The dismal plight facing the UK economy naturally brings to mind rousing and inspirational Churchillian rhetoric.
I am sad to report, however, that we are not even at the end of the beginning of this financial and economic crisis. Its impact on the fortunes of us all will be felt for many years to come. It is important not to heed some of the more outlandish predictions of our economic future (such as the so-called City expert opinion that the UK is now heading for bankruptcy) but a turbulent journey lies ahead. For in spite of the astonishing pace and extent of decline over the past twelve months there is no end in sight for the travails facing the banking sector.
The seven largest global investment banks have all lost their independence. One, Lehman Brothers, has gone bust. On these shores the government has spent or guaranteed unimaginably huge sums of public money trying to bring stability to the entire financial system on a scale that is barely able to be comprehended. Such is the price for the UK economy’s unbalanced position as a truly global player only in the financial services sphere. Watching the second attempt by the Chancellor of the Exchequer at a definitive bailout my gloomy, but overriding, thought was this: how soon before the government returns for a third bite of the cherry?
The nagging doubt remains that the government lacks any real plan of what UK banking should look like once the worst is behind us. I believe we must soon see a robust vision for restoring free-market disciplines into this stricken sector. For whilst the spirit of the age may point an accusing finger at ‘market failure’, history teaches us that governments fail far more often. As I have written before, politicians of all parties must explain to the general public some unpalatable home truths – Britons have spent and borrowed far too much over recent times; moreover, too many of us lack the necessary skills to compete effectively as a high-wage player in the global economy. Unless these long-standing failures of government are addressed urgently the UK risks social unrest on an unprecedented scale.
As the financial crisis took hold last October there was a failure of government to send a clear message to the financial system about its priorities at such a difficult juncture. Those UK banks taking government money (RBS and Lloyds/HBOS) were ordered to resume lending at 2007 levels yet simultaneously constrained by an FSA decree to shore-up their balance sheets by increasing their capital reserves. The imposition of a 12% interest rate on government owned preference shares (roughly double what US or European banks were being charged in what was supposedly a co-ordinated international bailout) led to sheer confusion. Belatedly the UK government has recognised that part-nationalised banks’ rational reaction to prioritise the repayment of government loans ran directly counter to its broader economic aims. As a result the government has transferred its preference shares into equity. But this policy confusion since October has cost the UK taxpayer dear.
By 19 January, the day of the second bailout, RBS’s total market value had plunged to only £4.5 billion despite the bank having received over £20 billion at what we assumed was the lowest values last autumn. In these short months ownership of RBS shares has cost the UK taxpayer over £17 billion – greater than the UK’s entire annual defence budget.
Speaking to City professionals in recent weeks my clear understanding is that the problem facing the financial system is not simply one of lack of confidence: the biggest danger now is that trust in our entire financial system has been so eroded that there is a limit to what government action can achieve. In the eye of this storm the City’s demise should not be exaggerated. Better times will return and our critical mass in this sector will stand the UK in good stead for the future. However, the reputational danger to both the City of London and New York means that both centres should expect a markedly smaller slice of the global financial services cake when the recovery comes.
How will this all play out? Whilst historically confidence can often be regained quite suddenly and seemingly without a trigger event, the restoration of trust in a failing system is much more difficult.
By the time the government has a third stab at a widescale banking industry rescue, RBS may well be fully nationalised. The Lloyds Banking Group and Barclays (notwithstanding the terms of its deal last autumn with Abu Dhabi investors) may well by then also have the government as a majority stakeholder. At which point given the imperative to protect the taxpayers’ financial interests (an issue which seems to have been forgotten in all the turmoil to date) the competition implications may force even the final ‘big bank’ HSBC, to sacrifice its independence in the interests of a ‘level playing field’. It would then be a short step from nationalising the banks to bringing large parts of UK industry and commerce under government influence, control or ownership. We already see the first signs of this in high-level discussions over what remains of the UK car industry. Indeed the fast deteriorating state of their corporate client portfolios represents the most serious short-term threat to the balance sheets of the UK banking sector.
This scenario would also open the door to the creation of a ‘toxic bank’, a step which the government has so far resisted. Whilst the creation of a vehicle to take on all the toxic assets of the major banks should in theory free-up inter-bank lending and with it the credit markets, it comes at a tremendous risk. In these turbulent times it is almost impossible to set an accurate value to such toxic assets. Valued too low and the beleaguered banks stand to be crippled by their debts for years to come and unable to contemplate a return to private ownership. Value the toxic assets too highly (a more likely problem) and the taxpayer will foot an unfathomably large bill, further delaying the restoration of confidence and trust in the broader financial system.
This nation needs to go back to the enduring values of personal responsibility, thrift and enterprise. We must recognise that the debt-fuelled credit bubble of the past decade – and the current government’s strategy for repairing the damage – is little more than a pyramid sales scam against the young. Future generations of British taxpayers will foot the ever increasing bill for the ‘rescue’, which fails to halt, yet alone reverse, the unsustainable levels of public sector borrowing. To pay for the years to come for present day consumption also makes it difficult to promote the much needed savings culture for the future.
The world of finance will look different. However, we have paid the price for short-termism, financial products being improperly understood and over-exuberant speculation in the past. This downturn is new only in its extent and the elusive ingredient, trust, will take a long time to restore.
Above all, at this of all times politicians need to defend capitalism and free markets as the only bulwark against an all powerful State. For whilst government’s role in stabilising our beleaguered economy cannot be denied, it will only be the hard work, enterprise and flair of our wealth-creators building businesses which will ensure that our economy rises again.