Root of the problem? What Can Be Done To Make Banks Lend?

Lots of them on Usenet too

On Wed, 14 Jan 2009 15:44:23 +0000 (UTC) 'M Holmes' wrote this on uk.politics.misc:

Michael, can I ask you to comment on my own analysis of this... which is stunningly similar to your own...in my own words.

ISTM that the UK economy has been surrounded by a thin layer of froth for years, maybe 5% of the total economy, but it was largely containable, albeit with ups/downs. What we have seen over the past ~10 years under Brown is a huge expansion of froth to unsustainable levels. This expansion was funded by a massive cheap money borrow/spend boom which gave birth to many businesses and much employment (including a lot of immigrant labour), most of which only exists in the frothy economy. It also created a rise in GDP and a huge rise in tax revenues, which probably explains Brown's rationale for expanding the economy in the first place. Not content with higher tax revenues, Brown himself went on a borrowing spree too. One of the consequences of this froth has been consumer inflation, hidden by the CPI measure.

Now the frothy bubble has burst we see Brown trying to keep it inflated by pouring £billions everywhere. It won't work for the reasons you have described well. In fact he will extend the period of adjustment by meddling. The only solution is to allow the froth to be cleared away by a natural process of market activity. He is on record as saying he won't wait for this.

What I don't know is how much of the total economy and how much employment is tied up in this frothy bubble. My best guess is maybe 15% of GDP. If so, it means we will see lower levels of employment for years, less borrowing, lower tax revenues and lower asset values. Much of that is a good thing. But it will have serious effects on society and on Govt spending programmes, many of which were justified on the frothy tax revenues, now disappearing fast.

Thus, Brown needs to take a sharp knife to spending programmes to bring them into line with available financial resources. It could mean whole programmes being slashed, but I see no action on that worth mentioning. Sound money must be the watchword.

rgds

It's not the risk of redundancy that matters, it's the risk of being saddled with a loan you can't make the payments on *if and when* redundancy happens.

No, that's not the way the system works. When you end up jobless, you will qualify for housing benefit to have your rent paid for you. But with a mortgage, you also get help with those payments, but not for the first N months. N is biggish. 9? 15? I forget. That sort of ballpark. To cover this bridging period, there is insurance which you don't need if renting.

the temptation is near to overwhelming...thank god for my iron will!

regards

Sure.

I think the credit bubble started back in the mid 1980's with the Big ang in The City. It'd been going a while by the time Brown appeared. Unfortunately he mistook it for his own personal economic miracle and encouraged the blowoff phase rather than try to raise rates and stop it.

Exactly. There was a huge retail buildup (amongst other things) expanding floorspace to servive bubble-generated demad as people used their houses as cash machines to live beyond their means. Unfortunately retail is labour-intensive and so as retail floorspace is reduced...

Yup.

Exactly, and with it the amount of lost potential GDP expansion as well as all of our mne he throws away. All my reading of past bubbles seems to indicate that those governments which keep their powder dry for the bottom can do the most good with it, not least because almost everything is much cheaper at that point. Those who try desperately to keep the bubble going will simply be throwing away the money we'll need at the bottom.

It's hard to say whether Brown has recognised that markets were doing the job that needed done (cutting overpriced assets down to size; putting overborrowed businesses on the block so that their resources and personnel can be used by more prudent investors; correcting the behaviour of overborrowed individuals; reducing lending and increasing saving) and didn't like it, or plain just doesn't understand that what's happened is a sign that these changes need to be made and made quickly.

Yes.

The government will eventually realise it has to cut its coat to its cloth too. I suspect there will be fewer Diversity Coordinators and the like, which will itself be a good thing.

If the Tories had a clue, they'd be saying this. Deep down, damn near everyone knows it's true, whether they'd like another year of the bubble or not.

FoFP

I've been on uk.finance for rather a long time and I can tell you that more people here saw what was coming than pretty much anywhere else other than Prudentbear.com and in quite some detail too. Certainly the so-called professionals in finance and property have shown themselves to be considerably more clueless. Not quite as clueless as Brown's government though. History will not be kind to them.

FoFP

On Wed, 14 Jan 2009 19:14:18 +0100 'abelard' wrote this on uk.politics.misc:

Ooh g'wan let yourself rip :-)

On Wed, 14 Jan 2009 19:46:49 +0000 (UTC) 'M Holmes' wrote this on uk.politics.misc:

Thanks Michael for your much appreciated comments.

I think the Tories do understand the reality and will almost certainly follow the right path if they win the GE. But they're in a dodgy situation. Brown is obviously trying to keep the bubble inflated and it only needs to be for 6-9 months, so he can run to the country claiming success. If the Tories are publicly set against his current actions, it could spell disaster for them at the GE.

On Wed, 14 Jan 2009 19:52:21 +0000 (UTC) 'M Holmes' wrote this on uk.politics.misc:

I know of prudentbear.com ... a very informed blog :-)

You should think about writing a few essays for publication...! Thanks for helping me to clarify my own thoughts...

I think *everybody* saw it coming, economists, shoppers, homeowners and in general the man on the Clapham omnibus. Many prominent people warned publicly of it.

The problem was, nobody had the slightest idea *when* it would happen, what the eventual last straw would be. Many people spotted the 'toxic debt' in the US, and said that would be it, but many people had already said that other things would be the trigger, and they hadn't been. 'Wolf' had been cried too often.

There wasn't really much that most people could do to prepare for the crash, so the only practical course was 'business as usual' until it actually happened. If the ship really is sinking, you might as well sit and help empty the bar as jump overboard straight away. Everyone who could take to the lifeboats already had.

Government lending not bank lending or guarantees by government (unless he forces them to lend naked and take the risk). The banks don't want to lend. That's what the fuss about.

Not quite true. As Buiter said, there is no such thing as a safe bank. They did not know timing and scale. Of course not. If that were possible the markets would not allow it to happen in the first place becasue they don't want to lose. What happens is that everyone hopes to get off the merry go round before the crash. How big the losses are then is not pre fixed. The worse the crash the more the losses.

But every economist knows there are regular banking and economic crises. There just ain't a crystal ball allowing you to know the future in detail.

Evan Davis said in his BBC prog this evening that if Adam Applegarth had reined back Northern Rock's lending he'd have been sacked. Everyone wanted to be on the merry go round.

Another regular feature of the upturn is that people know it can't go on indefinitely but expect a soft landing not a hard one. The difference can depend on a black swan like Lehman's collapse which spooked the whole system. It could just as easily have been taken over and the great panic avoided. Probably Fuld's arrogant self-belief decided the matter.

guess what people who understand the markets have been doing over several years..... while idiots have been claiming how much they've 'made' by continuing to ride the wave....

not entirely true unless you have no skin in the markets

such is the problem when employees run businesses instead of owners.... applegarth had clear options....state his case....take his wages....and go with his reputation intact and plenty to live on....

that would just have delayed the mess a little.... northern crock had already gone down before lehman....fuld did try to get out but seems not to have concentrated....

bush, mccain and greenspan and others saw the central problem years earlier... politics is the art of the possible, as bismarck said....

The idea that it was Lehman that caused this is risible. The quarter-century credit bubble was the cause. Lehman was just one of the triggers which marked the inevitable bursting of the bubble. If it hadn't have been them it'd have been Fannie and Freddie or something else. This was always going to happen. Every large credit bubble ends in debt-deflation and credit starvation followed by debt revulsion - by the time the banks can lend again, a great many people will have sworn off borrowing for life and will raise their kids not to borrow.

I do agree about folks running for the cliff because everyone else was. A trader told me three or four years back that he agreed we were headed for a crash and debt-deflation. For the reasons you give above, nobody can know quite when the bubble will burst. he was in the position that if he acted differently from the other lemmings and six months later it hadn't burst, his numbers would have been lower than everyone else's and he'd have been dropped. Since he had a mortgage to pay, he had to run for the cliff. I think huge numbers of people were in that position.

FoFP

Indeed. Doug Noland's stuff was incredibly prescient on Enron, and then he identified in amazing detail the nature of the mortgage bubble and how it would break. His columns had convinced me by 2003 that Fannie Mae and Freddie Mac would go down with the bubble.

A friend was working for One magazine and they gave me an outing for a couple of articles. I'll possibly publish another one there on the story of an idealised credit bubble by abstracting the common elements from the largest examples from history.

FoFP

The government clearly didn't. I'd lost count of the number of times they decried the housing market's "doomsayers". Not so convinced about the shoppers either. They just kept on blowing their mortgage equity withdrawals. That's not the behaviour of anyone who is convinced a debt-deflation is coming.

Indeed, and that's the nature of the beast. If the top of a bubble was spottable, folks would all sell 24 hours before it and the top would therefore happen earlier.

The media has too many people hooked on what the trigger was, even though that's possibly the single least important detail.

Pay off debt. Increase savings. Buy gold. Preparing for it isn't exactly rocket science. Even if it takes longer, those are hardly bad ideas anyway.

Really I agree with you. Bubbles will hurt the vast majority of those they suck in and there's little to be done about it. If politicians had stood in the way of people borrowing to buy their Golden Tickets to riches (it was housing this time, but that's a trivial detail too, it could as easily have been hyacinth bulbs or whatever) then they'd have replaced them with more amenable politicians.

There's another argument to be had though: Should we stop bubbles if we could? Everyone assumes they're a bad thing because of the damage wrought in a debt-deflation. However the bubble allows capital to flow to new business ideas and usually this drives technological revolution. The bust then weans out the less feasible ideas and frees up personnel and resources for the profitable ones. This time it was the internet and related technologies. Last time it was the car and radio communication. In previous bubbles it was colonisation of the Americas.

Seems to me that we may need both the bubbles and the busts to drive human progress and despite the bumps in the road, we might all be very much the poorer without them.

Could be a while before that gets much media airtime though...

FoFP

I always thought the money expansion for WW2 was the biggest initiator of business and technology for human progress. So many new ideas and industries came out of it.

? ? ? ? -- Roger Lee

You misunderstand me. Lehman did not cause the problem. It was merely one entity working a bubble. Lehman was however the event which destroyed confidence and produced a rapid hard landing because of its size prominence and long history. Other failures did not have that effect. OK something else similar might have happened or it might not and a gradual unwinding might have fiollowed instead of rank panic.

I agree, but the practical outcome to the person involved is very similar if they can't pay their mortgage or can't pay their rent. I wasn't aware that the unemployed get better/quicker benefits if they rent so this obviously makes a lot of difference.

They don't *have* to bail them out.