Mission Failed

‘Far from rescuing the world, Brown and his associates caused a sudden downturn of extreme severity and wrecked the British banking system’

Tim Congdon

Six months have now passed since Gordon Brown claimed to have “rescued the world”. In October 2008, the government, working with the Bank of England and the Financial Services Authority, put together a package of measures to recapitalise the banks and encourage them to lend more. The Financial Times, then and now a cheerleader for the government, praised the package as providing “a global template” and confidently expected its key features to be copied across the industrial world.

Six months is too short a period to arrive at a final verdict, but it is sufficiently long to make an initial assessment of the package’s effectiveness. Far from rescuing the world, Brown and his associates caused a sudden economic downturn of extreme severity and wrecked the British banking system. Only in the last few weeks, when a very different policy from last October’s bank recapitalisation has been put in place, have signs of improvement emerged.

It is true that the British economy was slowing in spring and summer 2008 after a period of buoyancy in late 2006 and 2007, but there was nothing particularly untoward in the main macroeconomic numbers. The consumer price index was misbehaving, with a surge in energy prices making it certain that in the autumn the official inflation target would be exceeded by more than the permitted one per cent. But it was widely (and correctly) expected that energy prices would stabilise or fall, and that better inflation figures would come through in 2009 without a big recession. The radical deteriorations in demand, output and employment have occurred since last October. Practically every major macroeconomic series shows an abrupt change for the worse shortly after the bank recapitalisation measures. Within a few weeks, the Confederation of British Industry’s influential trends survey reported that a net balance of over 40 per cent of UK companies were planning to cut output. This year will see the largest fall in gross domestic product since the early 1980s, with unemployment rising sharply.

The official rationale for the intervention was that more bank lending was needed for economic recovery and that more capital was required to support the risks associated with extra lending. If the banks themselves were not prepared to raise more capital, politicians and regulators would bully them into it. Indeed, the government would ride roughshod over management’s plans and the shareholders’ rights and force banks to comply with its diktat.

No previous government had behaved so arbitrarily or with such vindictiveness towards one of Britain’s leading industries. Within hours of the announcement of the supposedly world-saving package, the stock market value of the banking sector had collapsed amid wider financial turmoil. In November and December, share prices and housing values carried on falling, destroying confidence, wealth and spending power, foreshadowing the dreadful unemployment figures of early 2009.

Brown’s supporters might nevertheless assert that the regulatory intimidation and capital injections have restored banks’ ability to lend. Do official statistics validate this claim? Every month, the Bank of England publishes a figure for the stock of banks’ unused credit commitments. The peak of £320.3 billion was in June 2007, but even as late as August 2008 it was still at £298.2 billion. The big plunge, to £268.5 billion in January 2009, followed the Brown package.

One type of credit, residential mortgages, receives particular attention from headline writers. The monthly flow of new mortgage approvals slithered in the year after the run on Northern Rock from more than £30 billion to less than £15 billion. But another drop of over 30 per cent, the sharpest in percentage terms in the current cycle, occurred between October and November. In December and January, mortgage approvals were under £10 billion. The British public’s mortgage debt is now falling in real terms.

Pace the FT, the bank recapitalisation programme last October has not rescued the world or even Britain. It has instead proved a total disaster. The correct policy would have been not to bully the banks, but to raise the growth rate of the quantity of money. That could have been done if the appropriate financial operations had been organised by the Treasury and the Bank. Fortunately, these operations – under the label “quantitative easing” – are now being carried out, and have already been welcomed by financial markets. Share prices are rising and bond yields falling. If quantitative easing, rather than bank recapitalisation, had been adopted in October 2008, much unnecessary misery could have been averted.

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