis, and now ours. But cheap credit is a kind of drug, and we are well and truly hooked.
What the credit crunch is really telling us is that the inflated asset values which underpin the debt economy are no longer sustainable. House prices must come down to earth - either by increasing the cost of borrowing or by allowing inflation to rip and eroding asset values by debasing the currency. Inflation is the weakest and sneakiest way of repricing inflated assets - inflation ruins savings and the livelihoods of people on fixed incomes - so it’s a slam dunk certainty that this is what the government will do.
Of course, the Bank of England is supposed to be the independent and resolute guardian against inflation, at least that’s what its charter says. But by saving Northern Rock it has blinked first. Other banks will see this as a sign that they can continue to behave recklessly secure in the knowledge that the Bank of England will come to their aid in the end.
But the inflation unleashed by cuts in interest rates could be sensational, for right now we are entering a much more expensive world. Oil is stabilising at prices well over $70 dollars a barrel with no signs of a fall, and food prices are increasing for the first time in a generation. A world wheat shortage has led to bread prices going up 25% and there supermarkets are forecasting a shortages in eggs and even bacon for the first time since the Second World War. Meanwhile, America is running up a huge post-Iraq deficit, China is booming out of control and world stock markets are all over the place.
It’s all beginning to look like a nightmare on Downing St..for Alistair Darling. But look on the bright side. Northern Rock may finally have crushed the prospect of an early election. If Brown went to the country now, it would look like panic, and voters might want to withdraw their political credit from the bank of Labour. You can’t call in the Bank of England to halt that.