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Disaster of our credit culture

Published in Sunday Express (London), 16 September 2007, p. 26 

Reach for the salt when politicians start lecturing companies on how to manage their affairs. More than once politicians have been caught talking about things they do not really understand. The other tendency is to state the blatantly obvious. After all, if politicians actually knew so much more about the business world, why did they become lowly-paid politicians in the first place? Ministers complaining about the failures of business leaders are all too often simply trying to distract attention from their own mistaken regulation of the markets.

Chancellor Alistair Darling has been a politician for long enough to know the pitfalls of haranguing the business community – but this did not stop him from criticising banks for granting credit too easily.

He argued that the banks “need to know who they’re lending to, how much they’re lending and what the risk is”. He went on to call for a return to “good, old-fashioned banking”. On one level, his reminder of the elementary rules of responsible banking is scarcely revolutionary. And yet, Mr Darling may be right that Britain’s debt and savings culture will have to change in the face of the international turmoil. Politician that he is, though, he didn’t admit that his Government may have played a major role in this crisis, too.

Going back to “good, old-fashioned banking” is about as likely as going back to basics, as John Major once encouraged. Nor would it be desirable. The days when there were no cash machines, no internet banking and with branches shut in the middle of the afternoon and at weekends are long gone – and a good thing, too.

Nor is “good, old-fashioned banking” an option in another sense. International financial markets are far more integrated than they used to be. On the plus side, this means there are far greater opportunities for banks to do business in Hong Kong, Houston or Hammersmith. On the other hand, a crisis that occurs in one corner of the world – such as the American housing market – may well have a negative impact here. Just think of Northern Rock.

It is unlikely, if not impossible, therefore, that the slow-moving and parochial banking of the past will suddenly come back into fashion. Still, Mr Darling does have a point. In the “good old days” before globalisation, the attitudes of banks and consumers were characterised by a much more cautious approach to debt, savings and spending.

If, say, 30 years ago you asked for a mortgage five times your income with no deposit, your bank manager would have politely shown you the door. In the 21st century, until a few weeks ago at least, chances are he would have asked you if you didn’t really need six times your income. With house prices rising seemingly exponentially, the default risk for banks appeared negligible. And with interest rates much lower, buyers could afford the repayments, if only by stretching them over many decades. We as consumers have also become used to the combination of easy credit and rising house prices. We have forgotten about the virtues of saving for a rainy day and gone on an unprecedented spree instead. British shoppers now buy more consumer goods per head than any other European nation.

Along the way we have accumulated a national private debt mountain of more than £1.3 trillion – that’s £1,300,000,000,000. True, most of this comes in the form of secured mortgages but unsecured lending, too, has almost doubled in the past decade. And we haven’t become a nation of insomniacs as a result, it seems…

In a recent opinion poll only 29 per cent said that they could not sleep at night when they were in debt. No wonder then that almost a quarter of us admit to regularly buying things we cannot afford, while fewer than one in 10 Germans do it.

Our high debt and low savings culture might have worked very well for a long time – as long as house prices rose and the economy was growing. But it was only suitable for “sunny” days. The American mortgage crisis comes as a wake-up call – this cannot go on for ever.

Darling warns of the dangers of reckless lending and not saving – and who could sensibly disagree? But instead of blaming banks for all of this he could have been more candid. This Government can hardly be held up as a model of prudence. Of course, it had passed on the responsibility for interest rates to the Bank of England. But it still sets the inflation target. Two per cent, it appears, could have been too high. We should not forget, either, that the counterpart to consumers’ shopping addiction is the Government’s own public spending spree.

There have been massive public deficits since 2002 at a time when the economy was growing steadily. Unfortunately, this is not the full picture, either. Some future liabilities for the public sector are now hidden and do not even appear on the balance sheets. Private Finance Initiatives are one example; public sector pensions another.

Where Mr Darling accuses the private sector of reckless lending, the Government could equally be accused of reckless borrowing. Last but not least, it has failed to keep house price inflation under control – which accounts for much of the rise in private debt.

Private and public overspending has fuelled Britain’s economic growth of the past but it is now high time to rid ourselves of our sweet tooth for debt. The Chancellor is right but his words are just a little hollow without an acknowledgement that the Government has contributed to the current credit crisis.

The forthcoming comprehensive spending review would be a good opportunity for Mr Darling to follow his words with action. If his own finances were in order, his advice to the private sector would carry greater weight.

Oliver Marc Hartwich, Chief Economist, Policy Exchange

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