If there are any crumbs of comfort to be gained for the Chancellor in yesterday's Budget – and I suspect there are very few – no-one can accuse him of putting an overly bright face on our nation’s bleak economic prospects.
It lacked any credible narrative of a pathway for economic recovery. Yet still the seriousness of the situation is only slowly dawning on the political class, let alone the general public.
Last year’s budget predicted £40 billion public borrowing for 2009-10; by autumn the figures were £78 billion for last year, £118 billion this. Now we know that over the next two years aggregate borrowing will be around £350 billion. In short, over the near term – whoever is in government – for every £4 that government spends, it will raise only £3 in tax. This overspend cannot possibly be described as ‘investment’ - it is purely spending to consume today what will need to be financed by a future generation. Remember too this is only if the Government’s figures - persistently over-optimistic - prove accurate.
There has been a precipitous collapse in tax receipts, especially from business. But this also applies to the Government’s slice of bonuses earned by the wealthiest in more clement economic times. No bonuses means no tax, which means, as ever, that it is predominately middle-income salary earners who will foot much of the future bill for the Government’s over-expenditure.
The Government has flunked the really tough decisions on public spending that needed to be made. Instead, action on this has been delayed until a General Election is behind us.
Attention is understandably moving away from financial institutions as the ‘real’ recession takes hold, but as the City of London’s MP I'd like to highlight here the pressing issues which I believe will emerge in the months ahead.
The all-but-nationalised Lloyds Banking Group
Two of the big four domestic banks are all but fully nationalised. One, Lloyds Banking Group, contains ‘assets’ from HBOS which engaged in a series of balance sheet boosting debt-for-equity deals during the boom years in the middle of this decade.
As a consequence, LBG has large holdings in a swathe of leading UK companies. Doubtlessly many such household names will require refinancing as the downturn proceeds. Such financial rescue will come from the taxpayers’ coffers – in short, before long considerably large parts of mainstream corporate UK will be effectively nationalised.
How to nip regulatory problems in the bud
Whilst the days of financial sector governance by blind form-filling may be numbered, it is wistful to imagine a return to the days of regulation by informal eyebrow raising from the Governor of the Bank of England. This will apply even if many of that institution’s traditional powers are restored. However, we need to use smarter intelligence to nip regulatory problems in the bud. An enhanced role for the Bank of England must be accompanied by the appointment of high calibre, respected professionals in its top roles. I believe this should be augmented by the emergence of prosecutors with US-style status in place of the discredited SFO. Nothing less will restore confidence from market professionals and trust from the public at large.
No more bank bailouts
The banking bailouts have proved an expensive failure. No further nationalisation should be undertaken in this sector. The lesson we must learn is that any institution deemed too big to be allowed to fail will forever be prey to reckless risk-taking. If banks cannot fail, they cannot be effectively regulated, for regulation requires the eradication, not reward, of recklessness.
The operation of capitalism requires corporate failure. This is not ‘market failure’: it is a sign that capitalism is working properly. Instead the message that banks will not be allowed to fail only serves to make their effective regulation all but impossible. Regulation creates barriers to entry and favours large corporations over smaller start-ups. The wisest policy option should be to create smaller, more competitive financial institutions. Manifestly nationalisation takes us in precisely the wrong policy direction. The best form of regulation must be open competition; public ownership – other than on a strictly temporary basis – is anathema to this policy goal.
Letting Lehman Brothers fail was not a mistake
The conventional wisdom is that the heightened phase of the economic downturn since last autumn has come about as a result of the US government’s decision to allow Lehman Brothers to collapse. But letting a leading bank like Lehman fail will in time, I suspect, not be regarded as a mistake at all.
For by nationalising banks, governments have protected not only depositors (unarguably essential in preserving trust in a market economy) but also bondholders. The latters’ interests have been preserved at the expense of taxpayers, present and future.
Essentially this has been political gambit – much of the banks’ borrowing has been funded by insurance companies and other institutional investors and the risk of contagion in the event of their collapse was deemed too great. Yet bondholders, as lenders of capital, are supposed to take risks (and receive ample rewards by way of interest payments). In a “heads we win, tails you lose” inversion of classic capitalist practice when all has turned to dust they too have expected – and received – a taxpayer bailout.
The inflationary danger of quantitative easing
The current consensus promoting Quantitative Easing will find less favour as the year wears on. With little evidence that the velocity of money within the economy is any less sluggish as the real recession takes hold, printing money in vast quantities increasingly seems like a desperate last throw of the governmental dice when nothing else has succeeded. Inflation is clearly not an immediate problem, but mark my words, this unprecedented pumping of money into the system is certain to be inflationary.
History suggests that an unsustainable mini-boom will be on the cards by the end of next year, but stagflation (a toxic mix of inflation, rising unemployment and low growth/diminished competitiveness) will follow. Indeed the commodities and futures markets are already factoring this in when pricing for the early years of the next decade. I suspect the government has not seen the back of the problems it has recently experienced in trying to sell gilts as our national credit rating is hammered in the global capital markets.
Some lessons to be learned from the past
This crisis – now that globalisation has taken hold - is certainly different in magnitude to those we have seen before. One of the grand old names of British banking, Barings, collapsed owing £780 million only fourteen years ago: today RBS survives courtesy of a £26 billion bailout. However, there are clear lessons we can learn from the past. First, we need to restore the distinction between retail and investment banking which – in the US at least – existed for over six decades until the repeal of Glass-Steagall by the Clinton administration in 1999. The purpose of what was regarded as outdated 1930s throwback legislation is the protection of the ordinary depositor from high-risk, if innovative, banking practices. It now seems mighty apposite.
How then to deal with the toxic assets that banks still hold and find so difficult to quantify? Curiously enough, the UK has a template close at hand. The near collapse of Lloyds of London was avoided almost 20 years ago by the creation of a government-backed Equitas fund. This experience should be the starting point for consideration of any further large-scale government-backed rescue expenditure. In fairness the government has begun down such a path, although we should all be fearful of the ultimate overall cost to the taxpayer.
The danger of insecurity amongst the UK workforce
The nagging sense of insecurity amongst the majority of the UK workforce that the spoils of globalisation are being spread inequitably will grow and has the makings of serious social unrest.
The hollowing out of large swathes of ‘traditional’ UK industry as job employment has been exported to low-cost China and India has not even been accompanies by higher middle class professional earnings (at least for those outside the gilded world of financial and associated services until last year). Over the past decade the mirage of higher living standards was maintained only by the credit-fuelled residential property market. The sharp correction here has exposed the reality – international free-trade has done little to enrich personally the majority of our fellow countrymen in recent times.
It is dawning on many middle class folk that the losers from free movement of labour and capital are not simply the unskilled forced to compete with ever large numbers of immigrant workers. It is also increasingly apparent that the generation about to join the workforce will probably be less well off than their parents, not least as they foot the bill for the economic unravelling that began last September. Their phenomenon is almost unimaginable outside times of war – a shocking indictment for my generation of politicians.
The need to revert to a savings culture
So how will we know when the financial system has been fixed? In short, when can government stop pumping vast sums of taxpayers’ cash into a system which so desperately needs confidence and trust restored? Surely the main purpose of regulation in this sphere for the taxpayer is the establishment of a system that makes long-term investment worthwhile.
High profile allegations of mis-selling of financial products from the early 1990s and the near collapse of Equitable Life a decade ago had already done great damage to public confidence well before the credit crunch. Ironically this led to property becoming the investment of choice, rather than savings with pensions. We all now know where this credit bubble has led. It is essential that individually and corporately, the UK reverts to a culture of savings and responsibility with less dependence on debt.
Make no mistake, this path will be a long slog. However, if the problem has been too much borrowing and excessive spending, it is difficult to see how yet more government borrowing and a wilful, almost aggressive, determination to impose further public sector debt is the right way forward.