A necessary evil
Though largely forgotten now, the headlines ten years ago this week had an uncanny resemblance to those of the past few days. There was an emergency bailout, demands to slash interest rates, bankers warning that the world’s economic system was in danger of systemic collapse — countered by disgusted voices warning that nothing good would come of using taxpayers’ cash to prop up failed financiers. The only difference was the scale. The bail-out of the collapsed hedge fund Long-Term Capital Management in 1998 cost US taxpayers $2.3 billion. This week’s bail-outs will cost US taxpayers $700 billion and British taxpayers £50 billion. And already there are warnings that these mindboggling sums will not be enough.
The disgusted voices of 1998 were right. There is a connection between what happened ten years ago and what is happening now. The bail-out of Long-Term Capital Management by Alan Greenspan, then chairman of the US Federal Reserve, encouraged reckless behaviour just as was warned. The emergency cuts in interest rates, intended to avoid a collapse in the global economic system, instead inflated the dotcom bubble. While that collapsed 17 months later, the era of cheap debt was to inflate other asset prices, culminating in the property boom and the subprime scandal which has got us to where we are today.
A purist would argue that we should learn the lesson of this: banks should on no account be lavished with a penny of taxpayers’ money. True, many minds would be concentrated if bad banks were allowed to go bust. The bankers would not get their bonuses, nor even the final instalment of their salaries; the shareholders would lose everything. Such a laissezfaire approach would certainly discourage an irresponsible lending spree in the future. Unfortunately, it would also lead to depression, as blameless depositors lost their savings and responsible businesses were starved of loans. So sharp has been the decline in banks’ share prices this week that we risk being left with no banks at all. It is little comfort to think that a more responsible breed of capitalist would emerge from the economic ruins which would be left as a result.
There is an inevitability, then, that some kind of recapitalisation of banks must now be undertaken. As we go to press Alistair Darling, the Chancellor, has just unveiled the details of a £50 billion plan to support the banks by taking a stake in them, by the purchase of either preference or ordinary shares. Its true cost may be very much greater. Much though it grates with our free-market instincts to witness what amounts to a part-nationalisation of banks — paid for by yet more public borrowing, and announced by stages in the most bungling fashion by a Chancellor not up to the job — we reluctantly accept that an intervention of this sort had become inevitable. The British plan is a good deal less objectionable than the $700 billion bail-out of US banks approved on its second attempt in the House of Representatives. While US taxpayers will be forced to buy only toxic assets, British taxpayers will at least be buying a share of the good assets too, and therefore stand a chance of making a profit from the venture.
One thing, however, should be clear: any attempt to solve the present crisis should be founded on a principle that Alan Greenspan ignored in his ‘crony capitalism’ of 1998: markets only work if those who make bad decisions are made to pay the price. The price paid by the banks for submitting to part public ownership must be the cancellation of their bonuses and a severe pruning of their salaries. Whining shareholders who complain at the dilution of their holdings should be reminded: the alternative is a complete wipe-out.
Failure to punish those responsible for getting the banks into their present state risks not merely encouraging even greater irresponsibility on the part of bankers, it will encourage every other loss-making industry to go squealing to the government. In fact, it took less than a week for this to happen following the US bail-out. Among the provisions now included in the US Troubled Assets Relief Program is a handout of $192 million for rum producers in Puerto Rico and $478 million for the film industry. Many of those senators who opposed the bail-out initially but changed their minds when it was voted on a second time last week have turned out to be less than principled in their concerns for taxpayers: rather they have exploited the occasion to get their own snouts in the public trough.
Another price the banks must be made to pay for submitting to a government bail-out is regulation to treat their customers better. By this we do not mean, as some have suggested, that they should be forbidden from repossessing the homes of those who cannot pay their mortgages. The real victims of the banking crisis are not feckless consumers but businesses, especially smaller ones, facing ruin due to the arbitrary increases in overdraft rates and the calling in of loans — even when interest payments were being met. If banks were to call in the mortgages of homeowners who slipped into negative equity, even though they were still meeting their interest repayments, there would be outrage. Yet that is the reality which small businesses face, and the reason so many go to the wall in a recession.
Some will see in the banks’ troubles an object lesson in the evils of capitalism. They should be reminded that the crisis has struck the social-democratic paradise of Iceland — which, thanks to its spending programmes, last year topped the UN’s list of best countries in which to live — much harder than it has Britain. Anger with irresponsible businesses should not translate into a reactionary attack on markets: still the best mechanism devised by humanity for trade, wealth generation and the distribution of resources. Without a free, wealth-creating private sector, powered by the promise of personal reward, there cannot be sensible public spending. For the next couple of years or so the majority of bankers are going to have to accept that they will not be part of that private sector: but — amid all the crisis chatter — we dare not lose sight of the market fundamentals that will, more than any government intervention, ensure the eventual resumption of wealth creation and stability. This rescue package is a necessary evil, not the dawn of a new era.
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