Wednesday, September 17, 2008

Fear And Greed

At least it means the end of this

As we all know, financial markets are driven by fear and greed. We've had the greed, and now we've got the the fear.

As we all also know, the lesson of history is to stay calm. No, straight up - that is the lesson.

So what does staying calm mean for taxpayers?

Most important, it means not going along with media hysteria that the financial system is in meltdown. It isn't.

Yes, there's far too much debt - much of it stuffed into those opaque packages we read so much about - which must be reduced. And yes, bank profits and bank shares have taken a serious whack, and there may be more to come. And yes, financial sector jobs are under the axe.

But none of that means we're doomed. It's a necessary adjustment to the excesses of the last few years, and must be allowed to work through. And the horrible truth is that such adjustments never happen in a calm orderly manner.

So why do taxpayers have to get involved at all? We don't want to bail out a bunch of greedy bastards, so why not just stand back, rub our hands in glee, and let nature take its course?

Well, back in the early 1930s exactly that approach was tried. Following the 1929 Wall Street Crash, the US hit a banking crisis as the debt-driven excesses of the 1920s were worked out. The US authorities initially decided to leave things to nature, and there was a wave of bank closures. But the catastrophic result was a serious contraction in the US money supply and yes, the Great Depression. As the great Milt later wrote, “the Great Depression was produced by government mismanagement” (see also Milton Friedman and Anna J. Schwartz, A Monetary History of the United States, 1867-1960 ).

So tempting though it is, we can't simply stand back and leave things to nature. We have to stop depositors being wiped out. And the somewhat reassuring news is that these days, governments and central banks on both sides of the Atlantic understand that.

But as we've consistently argued, while we must protect depositors, we should not protect shareholders. We need to ensure they take the pain so they can remember how it feels. Because going forward, shareholders are key to ensuring bank managements give much greater weight to fear as against greed.

How are we doing so far?

All we know for sure is that we've taken on the Crock's £100bn of mortgages, some of which are clearly dubious.

More worrying is that we may be guaranteeing the dodgy end of HBOS's assets in order to sweeten the Lloyds takeover. But given the fair trading waiver they've already extracted, let's hope that hasn't been necessary.

So compared to US taxpayers, we seem to have escaped quite lightly.

Let's hope things stay that way...

PS Of course, a slumping financial sector also hits UK taxpayers in another way - lower tax revenues. As we blogged here, in recent years, booming banking and insurance companies have provided more than a quarter of Corporation Tax revenues, or some £10bn pa:

And that takes no account of personal tax payments on all those City bonuses. It's going to leave quite a hole.

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