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Could there be a greater corporate disaster in British history than the humbling of the Royal Bank of Scotland? Without £20bn of taxpayer support, the bank, with assets of £1.7 trillion, more than Britain's GDP, would now be bankrupt. Its mutation from bank to de facto giant hedge fund, cheerleader for casino capitalism with a portfolio of £500bn in derivatives and £100bn of takeovers in its wake, perfectly sums up our times.
The financial wreckage it has induced explains why the wider economy is in such trouble. There were many other asinine banks, but RBS was leader of the pack. News that it had lent the hedge funds of the now disgraced American fraudster Bernie Madoff £400m with insufficient due diligence was symptomatic of the failure of every aspect of RBS's corporate strategy.
Sir Fred Goodwin, the now deposed CEO, and his team should be asked hard questions by both shareholders and the police. So should the outgoing management at sister Scottish bank HBOS, whose incompetence rivals Goodwin's. The former RBS chief has rightly been dubbed the world's worst banker by Slate magazine's Daniel Gross.
For a decade, British banks had grown fat on what seemed an inexhaustible supply of cash from London's deep, wide market in money, succoured by savings from all over the world, and bet it on an increasingly complex and fantastical array of financial products hatched in the financial shadows.
The first crack showed when Northern Rock could no longer borrow in the interbank market in the summer of 2007 because others doubted its creditworthiness. After five months of government dithering, it was nationalised. But over 2008, the cracks widened into a fissure, so that following the collapse of Lehman Brothers in September, only the finest names in world banking could tap the New York and London markets. Vast loans could not be refinanced, let alone new ones made and as property values tumbled, the collateral against which the loans had been secured evaporated.
It looked like 1929 all over again, except governments, especially in Britain and America, were determined not to repeat mistakes made following the Great Crash. The Bush administration had already put aside its ideological commitment to non-intervention in a range of responses, nationalising the US's two giant mortgage companies, Fannie Mae and Freddie Mac, then launching a $700bn programme to buy toxic loans and aggressively cutting interest rates. But still the system tottered.
It was Gordon Brown who, over the weekend of 11-12 October, emerged as the world leader with a viable plan to head off what might have been the collapse of the western banking system. The response hatched in London - three pronged but centred on recapitalising the banks with taxpayers' money - became the model that the rest of the world copied. Brown sold it first to the Americans and then the Europeans.
It was a tour de force. It staved off immediate disaster. Brown's self-confidence, which had been wilting ever since he ducked calling an election a year earlier, suddenly revived. His government had a purpose: to manage Britain through the worst financial crisis since the 1930s. Labour's philosophy in favour of government activism, never wholly abandoned, was right for new times. It could not be clearer that markets were inefficient, made horrendous mistakes and needed governments; the philosophy that argued otherwise was bust. The public noticed and Labour's opinion poll ratings climbed out of the abyss.Yet he is travelling in uncharted waters. The International Monetary Fund has warned that recessions caused by financial crises are longer and deeper than others. The banking system in Britain and elsewhere may be saved, but the interbank markets on which lending depends remain broken. Banks do not have cash, their capital is under pressure and their borrowers are distressed, hardly a recipe to increase bank lending to stimulate recovery. Germany, Japan and the US are predicting a grim recessionary year in 2009; the Treasury forecast of a mere 1% decline in British GDP seems incredible.
The government's Plan A is that the combination of the fall in interest rates to 2%, the sharp fall in the pound and Brown and Darling's £20bn package - together with Barack Obama's stimulus package - will see off the worst of the recession. Critics, ranging from the Archbishop of Canterbury to the German finance minister, strongly differ. They say that lifting government borrowing to finance consumer spending only repeats the bad habits that got us into crisis, whose moral roots are unaddressed. It won't work.
These critics are wrong. The criticism of Brown and Darling should be not that they are Keynesian, it is that they are not radically Keynesian enough. They only understood the severity of the crisis too late, disbelieving that markets could make such enormous mistakes. They were too slow to nationalise Northern Rock. They should have introduced the package of schemes to make lending less risky not next month but last spring, as I and others argued. They have allowed the governor of the Bank of England to be too conservative and restrictive on the terms the Bank supplies cash. They have not urged police investigations into senior bankers, so vital for our collective sense that justice is being done, nor quickly introduced the tougher regulatory regime for which many seasoned bankers (privately) beg. They do not propose root-and-branch reform of the City. The terms of the bank rescue plan were far too penal. As a result, Britain is much less well placed than it should be.
At a secret meeting at Number 10 before Christmas, the prime minister, chancellor, governor of the Bank of England and head of the Financial Services Authority reviewed the prospects. London's interbank markets are short of up to a trillion pounds and remain crippled. Unless the Bank of England finds a trillion to plug the gap, the continuing failure of banks to lend could bring on a recession more acute than the America's. Measures that might have worked last year will now work much less effectively. Chances are being lost. As one official argued, Britain must go straight to so-called "helicopter money". Essentially, the government has to instruct the Bank of England to lend the banking system cash the Royal Mint has printed.
The case was given a hearing, but ruled out. The risk of a calamitous run on sterling is too high. The cautious view was that printing money was a last-ditch measure; everything else must be tried first. The problem is that the chance of the current measures working hangs in the balance.
If the government moves to radical Keynesianism - reconstructing and restructuring the financial system - it is possible that it might avert the need for helicopter money. It needs to develop policies that will assure us all that capitalism will be arranged more fairly in future. That would be crucial to lifting depressed expectations. There are many civil servants and senior financiers who are desperate that we are still in mainstream Keynesianism, however well-intentioned and even aggressive it is. This is a time for outside-the-box thinking.
For in one respect, the arguments made by the Archbishop of Canterbury are right. People everywhere are taking stock. The last decade and its values have ended in disaster, in potential depression. Everybody knows that we cannot go back. The bankers responsible must be held to account. Capitalism has to be done differently, both here and abroad. It has to be fairer. It has to comprehend that enterprise is a collective as much as an individual endeavour. It cannot just be based on "fairy money". Recovery will require radical Keynesianism. It also needs a moral vision.
- Economic policy
- Banking
- Banks and building societies
- Northern Rock
- Royal Bank of Scotland
- Tax and spending
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