The key political fact about the present credit crunch is that the Government didn't start it. This is very different from what has repeatedly happened since 1945. The pattern had come to seem immutable. First inflation would become a problem.
Then wages settlements would begin to increase. In turn the rise in prices would accelerate. Finally, to halt the spiral, the government of the day would sharply raise interest rates.
In other words, from time to time governments deliberately squeezed credit as an act of policy to curb inflation. And often for good measure they added cuts in public spending and tax increases. It was this boom and bust cycle that Gordon Brown, when he was Chancellor of the Exchequer, resolved to abolish. In fact he was never put to the test. For inflation remained subdued throughout his 10 years at the Treasury.
Now go back to early August 2007 when a small German bank got into trouble. At the time, inflation still remained modest. True, oil prices had risen sharply and food was becoming rapidly more expensive. But wages had scarcely shifted and governments weren't disposed to act. Yet it was then that the first spasm of fear convulsed the money markets and credit immediately began to tighten. Looking back we can see that from that moment in August 2007, a credit squeeze of unparalleled ferocity had taken hold.
Neither the British nor American governments deliberately brought it about. Quite the reverse, for as the credit crunch tightened, with money markets seizing up, governments around the world have done everything they can think of to halt the process. Without success. Even the $700bn bailout approved by the US Congress last week may not ease the pressure enough.
In the past, the question of who was to blame for a downturn seemed obvious – the Government. This time, however, attempts by the Conservatives to blame Mr Brown and his government haven't worked. Polls show that the Prime Minister is earning a degree of trust.
Who should stand in the dock? Should it be banks, regulators, or the ‘short’ sellers of banking shares’ or persons as yet unknown? Whether this will remain just a talking-point will depend upon the severity of the coming recession. If many workers lose their jobs and wonder why, they may well become angry. Bookmaker Paddy Power is taking bets on which will be the first city to experience credit crisis riots.
Who is chiefly at fault? In my view the banks are the guilty parties par excellence. They overtraded for years. Firms which overtrade, that is undertake business transactions at a level that exceeds their resources and use excessive borrowing to make up the difference, inevitably go bust – unless, that is, they are banks and the government of the day has to come to their assistance. That is why the regulations to which the banks are subject are designed to prevent overtrading. They do this by stating how much capital each bank must hold to support different levels of activity. Ambitious banks came to see these restrictions as a problem to be overcome not as an absolute bar.
I feel angry as I write the next sentences. Rather as rich people ‘legally’ evade tax, so banks evaded prudential restrictions by setting up special purpose companies – Northern Rock's was named Granite – that could do what banking is, borrow short and lend long, without being called banks.
They created these entities in such a way that regulators would be ignorant of their true purpose or, if they understood, they would not be able to reach them. And once clear of regulations, the banks gave staff generous incentives to build business.
To be specific: the directors of banks carry the full responsibility. Nothing their bank does should escape them. Each month they see the numbers. They can always ask for more detail. They approve and monitor the budgets. Their support is required for new initiatives. In particular they must have regard for the risks that their bank may be running. They are also responsible for compliance with regulations. They have a duty to treat customers fairly. And they set the remunerations packages for the executive directors, and it is these that are taken as a model for managers below board level. All these duties are well understood.
Pause here and glance across to Wall Street. There, faced with a similar situation, the FBI recently announced that it has opened preliminary investigations into possible fraud involving Fannie Mae, Freddie Mac, Lehman Brothers and AIG. Hundreds of Wall Street bankers are under investigation. That is as it should be.
Over here there has not been a peep from the law enforcement agencies. Perhaps the Government will remember Lord Penrose's recent account of the fall of the Equitable Life Assurance Society. The report was revealing. There should be a similar inquiry, with strong legal powers, into the conduct of banking. Bankers started this, not the Government. They must explain what they were doing. As unemployment rises, people will want to know.