As bank shares tumble, the scale of the financial shock becomes clear
Osborne's mettle will be tested when Greece defaults, as it surely will.
The Tories, after 13 years in opposition, have now been in government for 17 months and still they have no plan for growth. The Chancellor, George Osborne, made this clear in his rather flat and uninspiring speech at the Conservative party conference in Manchester on 3 October. He insists that he is not for turning – but a previously announced freeze in council tax, some money to pay binmen and a few extra pounds for developing graphene won't cut the mustard in a crisis.
It is unclear what impact the new right-to-buy and housebuilding plans will have. They certainly won't create jobs or new homes any time soon, because there are long lags between announcement and delivery. This looks like another of the coalition government's half-baked ideas that are all announcement and no substance and probably won't work.
Osborne offered some insightful economic analysis when he suggested, "Our economic problems were not visited on this country by some cruel act of God or blind force of nature. They were created by the mistakes of human beings." Amazing. I had always thought they were the fault of Martians but I stand corrected.
The Chancellor argued that there were three main problems. "First," he said, "the last government borrowed too much money." The second mistake was apparently made by the banks, which "ran up staggering debts of their own, buying financial instruments even they couldn't understand". Third, "Our European neighbours plunged headlong into the euro without thinking through the consequences."
He repeated his claim that both he and David Cameron are fiscal conservatives but monetary activists, hinting heavily that the Bank of England can take the strain of the crisis by doing more quantitative easing. His plan to introduce a "credit-easing" scheme to help small businesses is welcome.
This idea was first proposed by me in a recent New Statesman column and backed in a speech by Adam Posen, member of the Bank of England's Monetary Policy Committee. It would involve the Treasury buying bonds issued by companies, thereby boosting the supply of credit and cutting the cost. The need for such a scheme suggests that Project Merlin, a deal made between the coalition and banks earlier this year in an attempt to increase lending to small firms, has failed.
Given these announcements, it was surprising to hear Osborne, once again, drawing comparisons between Britain's economy, with its own currency and independent bank, and those of Greece, Portugal, Italy and Spain. Stuck in a monetary union and without their own central bank, these countries cannot devalue their currency, engage in quantitative easing or, presumably, introduce a credit-easing programme for small firms.
Worryingly, things are likely to get much worse - and fast - in the eurozone and the wider banking system. In recent weeks, the Franco-Belgian bank Dexia SA has sunk deeper into trouble. With a portfolio of loans and bonds reaching €651bn (£562bn) - many times its relatively small retail-deposit base, centred in Belgium and Turkey - the bank is a major holder of sovereign debt from the eurozone's fragile periphery.
Following the collapse of Lehman Brothers in 2008, the authorities in France, Luxembourg and Belgium injected €6.4bn (£5.5bn) into Dexia but the bank may now need rescuing again. At the time of writing, on 4 October, Dexia's shares had fallen sharply (by more than 20 per cent) for a second consecutive day and the finance ministers of France and Belgium made a statement that they would support the troubled bank, amid signs that it
could be broken up.
Over the past year, the share prices of French and German banks have been hit by fears of their exposure to Greece and the other peripheral countries in the European Union. The four main banks involved are down from their 52-week highs as follows: Société Générale by 66 per cent, Crédit Agricole by 63 per cent, BNP Paribas by 54 per cent and Deutsche Bank by 50 per cent.
Less well known is that there has been a collapse in the share prices of UK and US banks, as the table (below) shows. At the close of the London Stock Exchange on 4 October, Lloyds had fallen by 10.6 per cent, the Royal Bank of Scotland (RBS) by 8.4 per cent, Barclays by 10.5 per cent and HSBC by 4.7 per cent. On the year, the share prices of three of the four major British banks are down and they don't look so different from Dexia. Only HSBC looks significantly less exposed.
House of cards
The huge drop in the share prices of these banks over the past five years (compare their five-year highs in the second column of the table with the last trade figures in the first) indicates the scale of the financial shock that we have been exposed to.
One other point of note is that the value of the UK's investment in Lloyds and RBS has halved since the day that the coalition government took over - on 12 May 2010, share prices were £59.51 and £48.40, respectively, on the market opening. As I write, they are £31.80 and £21.52. I have not heard much from Osborne about the decline in the value of the UK's assets on his watch.
Osborne's mettle will be tested when Greece defaults, as it surely will. I recall how he and Cameron opposed the rescue of the banks in 2008 without telling us what they would have done instead. The former chancellor Alistair Darling made clear recently that, on 7 October 2008, the then chairman of RBS, Tom McKillop, called him to say that the bank would run out of money in two hours and wouldn't last the day if the government didn't step in with a rescue plan. I hope we won't have to find out how Osborne would respond to a comparable crisis but the markets appear to be expecting just that. One down, all down.
David Blanchflower is the New Statesman's economics editor and a professor at Dartmouth College, New Hampshire, and the University of Stirling