3 lesser-known effects of the global financial crisis

The collapse of Northern Rock ten years ago heralded the most severe financial crisis since the Wall Street Crash of 1929, and the most prolonged UK recession since the Second World War. But were there other, less well known, consequences of the banking collapse? Here are three to think about.

 

• EVENT: 10 years after the crash, Monday 11th September 2017

Massive and hidden redistributions of wealth

There were direct losers in the immediate aftermath of the crisis, of course, from business bankruptcies and lost jobs to much reduced interest payments to savers. But these took place in full view.

Meanwhile, many of us were turned into unwitting gamblers in a casino not of our own making.

The first roulette game was Quantitative Easing or QE. The Bank of England has created £435 billion of new money to pump into the economy since the crash, and there is broad consensus that this has supported growth, lowered long-term interest rates and eased pressure on government finances. So far so good.

Less well known is that it created unexpected windfall gains for those with significant existing financial wealth, such as shares and government bonds, as the flood of new money pushed up the value of these assets. The Bank estimated that the boost to the holdings of financial assets and pensions of the richest 10 per cent of households would have been between £128,000 and £323,000 per household.

Just try to imagine the reaction to a budget that gave the richest 10% of the population well over £100,000 per household in tax rebates.

Uproar!                      

And yet this stealth government windfall for the wealthy passed without much media, public or Parliamentary scrutiny.

The other example probably involves you, or someone you know, as one of the three protagonists so stick with me here.

In the years leading up to 2007, an increasingly competitive and overheated mortgage market was pumping out credit to all-comers, often regardless of ability to repay or indeed any evidence of financial status at all.

The self-certified mortgage, a product intended for self-employed people who are unable to produce regular payslips, became widely abused by lenders and borrowers to allow people to purchase houses far more expensive than prudence would normally allow.

Many mortgages were at rates of around 0.5% above the Bank’s base rate, which was around 5% at the time. The total mortgage interest rate of 5.5% sounds expensive by today’s standards.

But the cost of these mortgage fell dramatically as interest rates were slashed after the banking crisis, and many lucky holders of these mortgages are still enjoying a substantial windfall gain today.

It is quite likely that mortgages with interest rates as low as 0.75% are loss-making for the lending bank, so this represents a real cross-subsidy from other bank customers.

Compared with people with similar incomes and savings after the crash, they are substantially better off. It became much harder to get a mortgage after 2008, with larger required deposits and higher interest rates as well as more stringent checks on income and affordability.

If you could get a mortgage after the crash, you are probably paying many thousands of pounds more per year for a similar house to your neighbour with a pre-crash mortgage.

But if you were unable to accumulate the higher deposit before house prices raced away again, you could be renting a similar house on the same street at a cumulative additional cost of hundreds of thousands over the last ten years.

Three working people with the same income and savings with wildly different financial outcomes purely because of the interaction of banking bubbles, crashes and financial policy.

Is this any way to run an economy?

These are not even just economic or political issues, because questions of morality and social cohesion come into play when such manifest unfairness can arise between citizens.

The recession and austerity myths

The financial crisis blew a hole in government finances around the world, and especially in Britain. Not only from the £133 billion direct cash costs of bailing out the banks, but from the collapse in tax revenue from business, consumption and work as the recession took hold. Added to this were the additional costs of the welfare safety net that is designed precisely to cushion the vulnerable in such times of economic distress.

There has been a debate among economists ever since about the appropriate response to the recession. The Keynesian response is government investment to lead to economy out of recession, assuming this will lead to greater ability to repay debt in the long run. The ‘balanced budget’ response is to try to cut government spending to repay debt in the short run, assuming that this will help reinvigorate private investment.

I am not going to rehearse this debate now, because in truth the macroeconomic argument became merged with an entirely different, although equally legitimate, debate – what should be the size of the state?

In the end we had a programme to shrink the size of the state, most noticeable now in the severe retreat of local government, dressed up as an economic necessity to rescue the country from bankruptcy.

This is muddled thinking at best and downright dishonest at worst.

Proponents of a smaller state have coherent and valid arguments to offer, so we should have an open and transparent political debate about it rather than try to smuggle it in under cover of macroeconomic prudence.

However, there has been an even more invidious dishonesty that has cropped up from time to time. This is the argument that it was excessive government spending and debt that caused the recession.

This is, to put it politely, complete nonsense.

And to prove my point, allow me to quote George Osborne in his first budget speech on 22 June 2010:

“In putting in order the nation's finances, we must remember that this was a crisis that started in the banking sector. The failures of the banks imposed a huge cost on the rest of society.”

Society is still paying that huge cost. So, if you spot this particular falsehood scuttling around please stamp on it as soon as possible.

The renaissance of economics

Now we’ve got all that unpleasantness out of the way, what about a positive impact of the financial crisis?

One of the casualties of the crisis was the economic profession and the reputation of economic policymaking. This reverberated down through the years after the crash to Michael Gove’s infamous comment that ‘this country has had enough of experts’. Gove was not referring to experts in general. He specifically meant economists.

The problem was brilliantly expressed by Her Majesty the Queen at the opening of a new building at the London School of Economics when she asked (and I paraphrase) ‘how did you lot manage to miss such a humungous financial crisis brewing up?’.

In my view the honest answer is that economic teaching and practice had become too rigid, too monotheistic and prone to group-think. It lacked the theoretical and intellectual equipment to understand that such a credit bubble was even possible, let alone spot one on the horizon.

There were those who did predict the financial crisis, such as Steve Keen, Gillian Tett and Ann Pettifor.

But they were able to observe this from the standpoint of heterodox economic theories that had mostly been being purged from University departments by the dominant tribe of neo-classical economists, or from other academic disciplines more attuned to understanding human behaviour and the behaviour of systems.

Orthodox economists have not yet relaxed their grip on the Treasury or most Universities, but the seeds of a revolution were sown when economic students in many of the world’s top universities rebelled against their Professors and demanded to be taught more relevant economic theories that could explain the causes of the financial crisis.

Today the Rethinking Economics movement is still campaigning for greater pluralism in the teaching of economics, along with increasing demand from employers and civil society organisations such as Promoting Economic Pluralism for an ability to deploy a broader range of economic methodologies to solve real world problems.

At the more radical end are experiments such as the RSA’s own Citizens Economic Council, which demonstrate the ability of citizens with no economics training to engage in high quality deliberation on matters of economic policy.

There is nothing that can make up for the massive economic and social cost of the global financial crisis.

But if it led indirectly to a more flexible and pluralist approach to economics teaching, and a new era of democratic citizen engagement in economic policymaking, that at least would be a positive legacy.

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Join us for a special event at the RSA, with guest speaker and former UK Chancellor of the Exchequer Alistair Darling, 10 years on from the financial crisis:

• EVENT: 10 years after the crash, Monday 11th September 2017
• VISIT: 10 years after the crash website