Hamish McRae: Don't worry: when the regulators are fretting, things are returning to normal

When the monetary and banking regulators are worried we should really be scared, right? Er, no, wrong. The time for the rest of us to be concerned was when the regulators were too relaxed, as they were a year or more ago. Now that they running around saying that things are terrible I think we can start to relax a bit. That does not mean the banking crisis is past, for we still have a way to go. It is just the gradual correction process is taking place and that once that passes normal service will be resumed.

There were two examples of alarmist speeches by regulators in the past couple of days. Rachel Lomax, deputy governor of the Bank of England, said central banks were facing the "largest ever peacetime liquidity crisis". That cannot be right.

From a UK perspective the present squeeze on bank liquidity is not as serious as the run on the fringe banks in the 1970s, when the Bank's so-called "lifeboat" was established to supply liquidity to smaller banks and when there was the start of a run on NatWest. Unless the Bank knows something we don't, only one of our fringe banks, Northern Rock, has had to have artificial support, and there has been no suggestion whatsoever of a run on a large clearing bank.

And from a global perspective? Are the US banks in worse shape than they were during the Third World lending crisis or the early 1980s property crash? Remember that Continental Illinois, then America's seventh largest bank, became insolvent in 1984 and had to be rescued by the US authorities. Just about the entire Japanese banking system was technically insolvent after the property crash at the end of the 1980s. Or if you are looking at the national burden of supporting banks, remember that when Sweden had to rescue Nordbanken in the early 1990s the cost came to about 4 per cent of Swedish GDP. True, Continental Illinois and Nordbanken had solvency problems as well as liquidity ones, but I think my point stands, that what has been happening over the past six months is within the broad parameters of what has happened in previous banking crises, and on several measures it is less serious.

The other alarmist speech, plus radio interview on Today, came from Hector Sants, chief executive of the FSA. "I don't think markets are ever going to return to the way they were," he told the BBC. "The idea that at some point they will go back to normal, I think, is a misnomer." The era of cheap borrowing, he added, was over.

That cannot be right either – or rather it is only right if you assume that the past three or four years were normal. By historical standards they were most abnormal for two reasons. The primary cause was abnormally low real interest rates, as you can see from the first graph. This shows real short-term interest rates in the developed countries. That dip of real rates to below 1 per cent for five years was the result of flawed central banking policies. It led to banks making extremely risky loans, and because returns also became so low, to banks searching for ingenious ways to improve their earnings. The second reason for the banking problems, the complex instruments they developed to try to improve returns, were a response to these lax conditions. And the regulators allowed them to do so.

As for the era of cheap borrowing being over, well, the era of 125 per cent mortgages may be over, and about time too. But reputable borrowers still have no difficulty getting money on terms close to money market rates. In the past few weeks I have been told by one global resources group and one UK commercial property buyer that they have been greeted very warmly by their bankers. In fact in one case they were offered much more money than they wanted.

I don't want to absolve the banks from their mistakes; my point is simply that the central banks created the circumstances where they, and the borrowers, were likely to make mistakes, and regulators then failed to curb them. Excessively cheap money was mostly a US, Japanese and European phenomenon – though we should not be too hard on the European Central Bank, which had to try to reconcile the different needs of the countries under its monetary jurisdiction. Rates that were too low for Spain were too high for Germany.

Here in Britain money was not particularly cheap, but it was too freely available. The Bank took the narrow view, as it is required to do legally, that it must target inflation. As some of us pointed out from time to time, broad money was allowed to increase at around 14 per cent a year for several years, far above the growth of the economy. To over-simplify, if the economy grows at 3 per cent and the money supply grows at 14 per cent, you are permitting asset prices to rise at 11 per cent, which is pretty much what happened to our house prices in the early 2000s.

Unfortunately it is not as simple as that, because the link between money supply and inflation is much looser. But you see the point. The Bank did what it legally had to do, which was to target inflation, and latterly a narrow and unsatisfactory measure of it. But it failed to achieve the wider aim of all central banks, which incidentally long predates inflation targeting, of maintaining monetary stability and orderly markets. Arguably the FSA made a parallel error, in that it ensured banks ticked the boxes, but not that they ran a stable and sustainable banking system.

You can see the results in the other two graphs. Both the US and UK had a house price boom that gathered pace after 2001, and there was sudden surge in household debts relative to income after 2001 as well. Back in 2000 things were fairly stable, with UK households actually having lower liabilities than German ones. That was normality. What has happened since is abnormal.

So what happens now? I don't think it is very helpful for officials and bankers to bang on about how unprecedented current conditions are. There have been policy errors and failures of bank management. But there are precedents, and these are in the main more disagreeable than the present outlook. For example, any global economic disruption now is not nearly as dangerous as that caused by inflation in the 1970s. The UK housing situation is not nearly as dire as it was in the early 1990s. Equity markets in the developed world are not as overvalued as they were in 2000; in fact they may be rather undervalued. This global downturn may be more serious than the early 2000s one, but it is hardly likely to be as bad, at least for the UK, as the early 1990s or early 1980s. Even our public finances, which are much weaker than they should be at this stage of the cycle, are not as badly positioned as they were in 1990, and vastly better than in 1979.

I think this year will still see reasonable growth in the UK, though tailing off as the year progresses; 2009 will, I fear, be more difficult. There will be housing problems, though not as serious in the US. And the balance of probability is that there will be more financial disruption: we have not yet had the equivalent of Continental Illinois. So while there is a long slog ahead correcting past mistakes, at least the world of officialdom is on the case – not before time.

Start your day with The Independent, sign up for daily news emails
ebooks
ebooksAn introduction to the ground rules of British democracy
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
SPONSORED FEATURES
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

SThree: Experienced Recruitment Consultant

£20000 - £40000 per annum + OTE + Incentives + Benefits: SThree: Established f...

SThree: Trainee Recruitment Consultant

£20000 - £25000 per annum + OTE 40/45k + INCENTIVES + BENEFITS: SThree: The su...

Recruitment Genius: Collections Agent

£14000 - £16000 per annum: Recruitment Genius: This company was established in...

SThree: Trainee Recruitment Consultant

£20000 - £25000 per annum + OTE 40k: SThree: SThree are a global FTSE 250 busi...

Day In a Page

Refugee crisis: David Cameron lowered the flag for the dead king of Saudi Arabia - will he do the same honour for little Aylan Kurdi?

Cameron lowered the flag for the dead king of Saudi Arabia...

But will he do the same honour for little Aylan Kurdi, asks Robert Fisk
Our leaders lack courage in this refugee crisis. We are shamed by our European neighbours

Our leaders lack courage in this refugee crisis. We are shamed by our European neighbours

Humanity must be at the heart of politics, says Jeremy Corbyn
Joe Biden's 'tease tour': Could the US Vice-President be testing the water for a presidential run?

Joe Biden's 'tease tour'

Could the US Vice-President be testing the water for a presidential run?
Britain's 24-hour culture: With the 'leisured society' a distant dream we're working longer and less regular hours than ever

Britain's 24-hour culture

With the 'leisured society' a distant dream we're working longer and less regular hours than ever
Diplomacy board game: Treachery is the way to win - which makes it just like the real thing

The addictive nature of Diplomacy

Bullying, betrayal, aggression – it may be just a board game, but the family that plays Diplomacy may never look at each other in the same way again
Lady Chatterley's Lover: Racy underwear for fans of DH Lawrence's equally racy tome

Fashion: Ooh, Lady Chatterley!

Take inspiration from DH Lawrence's racy tome with equally racy underwear
8 best children's clocks

Tick-tock: 8 best children's clocks

Whether you’re teaching them to tell the time or putting the finishing touches to a nursery, there’s a ticker for that
Charlie Austin: Queens Park Rangers striker says ‘If the move is not right, I’m not going’

Charlie Austin: ‘If the move is not right, I’m not going’

After hitting 18 goals in the Premier League last season, the QPR striker was the great non-deal of transfer deadline day. But he says he'd preferred another shot at promotion
Isis profits from destruction of antiquities by selling relics to dealers - and then blowing up the buildings they come from to conceal the evidence of looting

How Isis profits from destruction of antiquities

Robert Fisk on the terrorist group's manipulation of the market to increase the price of artefacts
Labour leadership: Andy Burnham urges Jeremy Corbyn voters to think again in last-minute plea

'If we lose touch we’ll end up with two decades of the Tories'

In an exclusive interview, Andy Burnham urges Jeremy Corbyn voters to think again in last-minute plea
Tunisia fears its Arab Spring could be reversed as the new regime becomes as intolerant of dissent as its predecessor

The Arab Spring reversed

Tunisian protesters fear that a new law will whitewash corrupt businessmen and officials, but they are finding that the new regime is becoming as intolerant of dissent as its predecessor
King Arthur: Legendary figure was real and lived most of his life in Strathclyde, academic claims

Academic claims King Arthur was real - and reveals where he lived

Dr Andrew Breeze says the legendary figure did exist – but was a general, not a king
Who is Oliver Bonas and how has he captured middle-class hearts?

Who is Oliver Bonas?

It's the first high-street store to pay its staff the living wage, and it saw out the recession in style
Earth has 'lost more than half its trees' since humans first started cutting them down

Axe-wielding Man fells half the world’s trees – leaving us just 422 each

However, the number of trees may be eight times higher than previously thought
60 years of Scalextric: Model cars are now stuffed with as much tech as real ones

60 years of Scalextric

Model cars are now stuffed with as much tech as real ones