Sean O'Grady: Who was to blame for the credit crisis?
It took about 40 years for a reasonably consensual explanation of the Great Depression that could be rattled off in three minutes to emerge. Even with the perspective of today, that traumatic episode in economic history continues to generate some debate. (There are people out there who believe that Franklin Roosevelt caused the Great Depression, in case you were wondering).
It may well take a similarly long period of academic research and political argument to get to the bottom of what has gone wrong over the past 12 months, or longer. Novelty is one reason why. We haven't seen anything quite like this for a very long time. In an interview a couple of months ago, the Chancellor, Alistair Darling, made what seemed some spectacularly ill-judged remarks to the effect that the economic conditions the nation faced were "arguably" as bad as anything in the past 60 years.
His words seem not so sensational now, and the historical perspectives keep being pushed further back into the mists of time. The Governor of the Bank of England, Mervyn King, said the other day that the banking system has not seen a crisis like this since the First World War. His Deputy Governor for monetary policy, Charlie Bean, said that a financial crisis of this kind had not been seen before in human history. What next? The worst credit crunch since dinosaurs ruled the earth?
It may not take quite so long for us to get some sort of a grip on this crisis, or at least to develop an intellectual framework with which to analyse it. What is emerging is three schools of thought, or culprits if you like. These can be termed the "macroeconomic school"; the "regulatory school"; and the "banking school". The first, in effect, blames no-one and abstracts away minor consideration of institut-ional arrangements and political personalities to focus on the big picture. The scenario is quite simple, really. It starts from the well observed premise that much of the money that flowed into the western economies over the past decade came from China. ("China" here being shorthand for all the fast-growing, export-driven economies of the world, especially east Asia, and thus encompassing Malaysia, Korea, Indonesia and the like). That, in turn, originated in their large trade surpluses with us. In effect, we consumed more than we earned, and the Chinese lent us the money to carry on doing so.
And what did we do with the money? We created an asset bubble, an inflat-ion in one particular type of investment. It happened, in the US and the UK, to be housing, but it need not have been. The money could have gone into any kind of asset, as it has before. Before the Great Crash of 1929, it was shares, as it was before the dotcom crash of 2000. The belief that the value of shares would only ever go up, that there was a "new paradigm" because of fantastic new technologies, fuelled these booms. In eighteenth century Europe, it was the South Sea Company's untold – and unreal – riches on the other side of the globe, the original speculative bubble.
In the 2000s, it was dream homes in Florida and semis in the English home counties that were the subject of a frenzy. It could have been classic cars, or antiques, or fine wines. It doesn't matter, except in the important sense that housing has a social aspect. Capitalism usually creates bubbles where there is a lot of cash swilling around, and no politician has ever, ahem, been able to abolish boom and bust. We will always have crashes, and it is foolish to suppose that we can prevent this sort of thing happening again.
So, on this view, it is really no one's fault, except, perhaps, our own, because of our unquenchable desire for cheap DVD players, lovely homes and lack of fear about debt. However, people never look to blame themselves first. What is happening now is a reflection of that; we have to pay back our debts and cope with a transfer of wealth and income to China. The financial sector has to shrink and rationalise. We basically don't fancy making that historic adjustment. Hence our second school of thought.
This is the one that holds most attraction for the politicians and public. As we see with the conspiracy theories over the death of Princess Diana, the public are unwilling to accept simple explanations. They usually want to blame someone. Up to a point, they are right, though. You can have more or less effective people working as regulators; more or less satisfactory structures; and more or less satisfactory attitudes. It is difficult to argue that the UK's arrangements were perfect on any count. The example of Spain is a powerful one. There, the Government discouraged the banks from joining in the American sub-prime party, and the central bank required the banks to have a "counter-cyclical" attitude to their business. The Bank of England has now taken up the cause of what is called "macroprudential" rules. In a way, these are just a fancy answer to Ogden Nash's old complaint about the banks; that they only lend to people who don't need the money. Now, as the economy enters recession, we do need the money, and yet they won't lend. Even so, it is also fair to point out that Spain's real estate boom and crash has been almost as dramatic as ours.
Third is the banking school of thought. On this view, the blame lies with the banks. This is not because they were too greedy but because they were too stupid: they failed to maximise their profits. There is something in this, too. The banks are not some sort of force of nature that has to be tamed by governments and regulators. They are responsible for their own actions. They did not have to offer "Ninja" loans – to folks with no income, no job and no assets. They did not have to create derivatives that their senior managements didn't understand. They did not have to adopt the "originate and distribute" model of lending that converted bankers into dodgy salesmen and distributed risk arbitrarily. They did not have to have bonus systems that rewarded taking on too much risk and short-termism. And they don't have to rely on quite so much funding from the money markets – and often from abroad – as opposed to customer deposits. As the charts here show, the growth of the banks' balance sheets over the past few years was impressive; but it was driven by a dangerous increase in leverage (they borrowed too much as well) and by making less and less prudent lending decisions. Should the FSA or the Bank of England or the Government have stopped them? They could have tried harder but the regulators can't make the bankers' commercial decisions for them, and it was those that were flawed.
Of course, these schools of thought are not completely mutually exclusive. In reality, it is more a question of where the balance of blame attaches.