Adrian Hamilton: It's not all the fault of the banks

It's a year after the credit crunch first burst upon an unsuspecting financial world – never mind the consumers – and still we don't seem to have grasped either its magnitude or its ramifications. That it has led to the biggest collapse in house prices in a generation, both here and in the US, is now apparent to all. That it has led to a crisis in confidence and massive losses in the banking sector is equally obvious. Indeed one of the few silver linings in this grim scene – at least for the consumers – has been the sight of the once mighty "masters of the universe" now brought low by their own ingenuity, of the fat cats and bonus brigands of the new banking scene being forced from their jobs although not, unfortunately, their riches.

Schadenfreude is no basis for comprehension, however. It's a nice thought, even a comforting one, that, after all this unseemly explosion of the financial world and its multifarious products, we might return to a world where the banker took in deposits and lent responsibly to worthy borrowers, personal and corporate. There are even those who might hope that this crisis might lead to a crisis in capitalism itself. It won't. Nor should it.

The credit crunch is a crisis – according to some participants such as George Soros, the most serious one for the past 50 years. But it is essentially a financial crisis, the latest in a long line of financial bubbles and bursts that have marked, and marred, the industry ever since speculators went mad in the craze for tulips in the early 18th century. But what makes this crisis different from those bubbles and banking crises we have had in the past is that this has been a crisis in the capital markets themselves and the confidence in the instruments traded in them.

If it had just been about poor lending on sub-prime mortgages, it would be serious but not critical. Certain banks who had lent too heavily into this particular market might have gone bust - as indeed many still believe that Northern Rock should have been allowed to. But it wasn't poor lending that was primarily responsible but the creation of debt instruments which, ironically, were intended to spread the risk by bundling up poor sub-prime mortgages with other much better assets which could then be traded in paper form by anyone keen to invest in assets that might ride the normal gyrations of currencies, inflation and interest rates. The risk, so the theory went, was spread and so was the pool of investors.

The first question is how this model came unstuck so dramatically and so unexpectedly a year ago when the US Federal Reserve and the European Central Bank intervened to try to stop a slide. The answer is partly that the issuers of these debt instruments didn't themselves understand the risk. But it was also because it suited everyone to believe that, like tulips, the price would rise forever on the upwinds of growth. For New Labour politicians, and the Chancellor at the time (Mr Gordon Brown, to remind you), nothing could be better at a time of rising house prices than a form of finance that enabled the poorest to borrow to spend and own their own houses without recourse to the public purse. The Bank of England and the Financial Services Authority found it equally convenient that these newer forms of credit were "off balance sheet" and therefore out of their purview.

With the advantage of hindsight, there will be a great host of new regulations introduced nationally and internationally to improve oversight of the banks. Some of it will be just locking the door after the horse has bolted. Some will be useful, but much will be counter-productive, introduced out of that classic political desire to punish for the past rather than improve for the future. But none of it will really address the issue of just how was it that the Governor of the Bank of England could be saying that nothing needed to be done here weeks after the US and the Europeans set off the alarm signals or how the new Chancellor of Exchequer, Alistair Darling, could give such a fatuously insouciant Budget address as he did in March. Until that is answered, we can have no confidence for the future.

The deeper question remains: does this financial tempest herald an end to a whole system of finance or merely its correction? The "securitisation" of mortgage debt was just part of a fundamental movement in finance to replace traditional debt relationships with newer forms of tradeable paper. We are talking here not of billions but trillions of dollars of transactions. It still goes on. You only have to look at the commodity markets, oil and food, and raw materials, to see how they are still driven by traders betting on the rise and fall through the futures markets. The financial industry will be scarred for ever by the past year. The chief victims will be the chief beneficiaries of the financial bubble: the investment banks. But doubts must hover over the future of hedge funds as well.

"It is clear that growth models in our industry based on high and increasing leverage will no longer be sustainable," said the HSBC chairman Stephen Green,announcing reduced results this week. It is difficult to know whether this splendidly understated comment was an example of phlegm or British self-mockery in a crisis (unlikely in the case of Stephen Green). But the question is a real one. Green's own guess is that "ultimately the real economy will recover from the crisis although it may get worse before it gets better. Financial markets will not, and should not, return to the status quo ante".

Very sage, no doubt, but that doesn't answer the problem of whether, if modern financial innovation has been as much the progenitor as the beneficiary of globalisation and growth, its demise will not serve to accelerate its slowdown. There are a lot of pressures now for a worldwide economic slowdown. Financial orthodoxy could only make that worse. In which case it will be the poor as much as the once super-rich who will weep at the demise of an era.

a.hamilton@independent.co.uk

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