After the Storm by Vince Cable (Atlantic, £18.99)
I take partial responsibility for the elevation of Vince Cable to the status of national economic sage, because I spent many hours in opposition telling financial journalists about his good economic judgment. And it was good. Not, of course, in any sense of specific short-term forecasts. Economic forecasts are what they are: necessary extrapolations and useful checks on logical and consistent thinking. But the really valuable service that clear-thinking economists can perform is to highlight the big trend-benders. The risks. The icebergs. Vince got the biggest issue in the run-up to the Lehman Brothers crash spot on.
I know, because I was his deputy in the shadow Liberal Democrat Treasury team after I was first elected as an MP in 2005, and we spent time not just publicly telling people that the banks were overdoing it, but also making the case privately—for example, to a notably sceptical Callum McCarthy, then the head of the Financial Services Authority. There was a consensus across both Labour and Conservative front benches—George Osborne included—that the run-away mortgage lending was the product of carefully considered banking judgments. The markets simply did not get these things wrong, and those who worried about the light regulatory touch on the banks were dinosaurs.
Vince and I knew better. We had first met in the 1980s when we were both working on the third-world debt crisis of 1982. Vince was then at the Commonwealth Secretariat and I was the economics leader writer at The Guardian, writing a book on the debt crisis with Harold Lever. Lever had emerged from a close association with the Treasury in 1979 with a scarcely disguised contempt for its bizarre belief in the virtues of financial markets, and particularly its defence of hand-over-fist lending to Latin America.
By the time Vince and I were analysing the aftermath, both Lloyds Bank and the Midland Bank—then two of the biggest UK clearing banks—had lent more than the entire value of their capital to Mexico, Brazil, Argentina and Venezuela, all of which were in default on their debts. On any normal measure, much of the western banking system was bust, but the regulators of the day behaved like the courtiers of the emperor with no clothes and pretended that in fact bank balance sheets were perfectly in order. Only later did the Brady debt restructurings begin to recognise reality.
The warning phrase in any booming market is “this time it is different”; it never is. Even in my lifetime, there have been repeated financial crises: two global (1982 and 2007) plus several smaller, national or regional crises (such as the British secondary bank crisis of 1973). There is usually some new financial instrument—syndicated credits, or collateralised debt obligations—which allow people to argue for the benefits of innovation. Risks are said to be lower and better understood. Underlying all the jargon, though, is the old reality of high debt boosting asset values used as collateral: when the lending stops, the asset values deflate and the banks panic.
For most of this period, Hyman Minsky was a figure who would not have been mentioned in polite financial circles, though his understanding of market overreaction is a key extrapolation of Keynes’s early insights. “A ‘sound’ banker, alas! is not one who foresees danger, and avoids it,” said Keynes “but one who, when he is ruined, is ruined in a conventional and orthodox way along with his fellows, so that no one can really blame him. It is necessarily part of the business of a banker to maintain appearances, and to profess a conventional respectability, which is more than human. Lifelong practices of this kind make them the most romantic and least realistic of men.”
Britain’s economy is rather like a giant hedge fund: it takes in relatively cheap money (for example in banking deposits) and earns higher returns on it than it has to pay out. Higher returns, however, are usually associated with higher risks. And those risks are not merely private. As Mervyn King, the former Governor of the Bank of England, has said, banks are global in life, but national in death. I would not go as far as Vince does in his new book After the Storm in arguing that “a very large global banking sector may not be good for Britain... the current contraction of the sector may be healthy in the long run.” But there surely ought to be a much greater national debate about the risks that such a relatively large financial sector poses to British citizens, and the ways in which they can be mitigated.
Vince is also right to defend the Liberal Democrat change of view on the need for an early earnest fiscal tightening beyond that proposed by Alistair Darling. The Labour criticism of the Lib Dem U-turn was curiously blind to what was occurring in the financial markets in 2010. The general election was on 6th May. During April, Greece had been downgraded by my old colleagues at Fitch Ratings to one notch above junk. Standard and Poor’s followed with junk bond status on 27th April, and the following day Greece’s bond yields—the cost to the Government of new borrowing—traded at 10 per cent more than German ones, three times the level in January. On the day after our general election, there was a further rout.
All of this would have been of little concern if Britain had itself needed little finance, but we were borrowing £153 billion in 2009-10, or 10.9 per cent of GDP on the Maastricht Treaty definition. This was one of the biggest budget deficits—even in proportion to national income—of any EU country. During my rating agency days, I had lived through the 1997 Asian financial crisis, including the battering given to South Korea which at one point was counting the foreign exchange out of the central bank. No one should risk that sort of crisis hitting their economy. The decision to try to remove the UK from the chance of contagion by demonstrating a modestly faster track to fiscal consolidation that year —as Osborne did in his June emergency budget—was surely right.
Much of this might also have been avoided if, as Vince argues, the Treasury had been more willing to undertake investment funded by borrowing, particularly if there was a clear cash return as there could be for housing investment. It might also have been avoided if key decisions had been taken by the originally proposed wide Coalition Committee, rather than the Quad made up of David Cameron, George Osborne, Nick Clegg and Danny Alexander. Perhaps the most unexpected economic development during the coalition years was the behaviour of the labour market. Given such slow growth—partially self-inflicted— all past history would have suggested a rise in unemployment, but instead it fell. Past history would also have suggested a far bigger rise in unemployment during the recession: the 2008-9 recession was the most severe in the post-war period measured by its six per cent fall in output, but the rise in unemployment for each per cent drop in output was less than half what occurred in the recessions of 1979-81 and 1990-1.
You might suppose that a Conservative Chancellor would at least privately celebrate this evidence that Thatcher’s labour market reforms—essentially preserved by Blair and Brown—had left the UK labour market much more flexible. Instead of inflicting all the pain of cost cutting on the newly redundant, businesses were instead able to save money by squeezing everyone’s wages. This was surely a fairer social outcome. But Osborne has just put this achievement at risk by pushing up minimum wages to levels that will hit low-paid employment particularly during the next recession. He was never a Chancellor who could resist short-term political benefit even when paying a long-term economic cost.
This book has plenty of good policy discussions in what at times seems like a Cook’s tour of the economic issues confronting Britain, but readers who were hoping to hear about Vince’s battles in Government, his lurking presence as a touted alternative to Nick Clegg, his ultimate decision not to stand as leader, his key role in the student tuition fees policy and his judgment of whether the Liberal Democrats could have handled that toxic issue better, and the overall balance sheet for the Liberal Democrats in coalition will be disappointed. Instead, we have a book which could—and perhaps should— have been written by an economic adviser to the Government, not a protagonist. This is a shame because the tension between good policy and practical politics is severe. Vince is in a particularly good position to enlighten us on these conflicts, but that will have to await another book.
I take partial responsibility for the elevation of Vince Cable to the status of national economic sage, because I spent many hours in opposition telling financial journalists about his good economic judgment. And it was good. Not, of course, in any sense of specific short-term forecasts. Economic forecasts are what they are: necessary extrapolations and useful checks on logical and consistent thinking. But the really valuable service that clear-thinking economists can perform is to highlight the big trend-benders. The risks. The icebergs. Vince got the biggest issue in the run-up to the Lehman Brothers crash spot on.
I know, because I was his deputy in the shadow Liberal Democrat Treasury team after I was first elected as an MP in 2005, and we spent time not just publicly telling people that the banks were overdoing it, but also making the case privately—for example, to a notably sceptical Callum McCarthy, then the head of the Financial Services Authority. There was a consensus across both Labour and Conservative front benches—George Osborne included—that the run-away mortgage lending was the product of carefully considered banking judgments. The markets simply did not get these things wrong, and those who worried about the light regulatory touch on the banks were dinosaurs.
Vince and I knew better. We had first met in the 1980s when we were both working on the third-world debt crisis of 1982. Vince was then at the Commonwealth Secretariat and I was the economics leader writer at The Guardian, writing a book on the debt crisis with Harold Lever. Lever had emerged from a close association with the Treasury in 1979 with a scarcely disguised contempt for its bizarre belief in the virtues of financial markets, and particularly its defence of hand-over-fist lending to Latin America.
By the time Vince and I were analysing the aftermath, both Lloyds Bank and the Midland Bank—then two of the biggest UK clearing banks—had lent more than the entire value of their capital to Mexico, Brazil, Argentina and Venezuela, all of which were in default on their debts. On any normal measure, much of the western banking system was bust, but the regulators of the day behaved like the courtiers of the emperor with no clothes and pretended that in fact bank balance sheets were perfectly in order. Only later did the Brady debt restructurings begin to recognise reality.
The warning phrase in any booming market is “this time it is different”; it never is. Even in my lifetime, there have been repeated financial crises: two global (1982 and 2007) plus several smaller, national or regional crises (such as the British secondary bank crisis of 1973). There is usually some new financial instrument—syndicated credits, or collateralised debt obligations—which allow people to argue for the benefits of innovation. Risks are said to be lower and better understood. Underlying all the jargon, though, is the old reality of high debt boosting asset values used as collateral: when the lending stops, the asset values deflate and the banks panic.
For most of this period, Hyman Minsky was a figure who would not have been mentioned in polite financial circles, though his understanding of market overreaction is a key extrapolation of Keynes’s early insights. “A ‘sound’ banker, alas! is not one who foresees danger, and avoids it,” said Keynes “but one who, when he is ruined, is ruined in a conventional and orthodox way along with his fellows, so that no one can really blame him. It is necessarily part of the business of a banker to maintain appearances, and to profess a conventional respectability, which is more than human. Lifelong practices of this kind make them the most romantic and least realistic of men.”
"Britain’s economy is rather like a giant hedge fund: it takes in relatively cheap money and earns higher returns on it than it has to pay out"The problem for the UK is that it is the major economy most reliant on bankers. True, the United States financial sector is bigger, but then so is the US economy. Small economies with large financial sectors—such as Iceland and Ireland—suffered terribly in the crash. So did Britain, and the vulnerability to an inherently volatile sector remains. Every time the cry goes up to toughen regulation. But financial regulators are great at preventing the last problem from recurring, and less good at anticipating the next one. Yet there is a real cost not only to the public finances, but to the wider economy: the recovery from recession in the UK was far slower even than in France or Germany, despite the vaunted flexibility of a separate currency.
Britain’s economy is rather like a giant hedge fund: it takes in relatively cheap money (for example in banking deposits) and earns higher returns on it than it has to pay out. Higher returns, however, are usually associated with higher risks. And those risks are not merely private. As Mervyn King, the former Governor of the Bank of England, has said, banks are global in life, but national in death. I would not go as far as Vince does in his new book After the Storm in arguing that “a very large global banking sector may not be good for Britain... the current contraction of the sector may be healthy in the long run.” But there surely ought to be a much greater national debate about the risks that such a relatively large financial sector poses to British citizens, and the ways in which they can be mitigated.
Vince is also right to defend the Liberal Democrat change of view on the need for an early earnest fiscal tightening beyond that proposed by Alistair Darling. The Labour criticism of the Lib Dem U-turn was curiously blind to what was occurring in the financial markets in 2010. The general election was on 6th May. During April, Greece had been downgraded by my old colleagues at Fitch Ratings to one notch above junk. Standard and Poor’s followed with junk bond status on 27th April, and the following day Greece’s bond yields—the cost to the Government of new borrowing—traded at 10 per cent more than German ones, three times the level in January. On the day after our general election, there was a further rout.
All of this would have been of little concern if Britain had itself needed little finance, but we were borrowing £153 billion in 2009-10, or 10.9 per cent of GDP on the Maastricht Treaty definition. This was one of the biggest budget deficits—even in proportion to national income—of any EU country. During my rating agency days, I had lived through the 1997 Asian financial crisis, including the battering given to South Korea which at one point was counting the foreign exchange out of the central bank. No one should risk that sort of crisis hitting their economy. The decision to try to remove the UK from the chance of contagion by demonstrating a modestly faster track to fiscal consolidation that year —as Osborne did in his June emergency budget—was surely right.
"It did not surprise me that the rating agencies duly took away the coveted AAA rating which Osborne was ostensibly trying to protect"Where Vince is silent is over the more controversial decision by Osborne in the same budget to frontload the fiscal consolidation to 2011 rather than spreading it out evenly over the parliament. In doing so, Osborne broke the golden rule that the budget should not be tightened so far and so fast as to kill growth, and condemned the UK to a much slower recovery over the next two years than might have been the case. Ironically, it probably also meant that the improvement in the public finances was slower than it could have been if progress had been more steady and sure. It did not surprise me, therefore, that the rating agencies duly took away the coveted AAA rating which Osborne was ostensibly trying to protect. By the time of his omnishambles budget in 2012, there were calls for his head.
Much of this might also have been avoided if, as Vince argues, the Treasury had been more willing to undertake investment funded by borrowing, particularly if there was a clear cash return as there could be for housing investment. It might also have been avoided if key decisions had been taken by the originally proposed wide Coalition Committee, rather than the Quad made up of David Cameron, George Osborne, Nick Clegg and Danny Alexander. Perhaps the most unexpected economic development during the coalition years was the behaviour of the labour market. Given such slow growth—partially self-inflicted— all past history would have suggested a rise in unemployment, but instead it fell. Past history would also have suggested a far bigger rise in unemployment during the recession: the 2008-9 recession was the most severe in the post-war period measured by its six per cent fall in output, but the rise in unemployment for each per cent drop in output was less than half what occurred in the recessions of 1979-81 and 1990-1.
You might suppose that a Conservative Chancellor would at least privately celebrate this evidence that Thatcher’s labour market reforms—essentially preserved by Blair and Brown—had left the UK labour market much more flexible. Instead of inflicting all the pain of cost cutting on the newly redundant, businesses were instead able to save money by squeezing everyone’s wages. This was surely a fairer social outcome. But Osborne has just put this achievement at risk by pushing up minimum wages to levels that will hit low-paid employment particularly during the next recession. He was never a Chancellor who could resist short-term political benefit even when paying a long-term economic cost.
This book has plenty of good policy discussions in what at times seems like a Cook’s tour of the economic issues confronting Britain, but readers who were hoping to hear about Vince’s battles in Government, his lurking presence as a touted alternative to Nick Clegg, his ultimate decision not to stand as leader, his key role in the student tuition fees policy and his judgment of whether the Liberal Democrats could have handled that toxic issue better, and the overall balance sheet for the Liberal Democrats in coalition will be disappointed. Instead, we have a book which could—and perhaps should— have been written by an economic adviser to the Government, not a protagonist. This is a shame because the tension between good policy and practical politics is severe. Vince is in a particularly good position to enlighten us on these conflicts, but that will have to await another book.
