Jeremy Warner's Outlook: Brown stakes his future on handling of the credit crunch

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Mandy back. The Gov-ernor of the Bank of England forced to eat his words on moral hazard and say he'll give the banking system all the liquidity it needs. Interest rates about to be cut by a half a percentage point. Deposit insurance raised to £50,000 with consultation on going higher still. All that and the Chancellor says he'll guarantee the deposits of any bank that runs into trouble too.

Capitulation is a word which when applied to bear markets means the point at which the last stock market bull gives up all hope of recovering his losses and sells. With all sellers thus removed, buyers can return and the process of rebirth begins.

Yesterday's events are similarly a kind of political and supervisory cap-itulation. By bringing back one of his fiercest Labour enemies into the heart of the Government, Gordon Brown has acknowledged that he needs all the help he can get in reviving his political fortunes and managing his way through the present crisis.

It's quite a gamble. Peter Mandelson is notoriously accident prone, having twice before been forced to resign from the cabinet bec-ause of scandal. Yet in the same way as everyone loves a charming rogue, Mandelson has a chutzpah about him which commands political respect.

In a sense, the Prime Minister has nothing to lose. The crisis of the moment calls for bold action, both politically and in economic policy. To restore City and business confidence in his Government, Mr Brown needs a fully signed-up Blairite, and who more Blairite than Mandelson, one of the key architects of New Labour.

Remember, it was Mr Mandelson who said that Labour was intensely relaxed about people being filthy rich, though he did qualify this remark by saying "provided they pay their full share of taxation". Paul Myners as City minister – not everyone's cup of tea in the Square Mile but certainly someone who knows about financial markets – will, in presentational terms at least, further bolster the Government's claim to be getting on top of the crisis.

As I say, Mr Brown has nothing to lose. If he's judged to have mishandled the crisis, his fate is sealed and he's finished. If he can get it right, then he's back with a chance. Even the Bank of England has started singing from the same hymn sheet. Whether it was the talking-to he got from the Prime Minister and bankers last Monday, or whether he's simply changed his mind anyway, the previously reluctant Mervyn King, Governor of the Bank of England, now seems to be fully on message. Mr King's statement yesterday that "in these extraordinary market conditions, the Bank of Eng-land will take all actions necessary to ensure that the banking system has access to sufficient liquidity" signals a remarkable change in tone. Widening the collateral the Bank is prepared to take for liquidity from domestic mortgages to commercial property, corporate and even auto loans is further acknowledgement of the now dire funding shortfall faced across the financial system.

To complete the hat-trick, the Bank of England needs to cut interest rates sharply next week. Again, the time has come for bold action. It's now plain as a pikestaff the economy is heading into a possibly quite severe recession. Just as the Governor has been forced to swallow his scruples on moral hazard, the Monetary Policy Committee must put its concerns over inflation to one side and take the actions necessary to stave off economic meltdown.

The Governor may be mocked in changing his stance, but there is no shame in responding to changed events, reversing your position and doing the right thing. Defiance in the face of the storm is a much greater sin.



Comparisons with 1929 are misleading

For almost as long as I can remember, economists have been banging on about the unsustainability of global capital and trade imbalances. As some of them warned, the longer these imbalances persisted, the more likely it was that they would eventually unwind in a disorderly and destructive manner. It was a crazy old world that had some of the poorest countries financing the consumption and credit-fuelled property bubbles of some of the richest, but that was the way it was, with global capital markets providing the plumbing that kept this bizarre money-go-round operating. The root cause of today's financial crisis is that countries with big current account deficits have for too long been living beyond their means on borrowed money.

Now it's all come home to roost in what, by common consent, is the worst banking implosion since the 1930s. Is this undeniably earth-shattering financial event about to culminate in a similarly catastrophic economic meltdown? Thankfully, many of the parallels being drawn with the Great Crash of 1929 and subsequent dep-ression are misleading. History never exactly repeats itself and it seems un-likely this truism is about to be broken. The events of 80 years ago happened in completely different circumstances.

By the time the stock market crashed in October 1929, the US econ-omy was arguably already in recession. Savings were high and credit condit-ions comparatively tight. What's more, the 1929 crash was one of stock markets after a wild speculation which had driven valuations to crazy levels, whereas today's finds its origins in credit. Confusion about exposure to deteriorating mortgage portfolios caused a breakdown in trust between banks and thus extreme dislocation in money markets and a flight to safety.

Nonetheless, there are plenty of common factors. John Kenneth Galbraith's classic, The Great Crash of 1929, lists five key influences, some of which were self-evidently present in the build-up to today's credit crunch. One was an extreme and growing problem of wealth distribution, with as little as 5 per cent of US earners taking as much as one-third of income. It may not be quite as bad as that today, but the "fat cats" of financial markets and the "winner takes all" pay structures of corporations and entrepreneurial activity certainly give that impression. Over the last 20 years, the rich have become very rich indeed.

The complexities and leverage surrounding the industrial holding companies and investment trusts of the 1920s find their parallels today in the private equity boom, the hedge fund industry and the off-balance-sheet financing of major banks. The domino effect of failing banks which occurred after 1929 is certainly very recognisable in today's crisis, as is the collapse in lending standards which led up to the Crash. When one bank failed, the assets of others became frozen, making it hard for them to repay their depositors when they asked for their money back. Does this remind you of something?

Yet the other two factors listed by Galbraith are arguably absent this time, at least for the time being. America was, at that time, running a reasonably healthy trade surplus with the rest of the world, supported by high import tariffs. As economic conditions deteriorated, protectionism became flavour of the month, leading to a breakdown in trade. This time, there's a big, though now declining, trade deficit, while protectionism isn't yet a significant problem.

By the way, on reflection I was too cynical in yesterday's column in dismissing this weekend's summit of European leaders as unlikely to deliver anything of any practical significance. To the contrary, international co-operation is vital if the world is not to sink into a tit-for-tat series of overly zealous national policy responses.

European policymaking requires consensus, which makes it perhaps too long-winded to deal with a crisis as fast changing as this one. Yet the difficulty evident in the US of getting the Paulson bailout through Congress demonstrates that America isn't any better on this front. Taken together, the policy response pursued by national governments within Europe – the latest example of which was last night's nationalisation of the Dutch arm of Fortis – has arguably proved more effective than the US.

But it is essential harmony is maintained. Europe cannot have national policies which, like Ireland's guarantee of all its bank deposits, only transfers the funding problem at the heart of the banking crisis on to neighbouring countries.

In any case, the global policy response is another key difference with the aftermath of the 1929 crash, when the US mistakenly pursued a balanced budget and tight monetary conditions. This was the very reverse of what was required, and hugely contributed to the downward spiral in economic activity.

All the same, however clever the policymakers prove in wriggling out of the grips of the banking crisis, we cannot magic our way out of years of overborrowing. A long and painful workout now seems inevitable. The only questions are just how deep and just how long. Great Depression? Still implausible. Mid-1970s? Please no. Early 1990s? More than possible.

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