Central banks colluded in an endless cycle of credit expansion

It is time they set a lead.

My daughter, who knows a thing or two about the human body, keeps on telling me “Breakfast doesn’t count”, as we sit opposite each other of a morning eating our opposing meals – macerated fruit (me) versus two chocolate croissants (her). The point – her point – is that early on in the day you could chug down a cup of duck fat without consequence because you are going to burn it off anyway as you go about your day. It’s what you eat the rest of the time that makes the difference.

If you were setting up a bank from scratch today (for convenience let’s call it Stewart Cowley Unlimited Mortgage Bank – SCUM Bank for short) you would think pretty much the same way – you could eat as much risk as you wanted at the beginning because within not very long you would burn it off – all you need is rising property values as you go about your day. For instance, if house prices were going up at 5 per cent a year for five years then the loan you made would be only 78 per cent of the value of the house. As a banker your only thought would be – "If the borrower stops paying I could sell the house and get my money back even after all the other fees – happy days. Is that a bonus I see before me?"

Do the same calculation for 7 per cent house appreciation and the value of the loan is now only 70 per cent of the house value. And don’t forget this is with a 100 per cent mortgage; make the borrower put down 20 per cent up front and, after five years, these loan-to-value ratios drop to 62 per cent and 56 per cent respectively. In other words the cushion you have as a banker from making a loss is simply enormous. You understand why it is in just about everybody’s interests, in a functioning capitalist economy, that house prices keep on rising at a more or less steady pace; banks win, homeowners win, regulators win, politicians win.

More to the point, should things go wrong for some borrowers the chances of losing the money of the people you borrowed off in the first place (depositors) is minimal and what’s more, as a bank, you don’t have to put too much money aside for a rainy day to cover any losses that may arise from bad loans.

And so the system gets bigger and bigger – depositors are blissfully unaware of the risks being piled up and banks begin to function on wafer-thin reserves of money. And why shouldn’t they? In the US on rolling five year periods house prices rose by about 5 per cent for 30 years. Here in the UK it was just under 9 per cent with barely a pause for breath. It is a situation with some risks, many virtues and even more vested interests all aligned to keep it going.

You also understand why banks and bankers don’t self-limit; experience tells them that it isn’t necessary. Setting legislation that increases the amount of money bankers put aside for a rainy day, like those being introduced by the US and under the Basel III criteria, is against their instincts and experience. It has even led JP Morgan CEO Jamie Dimon to declare them “Un-American” because the idea of control is anathema to them.

So if you really want to control bankers you have to control the borrowers. Increasing interest rates to penal levels will stop the mathematics working. But we have had a generation of central bankers that colluded with the system and invented excuses not to rail in the excesses of either the lenders or the borrowers; interest rates were kept in single digits whilst house prices were rising by double digits in the run up to the peak in 2007, bolstered by the convenient theory that risks were being smeared around the system so thinly that no one would get hurt.

In fact risk was being concentrated in the hands of a few with disastrous consequences. Alan Greenspan, the Federal Open Market Committee and Sir Mervyn King and the Monetary Policy Committee of the Bank of England are all culpable in that sense of being unwilling to dish out the harsh medicine when it was needed. It’s something that shouldn’t be forgotten as we reignite the credit cycle, especially in the US, and watch as house prices rise, once again, far above the cost of borrowing. We need a new generation of central bankers prepared to lead, not follow.

Source: Bloomberg

 



 

Photograph: Getty Images

Head of Fixed Income and Macro, Old Mutual Global Investors

Getty
Show Hide image

Britain has built a national myth on winning the Second World War, but it’s distorting our politics

The impending humiliation of Brexit is going to have a lot more in common with Suez.

The Crown, Peter Morgan’s epic drama covering the reign of Elizabeth II, ended its first series with a nemesis waiting just off-stage to shake up its court politics. In the final episode, Egyptian president Gamal Nasser gives a rip-roaringly anti-imperialist – and anti-British – speech. The scene is set for the Suez Crisis to be a big plot point in Season 2.

Suez has gone down in history as the great foreign policy debacle of postwar Britain. The 1956 crisis – which saw Israel, France and Britain jointly invade Egypt to take control of the Suez Canal, only to slink off again, nine days later, once it became clear the US wasn’t having any of it – is seen as the point at which it became clear that even the bigger states of Europe were no longer great powers in the world. “President Eisenhower’s humiliation of Britain,” Jack Straw wrote in his 2012 memoir, “had been total.”

This was, though, a fairly limited sort of humiliation. Britain was not invaded or occupied; there was no sudden collapse in living standards, let alone a significant body count. Our greatest national debacle is nothing more than the realisation that Britain could no longer do whatever it wanted without fear of reprisal. As humiliations go, this one’s up there with the loss of status men have faced from the rise of feminism: suddenly, Britain could do what it wanted a mere 80 per cent of the time.

The Crown begins in 1947, when Prince Philip gives up his Greek and Danish royal titles and becomes a British subject, so that he can marry Princess Elizabeth. That year saw another British foreign policy debacle, one on which the show remains oddly silent. In the partition which followed India’s independence from the British Empire, 70 years ago this week, upwards of a million people died; in the decades since, the borders drawn up at that time have been the site of numerous wars, and Kashmir remains a flashpoint.

All this, one might think, might count as a far bigger regret than Suez – yet it doesn’t feature in the national narrative in the same way. Perhaps because partition was about the withdrawal of British forces, rather than their deployment; perhaps it’s simply that it all happened a very long way away. Or perhaps we just care less about a body count than we do about looking bad in front of the Americans.

I think, though, there’s another reason we don’t talk about this stuff: the end of empire is hidden behind a much bigger part of our national myth. In the Second World War, Britain is undeniably one of the good guys; for 12 months, indeed, Britain was the only good guy. Never mind that it still had the largest empire the world had ever seen to fall back on: Britain stood alone.

The centrality of the Second World War to the national myth warps our view of history and our place in the world in all sorts of ways. For starters, it means we’ve never had to take an honest account of the consequences of empire. In a tale about British heroes defeating Nazi villains, British mistakes or British atrocities just don’t fit. (Winston Churchill’s role in the 1943 Bengal famine – death toll: three million – by ordering the export of Indian grain to Britain rarely comes up in biopics.) In this dominant version of the national story, the end of empire is just the price we pay to defeat fascism.

More than that, our obsession with the Second World War creates the bizarre impression that failure is not just heroic, but a necessary precursor to success. Two of the most discussed elements of Britain’s war – the evacuation of Dunkirk, and the Blitz – are not about victory at all, but about survival against the odds. The lesson we take is that, with a touch of British grit and an ability to improvise, we can accomplish anything. It’s hard not to see this reflected in Brexit secretary David Davis’s lack of notes, but it’s nonsense: had the Russians and Americans not arrived to bail us out, Britain would have been stuffed.

Most obviously, being one of the winners of the Second World War infects our attitude to Europe. It’s probably not a coincidence that Britain has always been both one of the most eurosceptic EU countries, and one of the tiny number not to have been trampled by a foreign army at some point in recent history: we don’t instinctively grasp why European unity matters.

Once again, Suez is instructive. The lesson postwar France took from the discovery that the imperial age was over was that it should lead a strong and unified Europe. The lesson Britain took was that, so long as we cosied up to the US – Athens to their Rome, to quote Harold Macmillan – we could still bask in reflected superpower.

Until recently, Britain’s Second World War obsession and national ignorance about empire didn’t really seem to affect contemporary politics. They were embarrassing; but they were also irrelevant, so we could cope. Brexit, though, means that hubris is about to run headlong into nemesis, and the widespread assumption that Britain is a rich, powerful and much-loved country is unlikely to survive contact with reality. India will not offer a trade deal for sentimental reasons; Ireland is not a junior partner that will meekly follow us out of the door or police its borders on our behalf. The discovery that Britain is now a mid-ranking power that – excepting the over-heated south-east of England – isn’t even that rich is likely to mean a loss of status to rival Suez.

Morgan says he has planned six seasons of The Crown. (This looks entertainingly like a bet the Queen will be dead by 2021; if not, like Game of Thrones before it, he might well run out of text to adapt.) It’ll be interesting to see how the show handles Brexit. It began with the royal family facing up to a vertiginous decline in British power. As things stand, it may have to end the same way. 

Jonn Elledge edits the New Statesman's sister site CityMetric, and writes for the NS about subjects including politics, history and Brexit. You can find him on Twitter or Facebook.

This article first appeared in the 17 August 2017 issue of the New Statesman, Trump goes nuclear