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Dear Mervyn
No point in recriminations about the Northern Rock crisis, though if it dents images of omniscience and demonstrates the virtues of sympathetic flexibility it can serve a useful purpose. Our last submission warned of the need to boost liquidity and to reduce both interest rates on interbank lending (as the Fed did to relieve the constipation of the system) and interest rates generally to relieve the pressures on the borrowing public and particularly on the sub-prime sector in its British form.
In our view criticism of the Bank as regulator of the system (to the extent that it still is) are misplaced. Its real failures were in its basic role as controller of interest rates and liquidity. Had our advice been heeded, September`s outcome would have been less damaging because the problems posed by bundled debt, its real valuation and saleability, would have been dealt with at both the top and the bottom of the system.
It is the prerogative of the Central Banker to give moralistic sermons, blaming players for excesses the Bankers themselves have sanctioned. Yet it was always unrealistic to bang on about moral hazard and irresponsibility when political sense should have told the Bank that a threat to any major banking institution, and the prospect of Saatchi-style queues outside branches, would bring government in to stop a collapse.
A modern central banker must be manager not moralist. The best outcome now must be to learn the lessons, provide the same effective deposit guarantee as operates in the USA, and regulate the hedge funds because, rather than the new masters of the universe, they are in fact a new source of instability. There are too many funds to give all the skilled management success requires. Reserves are inadequate. Valuation of their “assets” is haphazard and collusion with the banks must endanger the banking system. The result of all this is that hedge funds` herd instincts are too strong and the consequences of that are serious, if lack of liquidity locks them in. All this was known before. It should be acted on now.
End of sermon. We hope, though, that this experience might lead the Bank to listen more attentively to outside advice. Like ours for this month. Our advice is that the Bank should boost liquidity, reduce the punitive rates charged on its interbank lending facility and reduce general interest rates by the same half percent as the Fed. This reduction should be the prelude to further reductions to take British interest rates below those in both Europe and the US. As justification of this advice we make the following points.
1) The problems which gave rise to the difficulties are still with us. American sub prime debt is still a problem. So is its British equivalent in the large numbers of people who took out a low interest rate mortgages or were allowed excessive borrowings on the assumption that house prices would rise. The first group now face a programmed increase whatever happens to interest rates more generally. The second has an unsupportable burden.
Estimates of British sub prime borrowing range between 230,000 and 300,000. It is important that the Bank research the numbers and assess their situation but immediately their plight needs to be eased by lower interest rates. A threat to them undermines the system at its base. If repossessions multiply and bankruptcies increase, confidence is easily undermined. Britain is more dependant on fickle Finance than any other country. Such difficulties, plus the problems of Barclays, the plethora of Hedge Funds working from here, and the general tightening up which will result from current problems must threaten confidence in London which would have a disproportionate impact on Britain.
2) There is already a threat of tougher times to the high street and consumer demand. The economy needs a boost similar to, probably larger than, the one the Fed administered to the US on l8 September 2007.
3) Inflation is just below the target range. That provides no justification for maintaining our currently high interest rates. Indeed it sanctions a reduction to stimulate.
4) A system kept going by an explosion of debt and credit and which rests on no strong productive base is heavily dependant on finance and therefore prone to perennial crises. This makes the UK`s prosperity more precarious than at any previous time and than most other economies. To treat the new economy in the same way as the old manufacturing economy where tighter monetary conditions were supposed to reduce demand and wage pressure and to manage it through the old disciplines of high interest rates and an uncompetitive exchange rate threatens the house of cards. Everything can move fast into reverse |
