Politicians who now criticise the bailout forget there was no alternativeby George Magnus / October 2, 2018 / Leave a comment
Systemic banking crises are not pretty. They have dire economic, and often political, consequences. We have seen a few in the last 25 years, including in Japan (1990s) Mexico (1994/95), Asia and Russia (1997/98), and Argentina (2001), but none as systemically serious as the one that rumbled through the western world in 2007/08. So why did aspiring prime minister Jeremy Corbyn use his keynote speech to the Labour Party conference last week to attack the UK political and economic establishment, which, he said, “instead of making essential changes to the broken economic system, strained every sinew to bail out and prop up the system that lead to the crash in the first place”?
This not-so-veiled attack on the last Labour government and others in positions of authority at the time is as perplexing as it is alarming. It’s perplexing because in 2008/09, there was no space or time for long parliamentary inquiries, or commissions to “make essential changes.” It was a case of act or go under. The then-Chancellor, Alistair Darling, has recalled that the head of the Royal Bank of Scotland warned him at height of the crisis that the bank might run out of cash. Upon asking when, Darling was stunned to be told “this afternoon.” It was about firefighting,nothing more, nothing less.
It’s alarming, because Corbyn gave the impression that he might either have let the banks fail, or introduced a siege economy behind capital and other controls.
In any event, the time for essential changes was before or after the crisis, but not during it. As it unravelled, the Brown government took Northern Rock into public ownership in 2007, stimulated the economy in late 2008, and later nationalised the Royal Bank of Scotland and Lloyds Bank/HBOS. These actions, together with the recapitalisation of UK banks, and the implementation of Bank of England programmes to boost liquidity, guarantee bank debt and insure toxic assets had an upfront cost of over £500bn. At the time this was nearly a third of the UK’s GDP. On top of this, the Bank of England’s QE programme, having started at £200bn in November 2009, peaked at £435bn in August 2016.
These are huge sums. It is no surprise that people take objection. But Corbyn’s judgment on the bailout is flawed for three principal reasons.
First, the end-cost of financial rescues is often a lot lower than early estimates as, for example, some assets get sold, guarantees may not be utilised, and emergency loans are paid back. According to the National Audit Office, the level of outstanding support to the financial sector in March 2018 was £46bn, comprising £32bn of cash, and the rest of guarantees. A full account can be found in a recently published House of Commons briefing. The cash balance outstanding, largely in respect of RBS, was the equivalent of just 1.6 per cent of GDP. So, all things considered, the cost of the financial rescue, without knowing what the future proceeds from the sale of the government’s RBS stake might be one day, was small beer.
Second, while there is a question mark hanging over the later escalation of QE, and the extent to which the government itself should have acted to support the economy, there is no doubt that the early QE initiatives were justified. The arteries through which credit flows through the economy had become sclerotic. Markets had failed, or weren’t functioning well. There were well-founded risks that payment systems for wages, and goods and services, could have frozen. Real time indicators of economic activity were plunging, and unemployment, normally a lagging indicator, started to rise quickly. It was imperative for the Bank to act.
Third, if the Brown government had not stepped in as it did, the economic and social consequences would have been far, far worse. The counterfactual case is, inevitably, hard to define but you don’t have to be Einstein to figure it out. Imagine a banking system collapse in which cash and credit dried up, payments systems didn’t work, businesses failed and supermarkets ran out of food. This is what happens when confidence and trust drain suddenly out of the financial system. It had to be shored up immediately.
Corbyn referred correctly to the things that the crisis spawned, such as economic stagnation, weak wages, cuts in public services, and the growth of racism and xenophobia. Now imagine, though, what letting the banks go or implementing a siege economy might have unleashed. Unemployment, for example, might have risen to 12-15 per cent or more instead of 8 per cent. The loss of output we suffered over a decade would have been still larger. The government could have been faced with a major currency crisis, social and economic dysfunction would have been much worse, and austerity even sharper.
It was, of course, ideologically consistent for Corbyn to tell political activists and voters “the elite” was to blame for the bailout that rescued the banks that caused the crisis in the first place. Yet at the time, however unpalatable the bailout might have been there was no other option.
Since the crisis, quite a lot of changes have occurred. Perhaps the change has not been extensive enough. Corbyn could have said a future Labour government would not permit regular private financial institutions to enjoy all the benefits of risk-taking, only to socialise the costs when those risks went sour. And that it would take a totally different approach to the structure of banking in the UK—going much further than the last government did in 2013 following the independent Vickers Commission report.
The thing about systemic crises, is that once they start, it’s too late to do anything but draw the sting from them, and only then in due course, do the fixing. Unless, of course, you see political advantage in economic and social chaos.