How to survive the credit crunch

Banco Santander (picture Junius)
With the vote by the US congress to kill the fatted calf and bail out the banks on Wall Street, the global financial crisis has finally passed out of the phase of getting uncontrollably worse. (It might still get worse, but the fightback has started.) The vote was controversial, but in the end it was necessary.

Robert Shiller compares a bailout with a child who refused to eat dinner with the rest of the family complaining about being hungry later in the evening. Maybe it’s not fair on the other children who ate at the appointed time, but what about the elderly aunt who has come to stay and would otherwise be disturbed by all the whining and the arguments? There is more than one dimension to fairness.

But while the details of international finance are outside the scope of this blog, I think that it is fair to observe a rather uncanny coincidence between the most determined opponents of banking regulation and the most determined opponents of the EU.

Janet Daley and Daniel Hannan elevate their objection to oversight of banks’ behaviour into a moral code, for example. They are appalled by the idea that the comprehensive failure of the current system of financial regulation should be used as a reason to revise and improve it. And to do so, they have to resort to all kinds of absurdities to explain away what we have witnessed in the past year or so (or, better, the last decade or so).

The explosion in lending, much of it to borrowers who had little chance of being able to repay the loan, is attributed purely and simply to the low rate of interest. Had interest rates been higher, sub-prime borrowers would not have borrowed so much. But the problem was that so many sub-prime borrowers didn’t know what the interest rate was and were not educated to understand what it meant even if they had known what it was. The only source of advice for many people was from the sales representatives of the banks and finance companies.

Also, if the problem was that interest rates were too low, we ought to be seeing the worst banking problems in the countries where the interest rate was the lowest. In the eurozone, the eurosceptics have never tired of telling us, the one size fits all eurozone interest rate has been held down to suit Germany and France and, as a result, the economic boom in Spain has been allowed to get larger than it might otherwise have done. So it is in Spain, therefore, that we should expect to find the biggest and worst financial collapses.

But in fact, no, the Spanish banking system is fine. It is to Santander, a Spanish bank, that Bradford & Bingley is turning for support. The problems of banking cannot be pinned solely on interest rates.

In any other walk of life, Janet Daley would be the first to say that government regulation affects the way that people behave. Why does she somehow exempt the people who run banks from this universal law?

So many economic activities depend on banking and the availability of credit that the government has to take an interest in keeping it going. The free market axioms that allow companies and even whole sectors to disappear cannot be simply applied to banking. And if banking is now organised internationally, the regulation that keeps banking healthy needs to be organised internationally, too.

This is why the free marketers and nationalists coincide. To create a supranational regulatory framework for the financial markets is to create the possibility of regulation. It does not create the certainty of it – that depends on a separate set of decisions to be taken – but at least those decisions become possible to take. Without that framework, regulation simply becomes impossible.

The speed and extent of recovery from the current financial turmoil and the ability of the global economy to withstand future similar shocks depends on the ability of the regulators to step in, and they have to do so at a level and on a scale commensurate with the problem itself. Pinning the blame on the borrowers alone is wrong and will fail.

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More on the global financial crisis:

Jeffrey Garten argues in the Financial Times for the establishment of a Global Monetary Authority to oversee markets that have become borderless – “Global authority can fill financial vacuum”

And Larry Wilmore explains the sub-prime loan market on The Daily Show with Jon Stewart

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