Pretty big steps. Does the real Minsky Moment lie ahead?
"We are looking at some pretty big steps which we would not take in ordinary times but we are ready to take them..."
That's what Alistair Darling just told my colleague Andrew Marr. But what can these be? They have already agreed to trade private banking dirt for Bank of England gold, effectively, by allowing US student debt and credit card debt (judging by my stay in Ann Arbor, home to UMich, the two categories overlap) to be traded for crisp new sterling notes. They have already set up a National Economic Council. They have nationalised two banks and brokered the forced merger of a third.
I will now spell it out: I am not going to indicate sources and I view with a mixture of frustration and sympathy the fact that the major decision makers keep coming out with these coy indications. Further down I deal with the intellectual resources that could inform a more coherent response to the crisis, and why all these "comrade Hank Paulson" jibes are missing the point...
1) They are considering taking an equity stake in some major UK banks and financial institutions. I know this for a fact. They are looking at which "public sector bodies" could do this under the February 2008 legislation that nationalised Northern Rock.
2) They will have to cut interest rates. I asked several senior advisers to those who will sit on the NEC on Monday "what is the first item on the agenda"? Nobody could answer. Clearly under the Bank of England Act the government has the power to re-set its economic priorities and order the Bank to slash interest rates, Nothing quite so un-City of London will happen: once the political pressure is high enough Mervyn King will find a reason to do it. Despite the cries of pain from the last inflation hawks in Fleet Street I suspect they will do it fast.
3) Since there is a danger that rival, piecemeal European banking system bailouts will leave the UK at the back of the queue for Asian and Middle Eastern capital needed to recapitalise the banks, they have to be ready to "do an Ireland" with banking deposits even though they think it is madness. By the way, apropos of some crazy blogging suggesting I am advocating this, I am not. The LibDems are advocating it so, as its a matter of party politics I am not allowed to have a public view on it here. But let's put it this way: small Eurozone economies declaring their bank deposits "safe" is about as logical as Wigan Metropolitian Borough Council doing likewise. The end result is going to be that everybody is back to square one, with their savings "guaranteed" by governments that have no money and, now, have to pay higher interest rates to borrow it. In any case Darling has already indicated: every time a bank has actually failed the government has stood behind all savings. 98% of deposit accounts are, as of Tuesday, safe. (But I ask, why not Monday?)
4) The Icelandic collapse threatens to take down several UK businesses. However there is a bigger systemic problem. If you combine Iceland's effective bankruptcy with the nationalisation of Hypo in Germany this morning, and of Fortis on Friday, then a wave of defaults is heading for any banking system in the world that is exposed to these latest casualties. And since London is the rip-roaring capital of international finance, well, stand by your Bloomberg machines on Monday.
5) The E15bn release of funds from the European Development Bank is the most significant move of the weekend. It is intended to provide short term liquidity for small businesses. I am not clear right now how it will avoid being swallowed up into the big banks' liquidity cushion. Answers please.
6) There is one thing they can do, but I know for a fact that some policymakers are nonplussed by the prospect. It's called quantitative easing. The "for dummies" summary is: the Bank of England starts printing money. It's a different deal from the usual mechanism by which central banks try to counteract a slump, which is cutting interest rates. Why? Because you can only cut interest rates to zero and then they stop working. That is why the only time it's been used by a major central bank was in the case of Japan in 2001 when short term interest rates were near zero. However some uber-Keynesians are now arguing it has to be done before a deflationary spiral kicks in. One of the most frightening indicators of the past few weeks has been the rapid fall in the broad money supply - "quantitative easing" is a kind of monetary version of Keynesian pump priming in which, instead of building bridges to nowhere you simply print money. This would be anathema to those who run the financial architecture today, but I expect some academic discussion of it around the fringes of the MPC soon.
7) Other stuff: well the majority of banking crises are solved by so called "regulatory forbearance". That is governments waive the banking regulations and let banks overstate the amount of capital on their books so they don't have to go running to the markets to find new capital (there is none around right now). This would be tough for Brown and Darling because they are big supporters of the Basel II international banking regulations, and have been part of the tightening of those regulations that happened, ad hoc, after the first credit cruch hit in August 2007.
8) One statement on Friday will bear further scrutiny: that "financial stability issues are addressed through the existing standing tripartite arrangements". Well the "arrangements" between the Bank of England, FSA and HM Treasury were not enough to prevent two banks going bust and UK competition law having to be suspended. If, as the government wants, there is to be a cross-cutting and holistic response to the various aspects of the crisis, how can this be done if it's all farmed out to three bodies that are still trying to decide who does what, and with - in the case of the FSA - a new managment still repairing the failures of Northern Rock and B&B? Well read the statement again: the "stability issues" will be dealt with this way. But the government's economic policy, as outlined in recurrent remit letters to the Bank, is stability and growth and full employment. This raises the tantalising question: could the government now take charge of a growth-oriented economic policy which removes responsibility (and as some in the financial world would see it the taint) from the Bank of England of having to chuck money at the situation (which its leadership has plainly felt queasy about at every turn)? Could it turn the Special Liquidity Scheme into something more permanent that in fact supports, overtly, the solvency of the banking system? Could it do what Sir James Crosby suggested and underwrite the entire mortgage market with government debt? That, the bank bosses know, is an urgent question. Let's have a clear answer.
9) Finally it is all being briefed to the papers that on Wednesday at a lecture (again, why not Monday in parliament?) Alistair Darling will signal the changing of the fiscal rules so he can raise debt to above 40% of GDP. Banking crises, says the recent IMF study, always have a high fiscal cost and we are about to find this out.
10) There is a massive regulatory challenge here: we have a commerical banking system allowed to be monopolised by public fiat on 17 September; we have large amounts of taxpayer money at risk. Designing the new regulatory system will be difficult because the whole of the dodgy lending, offshore hedge-funds etc that has brough us to this point was effectively designed by lawyers and accountants to get around the Basel II regulations. And it will take time. But the current light-touch regulatory regime cannot stand scrutiny. To give just one example: how is it right that B&B savers can earn 7% on a one-year investment when there is no risk to their money? If I, the taxpayer, am bearing some of that risk then I want some of the reward. Thus there is a capitalist, freemarket, Smithian logic to the demand that B&B's management becomes subject to public participation and has severe limits on its profitablity and competitiveness imposed: if it's right to rein in the Irish banks from aggressively touting for business, should it not be the same for British B&B? The logic of this is that parts of the banking sector become socialised. Actually part already is: National Savings and the Post Office Savings Bank - and these two institutions are, anecdotally, doing a roaring trade, the same as gold bullion offices are. Even if you don't officially socialise them, the banks are already on the way to becoming the new utilities - heavily regulated and prevented from reaping super-profits from their uncompetitive position.
In summary: with many debts socialised, some banks completely socialised, and the taxpayer acting as lender of not even last resort but right now first resort - could the ownership and control be socialised without imposing huge stagnatory factors on the economy; what would be temporary and what permanent; and what kind of new regulatory system will emerge?
Here's a final thought for any minister or permanent secretary mugging up over a bacon sarnie this afternoon in readiness for the first NEC meeting. Or for opposition politicians getting ready to respond to Darling's "pretty big steps". By now you will have heard the word "Minsky". Hyman Minsky was the man who explained why stuff like this happens. His explanation of the role of the financial system in creating crises on a scale of 1929-31 is virtually a handbook in US banks and hedge funds, just as surfers like to study shark fin ready-recognition guides.
But very few have studied his policy prescriptions. I will throw just one at you, from his book John Maynard Keynes, just republished:
"As socialisation of the towering heights is fully compatible with a large, growing and prosperous private sector, this high-consumption synthesis might well be conducive to greater freedom for entrepreneurial daring than is our present structure". (Minsky, HP John Maynard Keynes, New York 2008, p164-5)
We've come to think of the "Minsky Moment" as a catchphrase for the crisis. But his solution, a more stable form of capitalism with a different mix of private and social ownership, is what politicians seem to be grappling blindly towards (see this recent Levy Institute paper for a very readable explanation).
The book, as I say, is worth a read. I am not advocating any specific policies - but I do think the job of journalism is to go beyond hand wringing and the ever decreasing circles of received wisdom which is making some UK newspapers virtually unreadable.
Start with the final chapter if you are phobic about algebra and graphs. And hit the comments button.