In the first fortnight of October 2008, Britain went slightly mad. Perfectly rational people were pulling their money out of British banks and sending it across the Irish sea to banks in a country in even greater financial difficulty than ours. You could almost feel the panic in the air. Friends who had never shown the slightest interest in financial affairs were suddenly dividing up their savings into bite-sized chunks and depositing them in an array of institutions to comply with the government’s deposit guarantee scheme.
What drove this bizarre behaviour was fear – fear of something so strange, so unusual, that it has never actually happened in Britain, at least not since the modern banking system was invented in the 18th Century: a simultaneous run on the nation’s banks. Were these fears justified? Could the large British banks have folded? Probably not. The government was always going to step in – as it did – to avoid a systemic collapse, because the consequences of not doing so were too awful to contemplate. Loss of any one of the big high street banks would have reduced Britain to sub-Icelandic status . This was why the government had nationalised Northern Rock a year previously.
But the collapse of confidence extended to the government itself. Gordon Brown repeatedly assured anxious depositors that the government stood ready to act again if any other banks threatened to go under, but a lot of people thought it was still safer to hedge their bets and join the banking merry-go -round. According to the BBC’s Robert Peston, who has become the Walter Cronkite of the financial crisis, Royal Bank of Scotland was within hours of closing its doors because of a run on deposits. The heads of the big banks were summed to the Treasury by the Chancellor -Alistair Darling, whose place in history is assured – and given an offer they couldn’t refuse: accept government money, or be nationalised. Sir Fred “the shred” Goodwin the boss of RBS called it a “drive by shooting”, unconsciously comparing himself to a gangster.
It was ironic indeed that Scotland’s oldest banks, one of which had practically invented modern paper money, were at the centre of the crisis. HBOS and Royal Bank of Scotland, institutions which since the eighteenth century had been synonymous with prudence, caution and thrift were exposed as reckless gamblers, willing to take astonishing risks with their depositors money in the pursuit of world domination. RBS was one of the five largest banks in the world until October 2008, when it almost became the greatest casualty in the history of banking. Halifax Bank of Scotland was supposed to be the people’s bank, eager to help the first time buyer onto the “property ladder” and happy to bankroll Scottish entrepreneurs who were frozen out of the City of London club because they didn’t wear the right ties. More than half of corporate lending in Scotland in 2007 is said to have come from HBOS. Its collapse into the arms of Lloyds leaves much of Scotland’s economy without any means of financial support as we enter the worst economic depression since the 1930s.
The collapse of HBOS and RBS was a crushing blow to Scotland’s self confidence and has been compared to the Darien Disaster in the 1690s when Scotland’s great colonial adventure ended in disgrace and the loss of around a quarter of the nation’s entire capital. That is perhaps a comparison too far. Nevertheless, financial services was Scotland’s growth industry and we are going to have to look for something else in future to earn a crust – and no one is quite sure what that is. But we aren’t alone: unlike in the 1690s both Scotland and England now face the same fate, as the management of money has turned out to be a fools game. Both partners in the Union had bet the house on financial services and had allowed manufacturing industry to dwindle. The Crash of 2008 has been a devastating collective blow to the UK, but unionists believe it has brought the nations closer together in the face of a common financial adversity .That remains very much to be seen, of course, and depends on whether Scotland is perceived to receive a fair deal in the economic reconstruction that is to come. But it is certainly true that, right now, both Scotland and England are too busy clearing up the wreckage to be thinking about further constitutional change.
And it isn’t over yet. This is a global banking meltdown and the financial reactors are still burning out of control spreading toxic waste across the entire economy. The crisis that began with the collapse of the sub-prime mortgage market in America two years ago, is now expected to cost – in direct banking losses – between $1,000 billion and $2,000 billion before it blows itself out. The economic impact of this has to be multiplied ten fold to get a measure of the contraction of global credit that is entailed by losses on this scale. The days when banks lent multiples of thirty times their core capital – which was standard practice in th City of London as recently as 2007 – are clearly over. All the banks are now focussed on building their balance sheets and trying to pay off government loans and equity stakes, which is one reason why it is naive to expect them to return to the easy lending practices of the past. Another is that many of the businesses they are being asked to lend to are going to go bust in the recession.
But we are all now in the banking business. Half the British banking system is now nationalised, an outcome that would have seemed incredible this time last year. The UK taxpayer has injected some £600 billion in loans, guarantees and capital into the banking system during 2008. That is an astonishing sum, and of course, most of it will hopefully return to the Exchequer as loans are repaid and government shares are sold off when the banking system recovers. But for now we all now carry the losses of banks like RBS Northern Rock and Bradford and Bingley on our national balance sheet – even though the government is not quite prepared to admit that it is there. Many taxpayer billions will surely evaporate, or find their way into private accounts. The banking system, even when it is bankrupt, remains highly efficient at one activity: generating bonuses. Even in the year of the greatest financial crash in modern history, the City of London managed to pay itself around £10 billion in bonuses.
Curiously, public opinion seems pretty relaxed about this – certainly there have been no angry demonstrations in Threadneedle St. There has been no clamour for heads to roll in this crisis, and unlike in America there have been no angry public hearings or arrests. We seem to accept that being fleeced by bankers is just a fact of economic life. Indeed, it is extraordinary looking back about how complacent the authorities were about the economic crisis. As recently as August 2008, the Bank of England was insisting that the worst of the credit crunch was over, that Britain would escape recession and that economic growth would be around 2.5% in 2009. How can we have any confidence in economic forecasters that got it so spectacularly wrong? In his pre-Christmas BBC interview, the deputy governor Sir John Gieve, admitted that the Bank of England simply didn’t understand the crisis. It thought that the effects of the credit crunch on the real economy would be limited and that the housing bubble was a temporary and largely benign phenomenon. Well, now they know.
Yet it should have been clear to anyone with half a brain that house prices – which had nearly tripled in ten years – were an accident waiting to happen. It was the apparently endless rise in real estate values, actively encouraged by governments here and in America, that fuelled the credit bubble. The belief that house prices could not fall is what motivated banks to give sub-rpime mortgages to Ninjas – people in American cities with no income, no jobs and no assets. If these people defaulted on their loans, so the banks thought, their houses could still be sold at a profit in a rising market, and so there would be no losses. This was what underpinned investor confidence in the various mortgage instruments, like the infamous collateralised debt obligations, which packaged up loans of various qualities and sold them on as securities. It was the belief in ever-rising house prices that led Northern Rock to start lending 125% loan to value on houses in the UK and caused HBOS to throw caution to the winds in seizing a third of the UK mortgage market. All booms need fuel and it was this magic money from ever-rising property prices that provided the combustible material. When the inevitable happened and house prices started to fall, first in America and then in Britain last year, the whole system was plunged into crisis.
How could some of the most intelligent people on the planet, hired by the banks on huge salaries, come to believe in something so plainly ludicrous as the idea that house prices could never fall? Well, the short answer is that they were paid to believe it, or rather they were paid not to disbelieve it. As someone who repeatedly wrote about the inevitability of a house price collapse, I know from my own direct experience how difficult it was to challenge the orthodoxy. People got very angry if you said house prices were unsustainable – didn’t I know there was a housing shortage, that land was scarce, that immigration and divorce was creating huge demand for housing and that governments would ensure that house prices would not be allowed to fall? Most of the property experts accepted that a house price fall was theoretically possible, even that it was going to happen eventually – but not for the foreseeable future. And for the foreseeable future, there was money to be made. You see, no one made money from saying that house prices would eventually fall, except a few astute futures traders and people like Jon Hunt, the owner of the Foxton’s estate agent empire, who sold his business for £400m on the eve of the crash.
This confidence in ever rising prices was bolstered by the government and the Bank of England. I recall Labour politicians insisting that, if house prices fell, the Bank of England would just cut interest rates and everything would be fine. Governments gave huge tax advantages to home ownership, like exemption from capital gains tax, to keep prices rising. The state even underpinned the buy-to-let market by allowing landlords to set their mortgage interest against tax. This qualifies as one of the most ruinous tax breaks in fiscal history, since it encouraged a million or so amateur landlords to invest their pensions in badly built city centre flats at the very top of the housing boom. Most of these flats are now worth barely half of what they cost to buy.
The government believed that high property prices were a good thing. They boosted retail sales in furniture and home decorating firms. Rising property values underpinned the growth of the financial services industry which was built on the mountain of debt taken on by British families in order to enter the property market. Labour arguably won two general election victories on the strength of rising property prices. People felt rich because their houses had doubled in price.
But the flip side of property prices, of course, is debt. and Britain is now drowning in it. We now owe £1.5 trillion in mortgages and unsecured loans – more than Britain’s GDP and more than, per capita, any country in the world including America. Every household in Britain owes £60,000 on average, and of course house prices are now collapsing at a faster rate than at any time since the 1930s. Prices have fallen 16% in the last year alone, and are dropping at around 2% a month. There is no expectation that the fall will be halted in the coming year and the banks are pricing in a further 15% drop. This, rather than prudence, is why banks will not lend to first time buyers unless they can put up a sizeable deposit – at least 20% for the better mortgage deals. Continuing falls in house prices will further damage banking balance sheets as they have to accept further write downs in mortgage bonds.
And now we have recession and the spectre of mass unemployment entering the economic equation. It is quite possible that three million people will be unemployed by the end of 2009. Retail chains like Virgin, MFI and Woolworths are collapsing like skittles as the financial crisis deepens. The government is preparing to bail out the motor industry, even though it is mostly foreign owned. Having thrown billions of our money at the banks, the government finds it difficult to argue that other legitimate industries should go to the wall just because of a temporary lending famine.
The government’s financial credibility has been the other great casualty of the year. Gordon’s golden rules have been thrown out as the government has taken to borrowing like there is no tomorrow. £16bn in November alone. The PM is justifying this as a necessary corrective to deflation. Better to borrow than to end up with another Great Depression. But the danger is that the debts raised now will only have to be paid off a couple of years down the road while the economy is still contracting. There is a suspicion that Brown’s horizon is limited to the chance of winning an election in Spring of 2009, before the real mass unemployment begins to mount.
There is anyway something deeply suspect in tackling a debt crisis by yet more borrowing. At the end of 2008 he most indebted people on he planet were being urged to go out and spend their way out of recession. It was another kind of madness to add to the banking panic of October. Truly, 2008 was the year we all took leave of our senses. In 2009 many of us may have rather more leisure time than we expected in which to reflect on the insanity of the financial system we have created and sustained by our collective appetite for debt.