Hamish McRae: There are things only the state can do

It is awesome, isn't it, to see how powerful the world's financial authorities are when they act together? For some weeks the markets have been bitching that the governments and central banks did not grasp the gravity of the financial situation; that their response was piecemeal and tardy.

It was a reaction born of fear, a fear that showed through most obviously in the collapse of the value of shares worldwide but more insidiously in the squeeze on bank lending. Home buyers in Britain are in much the same position as the restaurant owner in Manhattan that a friend told me about just yesterday. Our flow of new mortgages has virtually dried up while his local Italian restaurant was being refused credit.

Some sort of corner now does seem to be turned. Those of us thought that three or four weeks ago were proved wrong. It took much, much more firepower to rebuild confidence than those initial (and maybe not too well aimed) salvoes from the different governments. The confidence is fragile still. But the markets have learnt what they should have known all along. It is not within the power of national governments, even acting together, to prevent a world economic downturn. But what they can do is prevent an international banking collapse, a catastrophe that would have both deepened the downturn and made the recovery from it virtually impossible. This is not the 1930s.

But it was governments that had to do it. We live in a world where the failures of government are pretty obvious. We read all the time about their inefficiencies and, in Britain. we have had a huge increase in government spending alongside falling productivity in the public sector. Governments are seen as slow-moving bureaucracies, having to build support before they push a policy into action – a contrast to the nimble, effective private sector. Co-operate internationally on major issues? No one thought it possible, which of course was one of the reasons why the markets were so spooked.

Well, it hasn't been like that in the past few days. Governments have shown themselves to be swift and effective and they really deserve credit for that. Sure, the near-collapse of the world banking system was in part a failure of regulation and of monetary policy. But the primary failure was in the private sector and it is government that has saved it.

That is going to change things. It is going to redefine the relationship between government and finance in the years ahead, certainly for a decade, maybe a generation. It is far too early to see any detail but we can catch a feeling for what might change.

If you look at what monetary authorities have done so far there are really two main elements. One has been for central banks to flood the world with liquidity, to lend to the banking system without limit. The other has been to offer partial nationalisation to banks if they need it. In the first the central banks have been carrying out their traditional role, dating back to the 19th century, of being lender at last resort to the banking system. In the second the governments have taken on a newer, but not unprecedented role of being investor at last resort in individual banks.

The first is textbook stuff. Because banks borrow short-term but make long-term loans, there has to be some mechanism to enable them to repay depositors in extreme situations. It is just that, this time, the lender-at-last-resort role had to be on a global scale.

The second has happened before when governments have felt that national interest requires them to invest in commercial enterprises and when other investors did not want to do so. This happened in a dogmatic way with nationalisation and that model clearly does not work. It worked particularly badly when the company being taken over was in some structural trouble, such as British Leyland. But there are much more encouraging examples going back 150 years and more: the government investment in the Suez Canal, or in BP. We tend to forget now that the government once had effective control of the company that, more than any other, discovered the North Sea oilfields.

So one should see the partial nationalisation of British banks as part of a continuum; it is radical but it is not absolutely unprecedented. What is clever is the optional element – we are there if you need capital but if you don't that is fine too – and that now seems to be a model for the rest of the world. It is not as important an intellectual export as privatisation itself, but it is an idea initiated here that will become a new norm in the future.

Government intervention quite rightly comes at a price. The price for having a central bank as lender at last resort is banking regulation. As for the newer investment in the banks, if public funds are invested then the public have to have an influence over how that investment is managed. That is not an issue. The old BP relationship where the government was in ultimate control but did not inhibit the commercial drive of the company worked very well.

That is all straightforward enough, or at least it should be. What is harder to see is how governments will assert their authority on a global scale. Taxpayers around the world have a right to be pretty angry at having to stump up for bankers' errors, even if they end up getting out at a profit. But they have even more reason to be angry if governments don't take steps to try to ensure that this does not happen again.

So there will be a rethinking of the relationship between the state and the world of finance. It has to be done internationally because, if there is one thing we have learnt over the past few months, it is that a problem that occurs in one country will end up in another. This is an interdependent world.

There are two broad paths. One would be to see if there is a case for some kind of new monetary commission that would oversee changes in bank accounting, supervision of derivative development, co-ordination of countries' monetary policy and so on. The other (which seems to me more sensible) would be to look in detail at what has gone wrong and make a large number of tweaks to the system. These would include a different system of bond rating, changes to bank accounting and so on.

That is all for the future. Meanwhile let's just be aware that, when push comes to shove, there are some things that only governments can do. On this occasion they seem to have done it.

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