The sub-prime crisis – a lecture by Liam Halligan
Report written by Old Persean Tom Neuberger (2015).
Jonathan Young, Head of Economics at The Perse, introduced Liam Halligan, high-profile economist, writer and broadcaster, by quoting the Downing Street Press Office who once singled Liam out as “impervious to spin”. Halligan certainly lived up to this accolade as he gave a fascinating and frank account of the cause and the subsequent policy response to the sub-prime global financial crisis.
As was made clear in the title of his lecture, Halligan wished to analyse the events of the sub-prime crash through the eyes of future historians looking back at the present. This, he said, would allow for the objective analysis required to produce an accurate account and evaluation of events.
Putting things in historical perspective, Halligan took us back many decades to the Great Depression of the 1930s. He pointed out the sheer devastation caused by the crash, with US GDP falling 25% during the 1930s, and with unemployment reaching 30%. Behind the numbers, Halligan was keen to emphasise the human tragedy of the events, particularly given the context that this was a time before the emergence of a real welfare state.
Comparing the events of the sub-prime crisis, Halligan stressed the fact that although the 2007/8 crash was a truly global crisis, “the Great Recession was no Great Depression”. In fact, the US GDP fell by 5.1%, and the UK’s by 7.2%. Although the impact of the recession should not be underestimated, the numbers do not come close to those of the 1930s. However, despite the fact that the Great Depression was clearly more severe in economic terms, Halligan questioned the audience why it was the sub-prime crisis which has produced the “slowest, most sluggish recovery ever”. In support of this, he pointed out that even today, 7 years after the crash, GDP/capita has still not reached pre-crisis levels.
To answer this question, Halligan again looked back to history. In response to the Wall Street Crash and the subsequent Great Depression, the US Congress passed the Glass-Steagall Act in 1933. Put simply, this legislation established an important divide between retail banks (that take deposits) and investment banks (that take big risks). However, during the 1980s and 1990s, there was a gradual breakdown in this divide. The UK’s own “informal Glass-Steagall” was removed as part of the 1986 Big Bang, the sudden deregulation of the financial markets. Following their competitors in the City, Wall Street bankers lobbied for the repeal of the 1933 legislation. This was duly granted by President Clinton, his campaign pockets filled with Wall Street cash.
Halligan argued that no other single act played a bigger role in precipitating the sub-prime crisis, and transforming it from a banking crisis into a broader fiscal and economic crisis. Once the Glass-Steagall legislation was repealed, investment bankers were able to use government-backed deposits to take ultra-risky bets with the knowledge that they’ll be rescued if their bets went bad – as Halligan put it, a “heads I win, tails you lose” situation. Halligan believes this is the primary reason why the Western economies have lurched from crisis to crisis since the repealing of the legislation – from the Dot Com bubble, to the 2003/4 crash, to the sub-prime crisis.
Halligan, as one of the most vocal supporters for the return of a Glass-Steagall divide, was able to reveal that many high-profile individuals have contacted him in support of his stance. However, with their jobs closely linked to the financial industry, many are unlikely to speak out in favour of such a policy. Halligan put this down to the fact that the “big banks have captured the government”. Whilst this stranglehold remains, little progress will be made. Our current lack of a decisive, legislative response is worsening our predicament, and we are already sowing the seeds for a future disaster. It is this which future historians will chide us for.
In addition to this failure to establish a Glass-Steagall divide, Halligan also believes that future historians will criticise other aspects of the government response to the crash – in particular, the ever-increasing government borrowing and the numerous bouts of quantitative easing. Halligan was keen to point out that “Keynes was definitely not a Keynesian”. He clarified that, although Keynes advocated government spending at times of economic depression, this was based on the assumption that the government budget was in surplus in times of prosperity.
Halligan is highly critical of Western governments’ “addiction to debt”, and he pointed to some astonishing statistics. In particular, despite the austerity rhetoric of the government, the UK’s national debt is up 120% since 2008. Halligan described such measures, so-called “pump priming”, as self-destructive as they would eventually lead to a loss in confidence. Moreover, as more and more debt is accumulated, an increasing amount of resources must be diverted from public services towards interest repayments. In fact, the UK government currently spends more on debt service than on defence (and nearly as much as on education). This accumulation of debt, which will largely rest on the shoulders of future generations, raises important moral questions as well. On the issue of government debt, Halligan concluded that future historians would find the policy of increased borrowing astounding. As he put it so aptly, “we have tried to solve a problem of too much leverage by taking on yet more leverage”.
Finally, Halligan described the likely criticisms that future historians will have of our policy of quantitative easing. In brief, this is the process by which a central bank purchases government bonds and other securities with newly created money, in the hope to increase liquidity and act as a stimulus for growth. Halligan conceded that the first round of QE (£50bn) was perhaps necessary, in order to liquidate the inter-bank market. However, this has now increased more than seven-fold, and the UK’s current level of QE stands at £350bn. Such a high level of QE is indefensible, according to Halligan, and now simply acts as an “on-going bank bail-out and, by rigging the gilts market, allows Western governments to keep borrowing”.
Although the initial bout of QE may have been necessary, Halligan does not support the unprecedented levels it has reached. He gave a stark warning that, although QE has not yet led to inflationary pressures, as it becomes more politicised, this could become the case. This does not seem too extreme a jump when one considers the floatation of ideas such as “Peoples’ QE”.
Perhaps it is not surprising that QE has extended on such an unprecedented scale. It is convenient for governments, allowing them to borrow more money (as their debt is bought by printed money), and for firms, acting as a drip-feed to so-called “zombie” firms. Thus this is another symptom of a government “captured” by the banks.
For the rest of society, however, QE will have devastating impacts. By protecting weak banks and firms from failing, it is exacerbating the “too big to fail” phenomenon, making them even more dependent on state-support. Halligan instead suggests that such “zombie” firms should be left to fold, so that they can merge with better competitors, wiping out shareholders, and yet protecting depositors and removing the idea that the state will act as a safety net. Moreover, Halligan doubts the effectiveness of QE as an idea, citing a fantastic quote from Keynes: “to think output and income can be raised by increasing the quantity of money is rather like trying to get fat by buying a larger belt.”
Halligan warned of the devastating impacts that QE is having on emerging markets. “QE has undoubtedly inflated currencies of large emerging markets – harming their exports,” he said. This has led to great resentment, which is ever increasing. In fact, the Brazilian ex-Finance Minister, Guido Mantega, called it a “currency war” and warned “there will be consequences”. Such consequences have already begun to appear, with the global economy now enduring the first failed multi-lateral trade talks since the 1930s. Thus, Halligan concluded, future historians will see QE as divisive and myopic.
Halligan warned that such divisive policies were highly dangerous at a time when economic power is shifting from the West to East at an alarming rate. Emerging markets are now the growth centre of the world. They make up 75% of humanity, and 55% of world GDP (up from 30% just a decade ago). BRIC countries have already eclipsed the EU/US in terms of a purchasing-power-adjusted share of world GDP, and this trend is set to continue. Not only is the West-to-East move happening at a great rate, but there has also been a rapid increase in South-South trade (trade between the developing countries). Thus Halligan concluded with this important lesson for the future: “go where the growth is, this is the Eastern century. Teach our children not to assume superiority, but instead interact, respect and trade with the rest of the world.”
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