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

Photo: Getty
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The New Statesman 2016 local and devolved elections liveblog

Results and analysis from elections across the United Kingdom. 

Welcome to the New Statesman's elections liveblog. Results will be coming in from the devolved legislatures in Scotland and Wales, local elections in England, and the mayoral contests in London, Salford, Bristol and Liverpool. Hit refresh for updates!

22:40: In case you're wondering, how would closing a seven point deficit to say, six, compare to previous Labour oppositions, I've done some number-crunching. In 1984, Neil Kinnock's Labour turned a Tory lead of 15 per cent at the general election to a Conservative lead of just one per cent. In 1988, one of 12 per cent went down to one per cent. (He did, of course, go on to lose in both the 1987 and 1992 elections). In 1993, John Smith's Labour party turned a deficit of eight points at the general to a Labour lead of eight points in the local elections. William Hague turned a Labour lead of 13 points to one of just six in 1998, while Iain Duncan Smith got a Tory lead of just one point - from a Labour lead of nine. 

22:35: John McDonnell is setting out what would be a good night as far as the party leadership is concerned - any improvement on the 2015 defeat, when the party trailed by close to seven points. Corbyn's critics say he needs to make around 400 gains.

I've written about what would be good at length before, but here's an extract:

"Instead of worrying overmuch about numbers, worry about places. Although winning seats and taking control of councils is not a guarantee of winning control of the parliamentary seat – look at Harlow, Nuneaton, and Ipswich, all of which have Labour representation at a local level but send a Conservative MP to Westminster – good performances, both in terms of increasing votes and seats, are a positive sign. So look at how Labour does in its own marginals and in places that are Conservative at a Westminster level, rather than worrying about an exact figure either way."

22:31: Oh god, the BBC's election night music is starting. Getting trauma flashbacks to the general election. 

22:22: A few of you have been in touch about our exit poll. Most of you have been wondering about that one vote for George Galloway but the rest are wondering what happens - under the rules of the London mayoral race (and indeed the contests in Salford, Bristol and Liverpool), 2 votes would not be enough for Sadiq. (He needs 2.5). However, all the other candidates are tied - which makes it through to the second round. What happens then is the second preferences are used as a tie-break. Of the tied candidates, Sian Berry has the most second preferences so she goes through to face Sadiq Khan in the final round. Final round is as follows:

Sadiq Khan: 3

Sian Berry: 2

3 votes is above the quota so he is duly elected. An early omen? 

22:19: Burnham latest. A spokesperson for Andy Burnham says:

"Approaches have been made to Andy Burnham to give consideration to this role. It is early days and no decision as been taken. Whatever the decision, he will continue to serve the leader of the party and stay in the shadow cabinet."

22:17: Anyway, exit poll of the office. We've got:

Sadiq Khan: 2

George Galloway: 1

Caroline Pidgeon: 1

Sian Berry: 1

22:15: Update on Andy Burnham. He has been asked to consider running. More as we get it. 

22:13: People are asking if there's an exit poll tonight. Afraid not (you can't really do an exit poll in elections without national swing). But there is a YouGov poll from Wales and I am conducting an exit poll of the four remaining members of staff in the NS building. 

22:11: It's true! Andy Burnham is considering running for Greater Manchester mayor. Right, that's it, I'm quitting the liveblog. Nothing I say tonight can top that. 

22:09: Rumours that professional Scouser Andy Burnham is considering a bid for Greater Manchester mayor according to Sky News. Not sure if this is a) a typo for Merseyside or b) a rumour or c) honestly I don't know. More as I find out. 

22:06: Conservatives are feeling good about Trafford, one of the few councils they run in the North West.

22:03: Polls have closed. Turnout looks to be low in London. What that means is anyone's guess to be honest. There isn't really a particular benefit to Labour if turnout is high although that is a well-worn myth. In the capital in particular, turnout isn't quite as simple a zero-sum game as all that. Labour are buoyant, but so are the Tories. In Scotland, well, the only questions are whether or not the SNP will win every single first past the post seat or just the overwhelming majority. Both Labour and Tory sources are downplaying their chances of prevailing in the battle for second place at Holyrood, so make of that what you will. And in Wales, Labour look certain to lose seats but remain in power in some kind of coalition deal. 

22:00: Good evening. I'm your host, Stephen Bush, and I'll be with you throughout the night as results come in from throughout the country. The TV screens are on, I've just eaten, and now it's time to get cracking. 

Stephen Bush is special correspondent at the New Statesman. He usually writes about politics.