It wasn’t Fred that broke the bank

Friday February 3, 2012

Tom Miers says Fred Goodwin is being held as a scapegoat by the very people responsible for the crash

It’s the classic witch hunt. The public calamity, after years of drinking at the font of plenty. Drinking too deeply, egged on by authorities keen to milk the applause. And when it all goes wrong those same leaders point the finger to distract the distraught mob from their own doors.

The lynching of Fred Goodwin is a story that recurs down the centuries. Weren’t there several scenes like it in Ken Follet’s medieval epic Pillars of the Earth? The trouble is that the real villains of our modern day story probably won’t get their come-uppance. Not directly, not like Fred ‘the shred’, anyway.

True, Mr Goodwin has only lost a knighthood, and gets to keep his millionaire’s pension. But the public disgrace must be enormously damaging to someone used to operating at the highest level.

The politicians are the real villains of the piece. They are responsible for the debt boom and the banking crash that has mired us all in the deepest recession in living memory. Politicians, and, yes, the public that believed and still half-believe their blandishments.

Businessmen react to incentives. In a well functioning market they respond to competition to provide better and cheaper goods and services. Free markets serve the public well, particularly the poorest, because the pricing mechanism is an efficient way of conveying information about risk, quality and demand.

It is when governments intervene to skew markets to achieve their own political objectives that trouble begins. I call these ‘were-markets’ – lycanthropes that look and feeling like ordinary capitalism until they turn and strike the public because of their innate contradictions. Banking is one, the railways another, and you can add all sorts of public-private partnerships and government outsourcing schemes. The common thread is that government guarantees the risks involved, often under public pressure, but the real liability is borne by a taxpayer that does not fully realise the risk he has taken on. And when the person making the money doesn’t carry the risk, you have a recipe for disaster.

The credit crunch was a direct result of such skewed incentives. Government has an interest in encouraging affordable home ownership. The roof over voters’ heads is their most important material possession. But the state, particularly in Britain, deploys a planning regime that could almost be designed to inflate the price of property. The result is artificially easy credit and artificially high mortgage debt.

A similar situation exists in the US, where the Clinton government in particular leaned on finance houses to provide unsustainable mortgage credit to poor aspirant homeowners. At the same time in the US the government has explicitly underwritten the mortgage market since the last depression, and here there is an implicit guarantee of the banking system.

For democracies have taken upon themselves the responsibility for every citizen’s economic well-being. This is manifest in the welfare system and the obsessive politics around economic data, with political parties routinely claiming the credit (or blaming each other) for economic performance. Such behaviour inevitably reduces people’s economic self reliance. It’s the government’s duty to ensure we have a job, and their fault if we don’t.

So government policy created a mortgage market with incentives skewed to encourage banks to take on more wholesale debt to provide cheap mortgages for expensive property. And at the same time both banks and the public understood that government underwrote the system. Both took undue risks accordingly.

Meanwhile the government’s main regulatory impact was to make it harder for small players or new entrants to the market, and to encourage big multi-nationals with colossal liabilities.

So when the system crashed, the politicians could not stand back and say ‘this is your fault, sort out your own mess’, as they had with the South Sea Bubble and the Railway crash at the innocent dawn of capitalism.

They created the system to mirror the contradictions of their own flawed policies. They took on the risk and underwrote both banks and customers. You would have thought they would take some of the blame. Yet take a look at the House of Lords and the lists of gongs and knights, replete with ex politicians, each complicit in the state induced boom and bust. So goodbye Sir Fred, but hello Lords Lawson and Kinnock, Howe and Healey, Sir John and, yes, Lady Thatcher.

Tom Miers is Editor of the Free Society. His book Democracy and the Fall of the West explores the concept of ‘were-markets’