Five years since Northern Rock - and no end yet to financial crisis

  Five years ago this week, on the 9^th of August 2007, the world changed. That was day the banks suddenly stopped lending to each other, causing the collapse of Northern Rock and plunging the world economy into a slump from which it has yet to recover. Indeed, last week's manufacturing figures suggest that we are heading into a new worldwide manufacturing recession, though you could be forgiven for not having noticed that we had come out of the previous one.

So what have we learned in the past five years? Well, not a lot, as the latest revelations about the behaviour of loss-making Royal Bank of Scotland confirm. The global financial crisis has simply become worse in precisely the way that many foresaw. Since 2008, governments have thrown ever greater sums of public money at delinquent financial institutions in the hope that they would mend their ways and become what banks should be: engines of credit that allow industry to expand rather than vehicles for personal self-enrichment.

The executives of the major banks not only lost any sense of financial prudence, they pretty much ceased to obey the law. The Libor scandal, where banks like RBS manipulated interest rates to boost profits, was fraud, plain and simple. But unlike normal people who go to jail when their fraudulent activities are discovered, no banker has had to face any kind of serious penalty. The new boss of RBS, Stephen Hester, said last week that he has been going over his company “turning over stones” and finding many activities that are “inappropriate”. But the slimy creatures exposed have been allowed to slip away into the mud. The British government could, after RBS was largely nationalised in 2008, have wiped out the shareholders, prosecuted senior executives like Sir Fred Goodwin, and abolished bonuses altogether. Unfortunately, it just handed over public money in prodigious amounts, through measures like Quantitative Easing and the  £80bn “Funding for Lending” scheme which is a bribe to make the banks do what they should be doing anyway: lend to small businesses.

Last week, a press report suggested that the government was thinking of fully nationalising Royal Bank of Scotland. This was a curious story because almost immediately it was dismissed as “nonsense” by the Treasury, yet everyone seems to believe that the Financial Times story came from reliable sources. One theory is that the government was trying to divert attention from the fact that RBS is already effectively nationalised, and that it's latest losses of £1.5bn are our losses. As are the large fines it will have to pay for its Libor fixing and for defrauding small businesses by selling them dodgy financial instruments they didn't need. The bank is state owned but out of control. It can't even keep track of its clients' accounts following its computer crash last week.

But RBS is a microcosm of what has happened to the global financial system. What began as a banking crisis has turned into a sovereign debt crisis, with governments as well as banks now sinking under the weight of their unsustainable debts. It is an oversimplification to say that governments simply took over the private debts of the banks. But that's essentially what happened. The crisis of the eurozone is a direct result of the measures taken by governments to cope with the collapse of the financial system after 2007. Countries that had sound and stable public finances before the crash, like Ireland, have been ruined because they promised to underwrite their banks' losses with public funds. The brutal recessions that came in the wake of the 2007 crash further undermined public finances.

The debts of the few have become the debts of the many. The crash was caused by excessive bank lending, largely based on over-inflated property values, which made vast profits for bank executives when the bubble was being inflated, but plunged their banks into insolvency when the property bubble burst. The banks knew that they were engaging in highly risky financial speculation, using complex derivatives like those infamous Collateralised Debt Obligations. They knew that house prices couldn't rise forever, that levels of leverage were dangerous, and that 125% mortgages was irresponsible. But they calculated that, if anything serious happened, then the central banks and governments would step in and bail them out. Which is exactly what happened.

In Britain, according to the Bank of England, the initial bailout required £1.2 trillion of public money. This figure is much misunderstood. Most of it was in the form of government guarantees, liquidity loans, and asset swaps rather than direct capital injections. But that doesn't alter the fact that the government rescued the insolvent banks in the way it would never have rescued any other loss-making industry. Royal Bank of Scotland alone required £454bn of public money.

The government had no choice but to rescue the banks, because institutions like RBS had grown so large that their collapse would have brought down the entire financial system.  However, the government did not have to bail out the bankers themselves, whose hunger for ever larger bonuses had been a major cause of the crisis in the first place. Unfortunately they did – a scandalous failure of regulation for which this generation of politicians will rightly be condemned by history.

There is much chatter in financial circles about the Bank of England and the government putting together contingency plans for nationalising all the major British banks should the eurozone crisis lead to the default of one or other of the Mediterranean states. If Greece, or Spain, or Italy were to leave the eurozone, the financial shockwave would plunge the banking systems of Britain, France and Germany into chaos. This is because the debts of those defaulting countries are held by banks countries like ours. If these debts have to be written off, because the debtor countries are no longer going to pay them, the losses would plunge the banks into bankruptcy again.

Why not let them go bust, you ask? Well, bankrupt banks cannot lend, and if no one is lending, the entire economy seizes up. ATMs stop working; people don't get paid; shops have to close; trade becomes virtually impossible. An economy without credit, without solvent banks, is almost inconceivable, since it would be an economy reduced to barter. Therefore the banks may have to be bailed out again on a much greater scale than in 2008. But what is becoming increasingly clear is that the money to do this simply is not there to manage another epic bailout.

Last week, Mario Draghi the head of the European Central Bank,  failed to come up with the financial “big bazooka” to rescue debt-stricken Mediterranean countries like Spain. Essentially, the ECB is unable,or unwilling, to do for these countries what the UK government did for banks like RBS - effectively taking over their debts and 'socialising' them. But if the ECB does not come up with a convincing rescue, then countries like Spain will simply, triggering bank rescues across the “creditor” nations like the UK. This would be the ultimate irony of the financial crisis: the excesses of the neo-liberal era of supposedly free markets could lead to the wholesale nationalisation of the financial system. Only this time, it would be for keeps.