Doing the fair thing is doing the right thing

Today’s cut in base rate to just 0.5% is horrible (though not unexpected) news for savers.  Anyone who has been prudent and saved to build a nest egg for their retirement or against a rainy day is getting hammered by the loss of  income; many retirees will be forced to dip into capital to survive.

But, apart from the obvious point that Gordon Brown’s once-vaunted reputation for prudence is now deader than the proverbial parrot, what does this tell us about his government’s priorities.  How is he proposing to spread the pain about, who will loose most and who will loose a little.  Will there even be some winners?

Forget all the economic jaw jaw.  We need a debate explicitly and in terms about what is fair and what is not fair.  If, as most Lib Dems fondly believe, ‘fairness’ is a core principle of their party then NOT having this debate is a gross dereliction of duty.

Moreover, it has become abundantly clear that most mainstream economists don’t have a clue about how the economy works, or they would have seen it coming – which they didn’t (with remarkably few exceptions).   The proposition that we should leave it to those who got us into this mess to save us from it is laughable.

This matters because I have an old-fashioned belief that doing the fair thing is in fact doing the right thing.

So, what is the government doing – and what should they be doing?

Their approach was and is to get lending restarted so we can all go back to where we were – carry on as before – no lasting harm done – trebbles all round.   But many banks have so much bad debt that they are bankrupt – zombies kept alive only by government guarantees of billions.   This will be a burden to taxpayers for decades to come – a massive inter-generational transfer.   Is this fair?

But the banks winnings are not limited to the immense cost of capital injections and guarantees.   Their gross margins (the difference between the interest rates they pay savers and the rates they charge borrowers) have gone through the roof.    So both savers and borrowers are also loosers.  Is this fair?

(An anecdote illustrates this.  A friend who runs a high quality small business with a strong balance sheet was recently looking for a modest loan.   Several banks quoted 10.5 – 11.5% for a secured loan.  Until recently he could get loans at around 9% unsecured or 2% over base rate secured.  Multiply the gross margin they are getting – say 10% – by all their loans and this is a LOT of money).

The government’s clear policy is to thus to fill the black hole in the banks’ finances thorough a combination of government cash injections and rolling up bumper profits (those monster gross margins) over many years.  (At the moment we are not ‘seeing’ these profits because they are being cancelled by write offs of bad debt).  Unfortunately we just don’t know how big the banks’ eventual losses will be nor therefore how long this will take.  At least a decade is a reasonable bet but an ongoing capital famine – for that is what would result – would be a disaster for businesses and would-be house buyers alike with opportunity costs that would be incalculable.  Is that fair?  

Also today the Bank of England has announced that it is to begin ‘quantitative easing’ (aka printing money) to boost liquidity in the banking system and therefore – hopefully – demand.   No-one, least of all the Bank, seems to have any confidence that this will work.   Neither do I  for it fails to address the core problem of too much debt.   What it may well do is stoke inflation that would wipe out the capital value of any remaining savings.  Is that fair?

This crisis started when debt was allowed to balloon to unaffordable levels; it will end only when debt is once again affordable.

The tragic truth is that there is no painless or even fully fair way to get debt down.  Realistically, killing the zombie banks that carry most of the bad debt is the only way to go and is less unfair than any alternative.   (Their branch networks and supporting systems would continue as before but under new management – they are the ‘Money National Grid’ and a vital part of the economy).  Killing zombie banks whose greed got the better of them is entirely fair.

(Interestingly, this is the solution that the private sector has come up with for rescuing firms that have been coaught out with unaffordable levels of debt.  Recent weeks have seen a slew of  ‘pre-pack’ administrations (i.e. bankruptcy) where a new company emerges the next day purged of its accumulated mistakes).

In the meantime the government should not pour taxpayers money into propping up bankrupt institution that have collapsed themselves by their own greed.  If it continues to prop them up there is a high probability that it will bankrupt itself – any that would be the ultimate unfairness.  That’s the scenario we shouldn’t have to face.


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