7 July 2008
Since I started this exercise on 28 June 2007, the business and economic environment has changed beyond recognition. The hubris and excess that characterised the financial markets until last summer have thankfully evaporated.
People — and especially the directors of banks such as the Citigroup, Merrill Lynch, Lehman Brothers, HBOS, Royal Bank of Scotland and UBS and the fund managers who were unwise enough to remain overweight in sectors like financials, retail, housebuilders and property even as the credit bubble stretched to bursting point — are genuinely shell-shocked. Some are suffering from depression.
The crisis is increasingly spreading into parts of the developed world economy which some previously thought would be immune. One example is that mid-market private equity players are admitting it is now hurting them too.
If bearish economic commentators like Nouriel Roubini are to be believed, the US and probably most of the rest of the developed world are about to go into a deep recession. Not only are house prices in the UK poised to tumble by more than 10% this year alone. They will probably have fallen by 25-30% before this bust is out.
It’s worth trying to think positively about these things, however. For example, in recent years, many banks have been behaving with the utmost recklessness. Isn’t it time they started behaving a bit more responsibly, for example by checking whether their customers have the wherewithal to repay their loans and ensuring they have a bigger capital cushion to protect themselves from the defaults and delinquencies that always accompany adverse economic conditions? Also, if residential property had become ludicrously over-valued in the past 10 years, as I believe it had, then surely a 30% correction is no bad thing? (For further thoughts on the property correction, read Here comes the bust.)
As Wolfgang Munchau put it in today’s Financial Times (Recession is not the worst possible outcome), it is critical that asset prices are allowed to find their natural level, without impediment or intervention from jittery regulators, central bankers and politicians. Some banks must be allowed to fail.
Unless the siren voices of the property/financial complex — which argue that the best solution to this crisis is a return to easy money and credit addiction, even though these were the very things that brought us to the brink of the abyss — are ignored, a mere “Minsky moment” risks becoming an eternity. If the ‘powers that be’ can be persuaded to ignore such voices and resist the urge to intervene, then I believe that some good will come out of the current crisis. For a start, we’ll end up with a better-balanced economy that is less dependent on the non-productive process of paper shuffling, and shifting money around, and which overcomes its addition to cheap borrowing.
The ‘cold turkey’ is bound to be painful — and it could be crippling unless the oil price does what it normally does in recessions and falls. But at least we’ll end up with economies that are more resilient and more sustainable than the extremely fragile, debt-fuelled edifices constructed by discredited politicians such as George Bush and Gordon Brown, and their regulatory and financial cheerleaders — of whom the most powerful, and therefore the most dangerous, was former Fed chairman Alan Greenspan.
One question that I have failed to properly address in this blog so far is this. Is what we’re currently living through just another downturn, part of just another business cycle? Or have both the upswing that peaked with insane leveraged buyouts in July 2007 and the current down swing been exaggerated by ingredients that were previously absent? I think the latter is the case, even though the exact nature of the missing ingredients is hard to ascertain. There are, however, a number of possibilities.
The greed of the transatlantic banking fraternity certainly played a big part. Egged on by a short-termist bonus culture, the bankers and other financial players were persuaded to commit acts of knavery with other people’s money that they would never have committed with their own. The widespread abuse of the “shadow banking system” to dupe regulators and shareholders about their true capital and liquidity positions is just one example of the deceit, verging on fraud, that became prevalent in the sector and fuelled the credit bubble.
The “light touch” regulatory system, including that practised by our own “Fundamentally Supine Authority”, has proved to be seriously flawed. How could the FSA have failed to notice that something was seriously awry with former building societies such as Northern Rock, Bradford & Bingley and HBOS — the unsustainability of whose models was transparently clear to many less partial observers.
It seems that during the credit bubble years, central bankers and regulators in many economies lost sight of their raison d’etre; most allowed themselves to become “captured” by the financial elite, allowing the wool to be pulled over their eyes by the very people they were supposed to be policing. Some, like Greenspan, fell for the financiers’ hype that the unconstrained use of derivatives and securitization would eliminate risk from the financial system. It didn’t. It actually increased the risk.
There are also, of course, big questions about whether it is advisable to continue with a ratings agency model which allows the people who are supposed to be in the “dock” to pay all the “judges” fees.
If you transpose the model onto the world of journalism, it would be absurd. Business and financial journalists would end up being directly dependent for their remuneration on the very companies they are supposed to be reporting on and investigating! And political hacks would be paid by the governments whose performance and shenanigans they were supposed to be exposing and monitoring.
The journalists would of course rapidly become as uncritical of their paymasters as were the editors and journalists of Pravda during the darkest days of the USSR — and newspaper sales would start to fall even faster than they are currently doing. This sort of financial serfdom would be a non-starter in the world of journalism. Therefore why should anyone believe it could work in the world of ratings or even auditing for that matter? (For more on ratings agencies from the FT, click here).
Then there is the role of consumers, including private equity and corporate borrowers. To what extent can we be held responsible for propelling the global credit bubble into the stratosphere through our lazy demands for bigger and cheaper loans and the expectation of continuously top-performing property investment and economic growth?
Sadly there are no easy answers to any of these questions.
However, I sincerely hope that, rather than just seeking to revert to the orgy of irresponsible borrowing, lending and greed that have so tainted the past eight years, people take a step back, re-examine what they’re doing, and use the current economic crisis as an opportunity to reinvent capitalism for the better.