Brian Reading: A Low-growth Decade (Inevitable, mistaken: Bears Stearns, 10 years on)

2017-07-26 IMI

This article appeared in OMFIF Commentary on June 23, 2017. Brian Reading was an Economic Adviser to Prime Minister Edward Heath and is a Member of the OMFIF Advisory Board. News broke exactly 10 years ago that investment bank Bear Stearns had 'rescued' two of its worthless subprime mortgage funds. This fired the starting gun on the 2008 financial crisis. The right combination of fiscal and monetary policy averted a repeat of the 1930s great depression. But it caused extensive collateral damage. The consequences haunt us still. We have seen the fall-out of the British vote, one year ago, to leave the European Union, as well as in diverse election outcomes in the US, UK and France. 'Bail-outs' over the last decade have transferred resources from the 'have-nots' to the 'haves'. Angry voters have had their say. The overall result has exacerbated inequality and social divisions, and depressed economic growth. When the next crisis arises, perhaps it will be better to allow dysfunctional systems to fail. Policy responses to the financial crisis explain deep divisions in the US, UK and France. Protected patricians are under popular attack. David Cameron and Theresa May, two successive UK prime ministers, have been humbled. Donald Trump and Emmanuel Macron, now in the White House and Elysée Palace, are, in (very) different fashions, anti-establishment victors who exploited anger in their countries. These fissures have much to do with the way financial institutions were protected from losses at the expense of everyone else. Credit systems fail when borrowers cannot service or repay loans. Losses customarily end up with 'haves' who can afford them. A failed lender passes losses on to others with assets. Losses may swell; asset prices collapse. This, normally, takes from the 'haves'. Systemic failure leads to a collapse in the willingness and ability to lend and consequently the ability to borrow and spend. This produces a short, sharp shock. Physical capacity in the economy is not destroyed. Factories and machinery remain intact. Labour skills are not diminished – and productivity is unimpaired. In traditional circumstances, the burden falls on the 'haves', reducing inequality. That is not what happened over the past decade. The overall response to the financial crisis may have been inevitable, but it was mistaken. Bank bail-outs rescued lenders, not borrowers. Subsequent fiscal retrenchment underestimated income multipliers in a balance sheet recession. Austerity programmes, as enacted in the UK, were unfair and inefficient. Spending cuts to public services, police, healthcare and education hurt all. Fiscal austerity is self-defeating. It damages growth, erodes tax revenues and increases needs-based welfare spending. Promoting monetary profligacy – which is what happened over the past 10 years – as a remedy for fiscal austerity makes matters worse. Loose monetary policy, though designed to boost demand, distorts financial markets and creates asset price bubbles. Ultimately, this exacerbates the division between 'haves' and 'have-nots'. Since the attempted Bear Stearns rescue, we have suffered a low-growth decade. Real GDP in the US is only 14% higher than in 2007; in the UK and euro area, it has risen 10% and 5% respectively. Real wages have stagnated or fallen. The young have never had it so bad. Perhaps it would be better to allow fiscal stabilisers to work, leaving deficits to self-correct. The solution for dysfunctional systems is systemic collapse. Maybe, we should have tried it.

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Brian Reading: A Low-growth Decade (Inevitable, mistaken: Bears Stearns, 10 years on)

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