The British impact: A deal that matters on this side of Atlantic too

Economics Editor,Sean O'Grady
Friday 26 September 2008 00:00

We've become used, especially in the current crisis, to the idea that economics has been globalised. We ought now to be very aware that politics has been globalised too. For the eventual success of the Paulson plan will ensure that one citizen in particular will be that much safer from the threat of eviction from a much-loved family home: Gordon Brown.

Unlikely as it is, George Bush and Henry Paulson are setting about a scheme so bold that it bears comparison with the New Deal enacted by Franklin Roosevelt in the 1930s, a period when he too felt the need to bail out the banks through federal funds.

The problem in the 1930s was the same as the one that has suddenly overtaken the financial world now; how to break the miserable, vicious circle of decline that the credit crunch has visited upon the American people. Then, as now, the housing recession and the banking crisis are feeding off each other. Every default and foreclosure leaves a bank somewhere with a bad debt. That bank, as it happens, can be in the United States, or Britain or Germany. The debt, as we have seen, will have been "securitised" and sold on many times, the bits of paper it and millions of others generated, the infamous "mortgage-backed securities", packed and repackaged and distributed around the globe. The householder in Florida having a hard time will be causing problems for some unsuspecting Australian pension fund or racy US hedge fund or a dozy British building society who once thought it a good idea to buy these high-yielding but risky pieces of paper.

What happens then? The banks have two options. First they can repair their balance sheets – make good their losses – by tapping their shareholders for more cash, or by asking cash-rich governments in China or Abu Dhabi for funding, or capital. More likely, and increasingly the case, they simply stop lending or get very picky. Hence the famine in mortgages for first-time buyers. Hence also banks' understandable unwillingness to lend to each other.

Think of money as the lubrication in the engine of the economy and the banks as the oil pump; and think of the damage that would be caused when the pump fails.

When the banks stop lending they push an economy into recession, at which point we see more unemployment and more repossessions and more bad debts for the banks, at which point they stop lending again. And so the cycle intensifies. The world saw this in the 1930s, and the Japanese have endured almost two decades of stagnation since their bubble burst and their banks plunged into crisis after 1990. It is not easy to break out of such a cycle; hence the Paulson plan.

The Paulson plan is essential to restore confidence, and to get banks lending again. HBOS was said to have had the biggest funding problems of a British bank, partly related to its sheer size, and it also has the largest exposure to the property market. That is why it had to be rescued by Lloyds TSB. Nervousness about that has seen the shares trade at a discount to the supposed deal price for some days now. The deal, we have to recall, was brokered by Mr Brown. He took, rightly, enormous credit for it. Should that deal fail, because of a renewed bout of nerves over the prospects for the Paulson plan, Mr Brown's credibility will slump faster than the Bradford and Bingley share price. Mr Brown cannot survive another major banking crisis; perhaps his government would collapse too. But by that point, Mr Brown's fate will be the least of the nation's worries.


Japanese banks plunged into crisis, leading to two decades of stagnation.

Register for free to continue reading

Registration is a free and easy way to support our truly independent journalism

By registering, you will also enjoy limited access to Premium articles, exclusive newsletters, commenting, and virtual events with our leading journalists

Already have an account? sign in

By clicking ‘Register’ you confirm that your data has been entered correctly and you have read and agree to our Terms of use, Cookie policy and Privacy notice.

This site is protected by reCAPTCHA and the Google Privacy policy and Terms of service apply.

Join our new commenting forum

Join thought-provoking conversations, follow other Independent readers and see their replies


Thank you for registering

Please refresh the page or navigate to another page on the site to be automatically logged inPlease refresh your browser to be logged in