Darling's having a good war

You wonder why they bother, finance ministers I mean. The stock market fell when Alistair Darling dithered over a rescue package for the banks. So he handed the banks the biggest bail out in history - £500bn of our money - and what happened? The market crashed in the worst panic since 1987. There’s just no pleasing some people

The same thing happened in America. When Congress rejected Treasury Secretary Paulson’s $700bn TARP plan last month the Dow collapsed; when Congress passed it, the markets collapsed again. The lesson seems to be that if you dither things get worse, but when you act they still get worse.
This revolution of falling expectations was a phenomenon noted by the economist JK Galbraith in his study of the Great Depression. It’s all part of the process called “deleveraging” - the modern term for drowning in your own debt. Government interventions, however well intentioned, become stages in the continuing crisis of insolvency.

Shocks like the Icelandic default, itself a knock on effect of the collapse of the investment bank Lehman Brothers last month, leave British savers bereft and British councils with hundreds of millions of losses. This breeds more fear and more government interventions which make markets even more nervous. The latest epic falls in the stock market are partly a consequence of the Icelandic insolvency reinforced by obscure traumas in the credit default swap market. And don’t be fooled that these are just paper losses. Last week’s share-price collapse will hit the asset base of companies and banks causing a further wave of write downs, fire-sales and bankruptcies. We are now in a kind of death spiral.

Last week we nearly saw a run on the entire UK banking system - an event which was only forestalled by the Chancellor, Alistair Darling’s, rescue package on Wednesday. Darling is having a good war, so far. His unflappable calm - which I witnessed at close hand at a reception at Downing St last week at the height of the crisis- has turned into a real asset for the government. He must have known about the bank run as he nibbled at canapés with various hyperventilating hacks. But he looked as if he’d just dropped in on his way to the opera. Not that the Chancellor appeared complacent or detached. No one can accuse Darling of failing to appreciate the gravity of the situation because of that Guardian interview two months warning us that this could be the worst financial crisis in 60 years. He was not wrong.

It’s a sobering thought, but our own Alistair Darling will now forever be associated with one of the greatest economic catastrophes of modern times. His face will adorn every website devoted to the Great Crash of 2008. That curry he bought in to feed his team on the night of the rescue has already become part of history as the “Balti bailout”. Economists and historians will now assess his every move, his slightest utterance. Remember hapless Tory Chancellor, Norman Lamont, outside the Treasury on Black Wednesday 1992 standing next to a dumpster and trying to sound calm while his hair was blowing away in what seemed like a financial hurricane. Further back, Philip Snowden had the misfortune to be Labour’s Chancellor during the 1929 crash and the Great Depression, and is hardly a congenial role model for Darling. The hard-bitten Snowden imposed a fiscal crackdown and split the government, and the Labour Party. with his call for cuts in unemployment benefit. Snowden never recovered. Let’s just not go there.

No, it’s really not a good idea to be a Chancellor in a recession - which may explain why Gordon got out when he did. Finance ministers are largely there to carry the can for everything that goes wrong - and as we know, in a financial crisis, everything goes wrong, even the things that go right. Darling’s economic package last week was in many ways a triumph. It was hailed by economists, commentators and financial analysts as an imaginative and comprehensive solution to the problem of credit drought and insolvency in the banking system. The recapitalisation of the leading banks, backed by colossal sums in liquidity and debt-relief, almost certainly halted the run on the banks. You could almost see people breathe easier. Coupled with the co-ordinated cuts in interest rates, it looked like the government had stepped up to the plate and hit a home run. How much better it seemed than the US Treasury Secretary Henry Paulson’s botched and divisive TARP bailout last month.

The only problem with Alistair Darling’s cunning plan was that it didn’t actually work - at least not in the markets. The FTSE share index shrugged, thought a bit, and then indulged in a senseless act of panic selling on Black Friday.. The FTSE dropped 9% in one day and is now down 40% on last year. The markets are simply not in the mood to be reassured right now, and the fact that the balti bailout was the biggest in history only made them more fearful that things must be really, really bad.

This is what Roosevelt meant in the 1930s when he said that there was “nothing to fear but fear itself”. It is the nature of markets to indulge in self-reinforcing panics which prolong and intensify economic crises. Unfortunately, it is not that easy to halt the fear spiral, as we saw last week. It takes more than a financial package, however well crafted.

So what would work? Well first of all heads should roll - and yes, I know that sounds a bit petty and vindictive, but it’s true. The fact that the bosses of those banks, like Sir Fred “the shred” Goodwin of RBS and Andy “spiv’s spiv” Hornby of HBOS are still in post with their multimillion pound salaries and bonuses is not just a scandal, it is an obstacle to recovery. Until the people responsible are cleared out of insolvent and irresponsibly-managed financial institutions, how can the public, and the markets, be sure that things have actually changed? In any other walk of life, when there is a major failure of leadership, the leaders take the walk to restore confidence.

The other failing is more profound. Everyone accepts that the problem has been one of an irresponsible credit and housing bubble which has now burst with spectacular consequences. House prices are falling faster than in 1991. The debt-model for the British economy is dead, the markets understand that viscerally. Just cutting interest rates and stuffing the banks with public money will not work - and, if it did, might just lay the ground for the next bubble.

We cannot live on house prices alone. Recovery will require a broad economic strategy - like the New Deal in the 30s - involving investment in infrastructure, like fast rail, sunrise industries like renewable energy, and a manufacturing and technology strategy. This is a lot harder than giving money to banks. But as someone said in another context: there is no alternative.