Ignore politicians: it’s time to stop borrowing

By Associate Editor David Stevenson Oct 09, 2008

David Stevenson
Bank branch window

The last thing any of us needs now is another loan

Yesterday in Britain we finally saw the well-leaked Great Bank Bailout. And the world chopped its interest rates, too. In their latest crack at stopping stock – and lots of other markets as well – heading for apparent oblivion, the greatest minds of the world's financial authorities tried something they haven't used for a while: the 'co-ordinated' rate cut.

That, of course, was like going back to square one – the way the Fed first tried stemming the US subprime home loan fallout last year.

Yesterday share prices kept slumping and money markets are still frozen. Though whilst central bankers are fast running out of ideas, there just may be a silver lining in the long term…

The 'co-ordinated' rate cut has done little for stock markets

Rate cuts, cash injections, mega-loans, bailouts, dodgy debt deals, bad banks, part state takeovers, full state takeovers, oodles of taxpayer cash, more rate cuts – over the past year we've seen more or less the full box of tricks from the 'experts'.

Yesterday the Bank of England, along with the US Federal Reserve, the European Central Bank and just about Uncle Tom Cobley and all, sliced half a percent off 'official' interest rates in what Bloomberg called an "unprecedented coordinated effort to ease the economic effects of the worst financial crisis since the Great Depression".

The UK base rate dropped to 4.5%, the ECB's benchmark rate is now 3.75% while Fed funds have dropped to just 1.5%. The Bank of Japan didn't join in but supported the move, while China's central bank lowered its key one-year lending rate by 0.27%. "They're throwing the kitchen sink in to try to find stability", says Gregory Miller at SunTrust, "they're clearly trying to get the transmission started again."

But stock markets round the world delivered their verdict, plunging again. The FTSE 100 fell over 5% to its lowest point for four years. And the money markets didn't exactly relax. Indeed, they did exactly the opposite. Overnight corporate borrowing costs jumped by more than 0.5% to 3.5%, reports Bloomberg, while one-day yields on the debt backed by car loans and credit cards rose by more than 0.4% to 5%. Meanwhile the bond market "remained all but closed". "In normal times, a rate cut would have a positive effect", says Gary Schlossberg at Wells Capital Management, "what's troubling the market" is concern about "the solvency and losses of major institutions. The market is uneasy because it doesn't have a lot of information on what the depth of those losses will be."

Yet Chancellor Darling was still pulling the stops out. He partially nationalised the British banking system by 9AM – something none of his socialist predecessors ever managed to do – in order to gee up the banks into lending again. By 9.30, he was on the hoof at the BBC, guaranteeing all the savings of UK depositors with the failed online bank Icesave "to make sure that they get their money back".

"I wouldn't normally do this", says Mr D, "but these are exceptional times". You're not wrong, Alistair. But what about all those stock market losses? Or the money markets seizing up?

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In a nutshell, there's some huge pain being suffered by lots of investors and property owners, despite all the politicians' and central bankers' schemes. And the angst has clearly intensified since the Americans decided they needed to organise the biggest bailout in history – the TARP (Troubled Asset Relief Programme), throwing more than $880m at the feet of the US banks. We were told that unless this successfully passed US Congress, Armageddon would soon be on the way.

A big natural slowdown is inevitable

So what's happened since? 'Son of TARP' did get through Congress. Yet stock markets have still crashed and money markets have gone totally haywire. Would leaving things for the market to sort out have made matters any worse?

Now we'll never know, though for what it's worth, I doubt it. But after the biggest credit bubble in history has so spectacularly burst, there has to be a big natural slowdown. The Great Unwind, as the FT has put it, is upon us.

Yet urged on by most of the media, the politicians keep telling us that more "packages" are needed to "get lending going again". They're trying to indoctrinate us in taking out yet more loans, just to keep our lives going. But those politicians only want us to keep borrowing – and spending – so that house and share prices can, temporarily, bounce back up. Then they can lecture us on how clever they've been in getting economies moving again.

Meanwhile the losses keep on stacking up… and the 'experts' are fast running out of options on how to stop them.

The rate cuts and £400bn UK bailout may steady the ship for a few days, but the long-term picture still looks bleak.

The silver lining in the failure to 'get the markets moving'

However, a big slowdown in borrowing might not be all bad news – over time, anyway. We've got ourselves so much into a 'must have now' mentality that in the UK alone we've run up almost £1.5 trillion of personal debts. The vast majority of that is owed on houses that are fast plummeting in price.

What's more, the Chancellor will be looking to cadge some £80bn over the next year, even before the latest bailout plan, to keep the government's coffers balanced. What any of us needs like a hole in the head at the moment is to be borrowing any more money. Or to have the banks throwing the stuff at us like they've been doing for years.

So maybe the failure of the financial bigwigs to 'get the markets moving' isn't such as bad thing. De-leveraging – paying down debt – is going to be very painful, but it will bring us right back down to earth after a long time of over-excess. And we might learn to start living off our means without borrowed money, too…

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Published in Economics | More articles by David Stevenson

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