Credit crunch consequences: three years after the crisis, what’s changed?


August 9, 2010 Larry Elliott, David Teather and Jill Treanor


Bankers were burned in effigy during the G20 protests in the City of London in 2009, and heads rolled metaphorically everywhere from Northern Rock to Bear Stearns, but capitalism is still flourishing. Photograph: Antonio Olmos for the Guardian.


It was supposed to have been the day the world changed. The credit crunch “officially” began on 9 August 2007, and there were plenty ready to dance on the grave of capitalism and the free markets. But three years on, for all the hand-wringing, the economic upheaval and the promises of politicians, there is a whiff of business as usual in the air. The banks have returned to substantial profit, City bonuses are moving back to dizzying heights, international efforts for further co-operation have largely come unstuck, cranes are once more rising over the Square Mile and house prices are moving north.


Many are beginning to question whether anything has really changed at all; others maintain that things have simply got worse, that the old hegemony has been reinforced rather than loosened, widening the disparity between the wealthy and the rest.Getting a mortgage has been put out of the reach of many people, savings are dwindling, high streets have become bleaker places and the expansion of public sector debt, partly to keep the world from plunging into a depression, means there will only be more painful austerity measures to come, affecting everything from arts funding to welfare. Politically, the shift has been to the right, particularly in Britain.


“Of course the credit crunch is leading to lots of changes and we haven’t seen all of them yet,” says Sir John Gieve, the former deputy governor of the Bank of England. “But in two big respects, I don’t think it did change the world. First, the speed of globalisation, the integration of the global economy, including finance, is continuing, and second, it is continuing around broadly a free-market model.


“There have been far fewer repercussions than there were after the 1930s,” he adds. “Then there was a real contest in the world about what was the right model for a modern society, and the crash convinced many people that capitalism and free markets were not the right way forward, but there has been no echo of that this time.


“Maybe India and China have slowed down on deregulating their financial industries, but broadly speaking, the direction the world had been moving in is continuing. It reflects an end of ideology. Capitalism is still the only game in town.”


Alistair Milne, reader in banking and finance at Cass Business School and the author of The Fall of the House of Credit, suggests there is still no willingness to change. “It is a way of life that we all enjoy. We are still locked into the mindset that rising house prices are a good thing. It will be a good sign that we are moving to a more constructive way of thinking when we don’t cheer every time house prices go up.”


The credit crisis had been brewing for a number of years, as rising interest rates in the US led an increasing number of low-income homeowners on sub-prime mortgages to default. But the pivotal moment arrived when a French bank issued a statement that most would consider arcane – but which would have profound consequences.BNP Paribas told investors in two of its funds that they would not be able to withdraw money because it was no longer able to value the assets in them, due to a “complete evaporation of liquidity” in the market.


The money markets became petrified. Banks refused to lend to each other as fear spread about where the toxic debt obscured in complicated derivatives might be sitting – and the European Central Bank pumped more than €200bn (£166bn) into the system in a desperate attempt to thaw the freeze. Stock markets went into freefall.For a time it seemed as if some commentators were right to predict a radical overhaul of the old world order that had existed for the 30 years since Ronald Reagan and Margaret Thatcher had encouraged a laissez-faire approach.


Within a month, queues formed outside branches of Northern Rock in the first run on a high-street bank in living memory. A year after that, the collapse of Lehman Brothers almost brought the financial system to its knees, followed by the first truly global recession of the post-war era.”The world did change and ultimately it will be seen to have changed for the better,” says Nick Parsons, head of research at National Australia Bank. “When the history of the past 10 years comes to be written, what will be surprising will be not the global financial crisis itself, but the financial conditions that preceded it – the excess and abundance of cheap money that was being lent without regard to borrowers’ ability to repay.


“Money was virtually free – in the case of Japan, where it had zero interest rates, it was literally free – and it was available in limitless quantities, which does not correspond to any definition of normalcy, so that created a bubble and bubbles burst.”Heads rolled. Three years later, the politicians who steered Britain through the crisis, and arguably helped to cause it, have lost their jobs and many bankers moved on. Adam Applegarth, who ran Northern Rock and described that event in August as the “day the world changed”, was an early casualty. Chuck Prince, the boss of Citigroup, was gone by Christmas as was Jimmy Cayne, the Bear Stearns boss who reputedly played bridge as his bank neared collapse. Stan O’Neal at Merrill Lynch, Fred Goodwin at Royal Bank of Scotland and Andy Hornby at HBOS all followed.


The banks have since become more conservative – so much so that politicians are now attacking them for not lending enough.”We have gone back to the type of conditions I was familiar with in the early- to mid-1980s,” Parsons says. “In order to get a loan, you need an income, you need proof of that income and you need to have a deposit – the very things that now appear to provoke outrage but are normal to anyone who is in their 40s. I think what we are seeing is a return to a banking industry as it was 25 years ago, which actually had many things to commend it.


“So capitalism has changed, yes, not in a huge cathartic way, but so that the owner or the custodian of capital is much more careful about where they use that capital,” he adds. “And this phase is going to be very uncomfortable for the economy. There is a lot of criticism that the banks are not lending enough, but that is a by-product of banks being more careful about capital – there is more emphasis on getting the money back than on pumping up assets that can be seized if the loan goes bad. The path we are on seems to be set for five or maybe even 10 years. It is not dissimilar to the way it used to be. We’ll just have to get used to it again.”


John Varley, chief executive of Barclays, underlined that point this week. From his point of view, banks are considerably less risky and more liquid.In the year of the credit crunch, 2007, the bank’s crucial tier one ratio – a measure of its financial health – was 4.7%. Today it is 10%, showing that the bank is holding a larger capital cushion to support its business. In the same period, the bank’s leverage has fallen from 33% to 20% of that tier one capital, and the amount of liquid assets it holds – such as government bonds – has jumped from £20bn in the year of the credit crunch to £160bn now.


Capital, though, is still broadly in the same hands: “You have the same people making the most money, doing broadly the same thing, but – we hope – more sensibly and prudently,” says Gieve.Three years on from the crisis, it is almost possible to forget that the banks, including those bailed out by the taxpayer, were loss-making. The major UK banks last week reported a combined £14.5bn of profit and a dramatic fall in impairment charges for loans that were not repaid on time. Certainly there is a sense of swagger returning to the City. Barclays, RBS and HSBC – just half-way through the year – have already set aside £6bn in pay and bonuses for their investment bankers.


The return of the bonus is likely to reawaken some of the public anger on show during the early days of the crisis and stoked by politicians. The crisis has “left a scar about banking and politicians” says Jim O’Neill, chief economist at Goldman Sachs.The return of the bonus is all the more unpalatable for many because of the wider austerity measures being pushed through. What started as a problem of private-sector debt has become a problem of public-sector debt. Governments spent and borrowed freely during the boom, and latterly to avoid turning the great recession into a great depression – and the cost to the public purse has been enormous. The UK ran up its biggest peacetime deficit of £155bn, about 11% of GDP. In Greece, the debt burden was more than 13% of GDP.


New banking regulations are being introduced at different speeds and in different ways in the main economies. The UK has been accused of moving too quickly by introducing a bank levy ahead of other main markets, while crucial changes being demanded by international banking regulators based in the Swiss city of Basle that require banks to hold more capital can now be implemented at whatever pace each country chooses. Economist Sir John Vickers is leading the banking commission report into whether the banks in Britain should be broken up.


Gieve says the broad package of measures agreed by the G20 and in Basle, requiring banks to hold more capital, increase transparency and defer bonuses, has broadly addressed some of the problems that led to the credit crunch. But, he says, two key issues remain to be addressed. “First the structure of banking. In the UK we are looking at the concentration of retail banking, but the more interesting question is about investment banking, which to me feels like an oligopoly and the extreme levels of rewards probably reflect that.


“The second is international co-operation. The really glaring thing about this crisis is that it was international. We were seeing people default on mortgages in California and Nevada, but the first banks that fell over were IKB in Germany and Northern Rock, which didn’t have any US sub-prime exposure but got caught up in this global financing market. One key lesson should be the need to co-ordinate policy, both macro and regulatory, more closely and I don’t see that happening.”


Lord Davies, a former trade minister and banker who was at the helm of Standard Chartered when the crisis erupted, agrees. “My worry is that the lessons of the crisis will be forgotten too quickly,” he said. “It was the first test of globalisation. The world did come together [but] we haven’t made a lot of progress since then – no global bank levy, everyone has gone back to business as usual. Compensation is still too high and the underlying factors that caused the crisis are still very evident.”


The banks are buoyant in part because the economy is stronger. The UK economy grew by 1.1% in the second quarter of 2010 – its fastest growth in four years. For all the talk of rebalancing the economy away from the City and commercial property, more than two thirds of the expansion came from the old bubble-era staples – construction and financial and business services. Retailers, meanwhile, have had their best month of sales growth in July since the spring of 2007.


However, politicians, claiming to have learned the lessons of the financial crisis, are still pressing for a rebalanced economy, with a new emphasis on expanding exports and manufacturing and a move away from an overreliance on financial services.


O’Neill says he is encouraged that increasing exports could be achieved by the low value of the pound – exports grew at 9% per annum for three years after Britain left the ERM – and heartened by the coalition government’s pursuit of better trade relations with the so-called Brics, Brazil, Russia, India and China. The credit crunch he says, has accelerated the shift to the new world order: “For the UK to rebalance, we have to have a serious export relationship with the Brics and it is something this government is talking seriously about.”


He says that the four countries together will create another $8 trillion of consumption this decade if they continue to grow at the current rate. “This is, clearly, three years on from the crisis, something which many companies are starting to see signs of,” O’Neill says, although western policymakers remain “pretty clueless”.Others are more circumspect. “Establishing a leading position in any industry takes a long time,” says Gieve. “We shouldn’t assume it happens automatically and that if you squeeze financial services, somehow we will establish a lead in plastics. If you go around the world, most other countries would love to have a financial centre like London. From here we can see the disadvantages, such as the way it sucks talent from other industries and widens inequality, but London’s position in finance has been built over centuries and we would be foolish to undermine it.”


The reality, though, is that very few of Britain’s companies currently export to China, and the rest of Europe is coming up with the same plan. While more than 50% of Britain’s visible trade goes to other members of the EU, China accounts for 2% of UK exports and India under 1%, or about £3bn.China and India, the world’s two largest emerging economies, have proven far more resilient to the global recession than many developed economies. Europe has struggled to haul itself back from recession, while in the US, one in four homes are suffering from negative equity and the faltering housing market risks dragging the world’s biggest economy back into a double dip.


Alistair Milne at Cass Business School says the world has fundamentally changed and it is less about the banks than about the way the world economy has got used to doing business. It is a change yet to be acknowledged by politicians and policymakers, but then, Milne maintains, the UK could be in for 25 years of stagnation – not something that wins many votes on the stump.


“When you get to the root of it, the crisis was not about the banks,” he says. “It was the result of credit-driven growth. That we all feel wealthier because we are borrowing bigger mortgages and house prices are going up is misguided. A country gets rich by producing things. The problem is the imbalance between countries producing goods, such as China and Japan, and ourselves and the US. They lent us money to buy things they make.


“It wouldn’t have mattered if banks hadn’t been gross risk-takers, this way of doing business would still have come to a shuddering halt. And no one has really addressed it. The world has fundamentally changed because we can’t go on by saying: ‘OK, China, lend us another trillion dollars so we can go on buying your stuff.’ I am deeply pessimistic about our society. We have papered over the cracks but things will get worse.”


Source:The Guardian




Comments are closed.