Archive for October 20th, 2008
20th October 2008
Some thoughts on strategy
I think it was the former Irish Prime Minister Garret Fitzgerald who once criticised the Government of the day’s policy as good in practice, but not good enough in theory. I think that probably just about sums up where we are with the Government’s response so far to the economic crisis. The Government has staved off the meltdown of the banking system by eschewing the kind of neoliberal dogma it once espoused as part of the WashingtonConsensus and offering to nationalise large chunks of the banking sector. What is less clear is where the Government wants to go from here and why it thinks we are in this mess in the first place. Asking those kinds of questions are, of course, uncomfortable for incumbents as John McCain has found out on the other side of the Atlantic. What we desperately need now - and pretty urgently - is, to dust down a phrase from the past, an Alternative Economic Strategy to lead us out of this morass and to help form the building blocks of a new Washington Consensus as the wind of change begins to blow down Pennsylvania Avenue.
The Chancellor has begun to make some reflationary noises, and hinted that he has dropped Friedman and rediscovered Keynes. But he doggedly refuses to change the monetarist terms of the Bank of England’s remit. So what might an alternative strategy look like. Here’s a first stab:
1. An immediate cut of 2% in base rates. This should, under normal circumstances, raise disposable income and business investment. A repayment mortgage of £200,000 would, by a rough estimate, be on average £200 a month cheaper. Businesses that were facing bankruptcy would be saved. And the banks’ balance sheet would not be looking so bad as the terms of some of some of their dodgier investments would start to look not so madly optimistic after all. All of this is contingent on the banks passing these rate cuts on , of course, which might need some strong-arming from the banks new owners: us. There are inflationary risks to all of this and other worries like a redistribution of wealth away from savers which is not good if we are trying to get people to change their financial habits. But in an emergency we have to prioritise, and the immediate priority is preventing a deep and long recession more commonly known as Depresssion. Or a Great Depression, which always sounded like an oxymoron to me, unless you beling to the Austrian school of economists who actually appear to enjoy this kind of thing.
Of course, these are not normal times as banks are exhibiting some of the money-hoarding behaviour traditionally associated with a liquidity trap. Even a 2% cut might not be enough to get the economy moving as seen from the experience of Japan in the early 90s. The key as Graham Turner argues is to act quickly and decisively enough to provide a kind of psychological jump-start to people’s expectations. The longer we leave it , the less likely it will work.
2. Force nationalised banks to lend to each other. Restarting interbank lending is the first step in rebooting the entire banking system. Unless banks start lending to each other through the wholesale market there is little chance they will start lending to you, me and Dai-the-Plumber on the retail side of the sector. Since many if not most of the banks in Europe soon will be part-owned by Governments then the risk of lending between those nationalised banks at least should be minimal. In order to reduce the risk even further we should force banks to go open-book with each other, as suggested by Richard Murphy. They should co-operate rather than compete.
3. Agree a Social Contract with the banks. All the major banks should be required to agree policies on arrears, repossession, responsible lending and the provision of debt advice in return for any financial assistance from the Government or the Bank of England - not just the recapitalised banks but also those seeking Government guarantees for loans and short-term liquidity. The Chairman of Resolution, Clive Cowdery, for example, has called for banks to commit £50 million to help fund advice services like the CABs. This is the least they should do under the circumstances. We cannot allow tens of thousands of people be made homeless unnecessarily, causing them misery, driving property prices down even more and, ironically, further undermining the banks’ balance sheet in a vicious debt-deflationary circle.
4. Create a National Housing Corporation. I and others have argued for this before but now is the time to do it. This would have two functions: taking into social ownership properties that are about to be repossessed and renting them back to the tenants thus keeping them in their own home (either as a social housing property or as a rent-to-buy lease) and unsold buy-to-let properties; building new social housing for rent, meeting the massive unmet demand demonstrated by ever lengthening council house waiting lists. The Welsh Assembly Government would probably need emergency Westminster legislation to be able to do this on its own. This might be feasible as the Spanish national public radio station RNE1 was reporting over the weekend before last that Gordon Brown, in a private meeting with Jose Zapatero, had talked of “the possibility of buying homes and creating a new mortgage system to revitalize the property market”
5. Break Up the Banks. The financial crisis has led to the creation of bigger, more interconnected institutions. This may make sense in the very short term as big banks help shore up their smaller, weaker counterparts. But it could result in an even bigger crisis further down the road. The creation of mega-banks that are literally “too big to fail” may lead to even more reckless risk-taking by banks that know they are too important to be allowed to go under by Governments. The answer is to make banks smaller - by de-merging existing institutions - and less inter-connected by reintroducing barriers between what used to be called in this country higher-risk ‘merchant’ and lower-risk ‘retail’ banking’. As a first step, we should not allow the merger of HBOS and LloydsTSB - no longer needed now because of nationalisation - that would create a banking behemoth with 29% of the UK mortgage market, to go through. The kind of restructuring we need will take a long time to work through not least because of the massive amount of opaque financial liabilities that some of the banks may hold. In order to bide some time in dealing with this and to insulate the system from further waves of destabilisation we should create a UK version of the Swiss ‘bad bank’ idea to park the so-called ‘toxic assets’ which have come back to bite the banks with a vengeance.
6. Create a 21st century investment programme. I have already suggested a major programme of capital investment and a green jobs recovery programme to provide fiscal stimulus. It looks as if the Government is conceding some ground on this one.
7. Give public money back to the poor. People who are struggling financially - pensioners, those on low incomes, families -are more likely to spend in the current climate than anyone else. Even the wealthy are tightening their belts if the Frieze art fair is anything to go by. We should do what the Australian Government has just done and create a package of benefits and tax cuts targeted at low and middle income groups equal to 1% of GDP. How about extending the winter fuel allowance to everyone in receipt of child benefit, raising the tax threshold and increasing the Basic State Pension?
8. Create a People’s Bank. With the banks stubbornly sticking to a policy of credit contraction, we need to find other ways of offering credit to people, especially first-time buyers unable to take advantage of lower house prices because of excessively stringent lending criteria. I have already floated the possibility of expanding local authority mortgages - possibly backed by a Government guarantee. An alternative would be to turn the Northern Rock and Halifax network into a new remutualised building society.
9. Introduce price controls on energy. The Government has annoucned that it may reintroduce the price controls on gas and electricity abolished by OFGEM in 2002. It needs to do this immediately and impose a windfall tax to fund an energy bill rebate which would pump money back into people’s hands at a crucial time. The Government should extend this, through the creation of a fuel regulator, to petrol and diesel where lower oil prices are not filtering through into pump-prices as quickly as could be expected. Finally, the abolition of VAT on electricity and gas and the introduction of a fuel price stabilisation mechanism (lowering duty in response to any future price increase) should guard against the negative effects of any action on oil supply by OPEC.
10. Government should take a stake in small businesses. It’s not just the banks that could drive perfectly sound companies under because of short-term cash-flow problems but the Government too through Her Majesty’s Revenue and Custom’s habit of posting a petition in the London Gazette advertising to the world said company’s financial difficulties and rendering it nigh on impossible to get any credit thereafter. The Conservatives have suggested a six month holiday on VAT. A better idea might be for the Government to take a temporary equity stake in companies with a solid order book to help them overcome any short-term problem with liquidity.
These ideas are work in progress. Let me know what you think.