The sunshine and balmy temperatures of Rome this weekend would have seemed
like welcome respite for Alistair Darling from the wintry weather and grim
economic tidings back home.
The chancellor had travelled to the Italian capital for a meeting of finance
ministers from the Group of Seven leading economies, which was essentially a
preparatory session for the larger Group of 20 gathering in London in April.
However, instead of looking forward to discussions about the G20 agenda,
Darling found himself exposed to chill winds from Britain. Disaster had
struck banking yet again.
On Friday the Lloyds Banking Group revealed that HBOS, which it acquired in an
emergency takeover during last autumn’s banking panic, had lost more than
£10 billion last year, twice the worst forecasts from City analysts and more
than wiping out Lloyds’ £1.3 billion profit.
For Darling the embarrassment came in the government’s use of £17 billion to
prop up the two banks and its ownership of 43% of the enlarged group. With
the share price tumbling by about a third on Friday, that stake was now
worth £8.3 billion less. Questions were already being asked about whether
the shotgun merger, brokered by Gordon Brown himself, was really in the
public interest.
The news came at a terrible time. The week had been dominated by the apologies
of some leading bankers to a committee of MPs for their role in causing the
meltdown and then by the suggestion from Mervyn King, governor of the Bank
of England, that Britain is in a “deep” recession.
Only six months ago the Bank was saying the economy would have a mild downturn
and no more. Now it expects a slide of 4% in gross domestic product between
the middle of last year and this summer and warns that the fall could be
even worse – to 6%.
If the Bank is right in its forecast, 2009 will be the worst year for the
economy since the aftermath of the second world war. If its gloomiest
predictions come true, this year’s downturn will resemble that of 1931 when
Britain succumbed to the Great Depression.
Darling and King, who accompanied him to the meeting, were not the only people
in Rome being assailed with bad news. Timothy Geithner, Barack Obama’s
Treasury secretary, was supposed to be bringing cheer from the United
States. Instead his banking rescue package, which he had announced on
Tuesday, had fallen flat. The reaction had been one of huge disappointment.
Wall Street plunged 382 points, losing almost 5% of its value in response to
what critics described as a “half-baked” set of proposals.
Not only that but the Obama administration’s $787 billion (£545 billion)
fiscal stimulus of government spending and tax cuts intended to kick-start
the economy, which was finally approved by Congress on Friday night, was
derided in the United States as poorly targeted and too slow-acting to make
a difference.
Even Giulio Tremonti, the Italian finance minister and host of yesterday’s
meeting, added his voice to the criticism. “If the problem is an excess of
debt, the cure is not adding more debt, whether that debt is private or
public,” he said.
Tremonti, however, had problems closer to home. In a set of figures described
by analysts as a “Friday the 13th horror”, the eurozone economy was shown to
have shrunk by 1.5% in the final three months of last year, with Italy
sliding by 1.8% and Germany by 2.1%.
King’s “deep” recession is engulfing the world. Bankers are in the dock and
the blame game is in full swing. That is important. But a more relevant
question for now is: how do we steer the economy out of the mess the banking
crisis created? What options are there that have not already been tried?
Fundamental to recovery is the restoration of the banking system to health and
getting money flowing to the wider economy again.
Questioned on Friday over what he was going to do about Lloyds, Darling was
typically lawyerly. He said that to help banks rid themselves of the bad
assets that have laid them low, there were a “range of options that we will
be deploying, a range of levers that can be pulled to help all banks”. But
he twice refused to rule out an option that is growing in popularity among
economists: the nationalisation of banks.
Vince Cable, the Liberal Democrat shadow chancellor and an economist by
profession, said that Lloyds, dragged down by the “financial disaster” of
HBOS, was on a path that would lead “inevitably to nationalisation”.
Nouriel Roubini, the maverick economist who has made his name during the
credit crunch, says the banking system’s losses are likely to reach $3.6
trillion, about half of them borne by American banks, a far cry from the
initial estimates of $200 billion. Propping up failed banks would be
ineffective and encouraging troubled banks to merge was “like having two
drunks trying to help each other to stand up”.
“The nationalisation approach was successfully taken by Sweden [in the early
1990s] while the current US and UK approach may end up looking like the
zombie banks of Japan that were never properly restructured and ended up
perpetuating the credit crunch and the credit freeze,” said Roubini.
The United States and Britain faced the risk of years of depression, like
Japan’s “lost decade” of the 1990s, he warned, which was caused by a refusal
to act decisively to cure the banks of their problems.
Indeed, last year, before the banking crisis had emerged in full, a group of
MPs met Japanese officials who told them that first Britain would have to
nationalise some banks and then the entire banking system to fend off
disaster.
Nationalisation has its problems, though. The public purse would have to take
on all the debts of the banks and it is far easier eventually to privatise
them if they are not wholly state-owned. In the United States, where most of
the problems lie, there is also a visceral antipathy towards the idea. Not
only are there huge numbers of regional banks that might need rescuing,
making it a practical nightmare, but it is also seen by many as “creeping
socialism”.
While bank nationalisation is probably the “nuclear option”, there are other
ideas that could be an improvement on what governments are doing.
“A lot of the focus is on the ‘bad bank’ idea [where a government siphons off
toxic assets], but another way would be for the government to stimulate new
entry into the banking system,” said Martin Weale, director of Britain’s
National Institute of Economic and Social Research.
“If Tesco wanted to come in and enter the banking system by setting up a new
bank, it should be encouraged to do so.”
The “new bank” idea has plenty of supporters, particularly in the United
States. Even with government guarantees, the old banks will be encumbered
with toxic debt for years to come and unable to provide an adequate supply
of credit for the economy.
Paul Romer, a professor at Stanford University and one of the world’s leading
experts on economic growth, says that instead of propping up old banks,
governments should instead put taxpayers’ money into new ones.
“If the government starts as a shareholder in new, healthy banks that
eventually end up entirely in the hands of the private sector, the political
risks start small and diminish,” he said. “If instead the government
combines open-ended and opaque financial support for troubled banks with
promises of tight supervision and punishment for bad behaviour, the risks
are large and grow.”
The new bank idea, which is backed by Joseph Stiglitz, a Nobel prize
economist, among others, is not without problems. Banks need bankers to run
them and they also need networks of branch offices and customer contacts.
With so many bad debts hanging over the existing banks like a poisonous cloud,
governments could not just wash their hands of them. The collapse of Lehman
Brothers and its catastrophic impact on global markets showed how deep the
poison reaches.
That is why experts say it will be necessary to act, not just on the banking
problem but also on its causes. In the United States there is no sign of an
end to the housing collapse, which has seen prices slide by nearly a fifth,
and in some areas by a third, and which sparked the global downturn.
The Federal Reserve, America’s central bank, has stepped in to drive down
mortgage rates to zero. Some think it should go further. Ben Bernanke, the
Fed chairman, has spoken in the past of a “helicopter drop” of money to pull
the economy out of recession.
Time, the US news magazine, has proposed that it come in the form of a gift to
every household equivalent to 30% of the value of their mortgage. Cutting
home loans in this way would provide a direct boost to spending and reduce
the likelihood of default, the big factor weighing on the banks. It would
cost a lot to implement, but that might seem a good investment if it stopped
mortgage defaults.
In Britain, Fathom, an economic consultancy, says that instead of buying
assets from the banks, the government should spend £50 billion buying houses
from homeowners under threat of repossession.
Danny Gabay, a director of the firm, predicts that without government action
there will be 375,000 repossessions in this recession, compared with 225,000
in the early 1990s. Under the Fathom plan the government would buy
properties from owners facing repossession, at 10% to 20% below market value –
above the 37% discount at auctions – and rent them back to the owners.
“What we’re trying to do is stop repossessions,” he said. “All these rescues
tackle the symptoms, not the cause. We need to target the underlying asset,
housing.”
With the “lever” of interest rates at 1%, the lowest in history, King last
week prepared the ground for a programme of “quantitative easing”, the
central bankers’ term for printing money. This is not as exciting or –
for those who look to the hyperinflation in Zimbabwe– as worrying as it
seems.
The Bank would not distribute free money but would instead buy up corporate
bonds and other financial instruments so as to inject capital into the
system. King last week signalled that this is likely to start next month.
He also added that the Bank is faced with a “paradox of policy” in that it is
trying to make people spend, which is the opposite of the saving culture it
would normally encourage.
In such confusing times the one reassuring message that King was able to offer
was that, like most economists, he expects things to get better towards the
end of this year.
The measures that are already in place were not quick fixes and their effect
would take time to trickle through to consumers and businesses.
King pointed to the record low interest rates, the boost that the economy
should get from a lower pound, the sharp fall in oil prices and the
government’s five-point plan for getting the banks lending again.
They would work in the end, he insisted, and the economy would return to
growth. For his sake, and of the government and the banks, that cannot come
soon enough.
Additional reporting: Holly Watt
