Financial crisis: It was Gordon Brown's bubble that we saw burst
Shortly after I became chancellor of the exchequer in 1990, I had a meeting with my Japanese opposite number, a charming, able man who insisted on speaking English without an interpreter. His English was better than my non-existent Japanese, but I could hardly make out a word he said. Eventually, leaning forward, I was able to discern one phrase endlessly repeated: "the bursting of the bubble". Over the years, I met many Japanese ministers. The speech was always the same because the pain lasted a long time. What we have been seeing is the bursting of the Brown bubble. It is extraordinary how Gordon Brown, who as Chancellor produced endless heavy government publications on so-called stability, could not see that soaring personal debt and ever-increasing house prices would eventually hit the rocks. The longer the illusion lasted, the greater the boasting became. At first it was "the longest period of expansion in the 20th century". That was always untrue, as the period 1950-1964 was longer. Then it became the longest period of expansion "on a quarterly basis" for 100 years, and then even "250 years". These claims were ridiculous because records were not kept on the same basis for these periods. Just how great an illusion it was can be seen by comparing the growth in real, personal disposable income (after-tax) under this Government and under the Conservatives. During the governments of Margaret Thatcher and John Major, post-tax disposable income grew steadily. Since 1997, take-home pay has only grown very slowly because of increased taxes. The illusion of rising prosperity has been maintained by borrowing to spend, often in the form of equity withdrawal from increasingly expensive houses. The impression is given that this is entirely some self-generated crisis from within the financial system. There has certainly been irresponsible lending. But the primary responsibility for where we are today belongs to governments and central banks. In the United States, the boom was fuelled by too low interest rates and the Fed continually pumping large amounts of money into the system to avoid "deflation". Far from working, injections of money only delayed the problem and, indeed, exacerbated it. Here, the Bank of England's remit, set by Gordon Brown in 1997, was too restrictive as it targeted a narrow definition of inflation which excluded house prices and did not give any weight to the growth of money. As the boom took off, financial institutions rushed to satisfy the insatiable demand for credit, creating ever more esoteric financial instruments, hard to understand and apparently not understood by those who created and sold them. In the US, profits of financial companies increased to no less than a staggering 41 per cent of total company profits in 2007. There were lots of warning signs - and many did warn at the time, including Warren Buffett and The Daily Telegraph's Roger Bootle. What we face today is potentially the most serious financial crisis since the 1920s. The US Government's decisiveness contrasts strongly with our own Government's dithering over Northern Rock, but there can be no certainty that even in the financial sector the problems are now largely behind us. The actions of the American government have been awesome in their scale, but also involve risk. The $300 billion to take over Fannie Mae and Freddie Mac, the US housing finance corporations, doubled at a stroke the government's liabilities. The securities the Fed is taking on to its balance sheet from the private sector could fall in value, or be subject to defaults. It was a sobering moment when one of the rating agencies felt it necessary to announce that it was not proposing, at present, to downgrade the rating of the US Government. The British Government will be hoping the actions of the US will improve confidence throughout the whole world and make it less likely they will have to bail out another bank. But the problems of the banks will only be over when house prices stop falling. At present there are few definitive signs of that in the US, and here, prices clearly have further to fall. Even so, it would be a great mistake for the Government to seek to prevent prices reaching a more affordable, sustainable level. Even when the financial sector settles, the effects will then be felt increasingly in the wider economy. Banks will be more cautious and will have less capital to lend. As credit shrinks so will private sector demand. There will be calls for more regulation. It must be remembered that banks are already heavily regulated because of the privileged access to the lender of last resort, the Bank of England. But if banks are wise, they will take a long look at their own remuneration practices. Too many people have been allowed to make massive sums of money and then walk away, leaving nothing but wreckage behind them. The Government must be ready to support key parts of the financial system, but we must be careful that in solving this crisis, we do not again sow the seeds of the next. It was never the view of Walter Bagehot, the great 19th-century financial writer, that central banks should bail out unwise lenders, but rather that they should make finance freely available to bona-fide institutions at a penal rate. The consequences of this crisis will be with us for a long time. They will be political as well as economic, affecting what America and we in the UK can spend on our armed forces. So our standing in the world, and that of the US, will be diminished. Other countries will be less inclined to listen to lectures from us as to how they should run their affairs. And perhaps they have a point.
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