Monday, September 17, 2007

The Economic (& Political) Conseqences of the Crunch

As regular readers of this blog will know, I, like many Liberal Democrats, have been warning about the extreme imbalances in the global economy for some time. Vince Cable first talked about the problems more than two years ago.

It does not give me much satisfaction to say "We told you so".

The old fashioned run on the Northern Rock is not supposed to be happening- the Bank is reported as solvent and has the support of the full faith and credit of the Bank of England. Nevertheless with every hour that passes the depositor base is draining away and when only the loan assets are left the Northern Rock will simply have to be sold. This was the fifth largest mortgage lender in the UK market and in the course of a week it has ceased to exist as a business. The shareholders who in February owned shares worth £12 each may end up being lucky to get more than £2, and there is the possibility that they will end up with nothing.

The crisis in US sub-prime has claimed its first British victim, and it will not be the last.

In the face of this, it is easy to panic. Will Hutton on the Today Programme this morning was exhorting the government to press every panic button in site- extending depositor protection- which might be reasonable- to nationalising the Northern Rock and the credit vehicles like SIVs, coupled with massive new regulation; this is not only unnecessary, it is potentially extremely dangerous and horrifically expensive.

There is a real risk that the turmoil in the global financial markets will start to have an effect on the real economy pretty soon: and that pretty much guarantees a deep recession, even a prolonged depression. However this spectre will not be propitiated by massive government or Central bank intervention.

The key is to establish as quickly as possible the scale of the market losses, and to start to carve out the good loans from the bad. At Jackson Hole, last month David Hale spoke of "a crisis of information". He is right. Right now each regulator across the globe should be quizzing their banks about the extent of the write downs that they may need to take. Once the scale is understood, then the markets can price in their risks. Admittedly that would in normal circumstances mean a likely increase in interbank interest rates, which could deepen the problem, so the central banks should continue to provide liquidity at the discount window in order to maintain order in the interbank market.

Part of the particular problem for the UK is that there is at present a great deal of borrowing in Sterling Commercial Paper (CP)- the short term IOUs that companies issue to the market, and which are underwritten by the banks. As we close out the quarter, a record amount of CP needs to be rolled over. However the market is not willing to take on the new lending, so the banks will, under the terms of their underwriting, need to take the paper onto their own balance sheets. This is why they have largely withdrawn from the interbank market, while they establish the scale of their own obligations. Unfortunately, the Sterling market is relatively small, compared to the US$ or the Euro-zone, and despite interest rates that are 2% higher than the Euro zone, there has simply been insufficient liquidity to fund these new CP obligations and maintain stability in the Sterling interbank market. Sterling thus faces a liquidity drought that could be very damaging to the domestic economy. Had we been members of the Euro, this problem would have been far less likely to occur.

We stand now at the inflexion point that we have been discussing as a possibility for the past few years. The asset price bubble, led by house prices, is well and truly over. The availability of cheap and easy credit is likewise over. The benign circumstances that have supported the long surf of the British Economy along a giant wave of liquidity is over. The 15 year boom is over.

The air is dark with chickens coming home to roost.

Many political assumptions will now need to be recalculated. Unless Gordon Brown announces an election in the next two weeks, his room for manoeuvre next year is likely to have gone- it means that the chances of a full Parliament are now dramatically higher. Labour will get the blame for the bust, as they have claimed the credit for the boom.

The Conservatives too will be wrong footed- the spivvy bunch of estate agents that they represent have been in the thick of those getting their noses in the trough- and their anti-Europeanism will be seen as the ill judged mistake that it is.

The mature gravitas of Ming Campbell, previously derided as old and out of touch, suddenly begins to look reassuring and wise, compared to the shallow, puppyish eagerness to please of David Cameron and the hapless would-be Stalinism of Gordon Brown.

This inflexion point in the economy could turn British politics upside down- there is suddenly all to play for.

5 comments:

Anonymous said...

Well it's good to know you can see the future so clearly Cicero. Perhaps you can give me next year's Derby winner as well? On the Euro hmm nice try, just take a look at Portugal's pain at having to slam on the brakes or Spain's speculative property bubble which resembles an unexploded bomb. The Euro is no panacea, no matter how you dress it


Lepidus

Cicero said...

I am not talking about the future, Lepidus, as you know I am a student of Nassim Taleb and I would not be so foolish.

I am talking about now.

Anonymous said...

Cicero


I know this. Some leavened humour on your part would be welcome, especially as you seem to think all Conservatives are closet fascists from a previous post. My point that you do not address is that being in the Euro is no more a guarantee against problems than staying out is. We can argue about the merits of membership or not until rapture if you like. What we may? agree on is that ultimately the behaviour and stewardship of the Govt counts for far more than whether Trichet or King is conducting the interest rate orchestra. Btw Congratulations on your shortlisting. Far be it from me to point out that there is a sizeable Conservative vote which may very well hold the key if you are selected, and telling them they have been voting for an "extremist" party in your eyes, may not be the best way to attract their support. So it may do you no harm to start being a little nicer about us Cicero. Better get started!


Lepidus

Cicero said...
This comment has been removed by the author.
Cicero said...

Leavened Humour, Lepidus? The mind boggles :-).

Of course I was not accusing the Tories of being fascist- a) I have too many Conservative friends to think such nonsense and b) that would imply that the Tories still had some beliefs! No, it is the opportunism which rankles, and frankly it is a betrayal of the good Conservative tradition to sit with the Russians, who, if not fascists are cetainly no democrats.

As to your other points, I agree it is not the administrative style that is the matter- but would add that it is the size of the market, and Sterling is looking more vulnerable, because it is smaller therefore less liquid over all, and has a more short
run financing structure.

BTW- Do you work at Rabo?