- Friday, 4 May 2012 at 12:28 pm
The Defence Secretary Philip Hammond tells The Daily Telegraph today that ordinary people are blaming the banks for Britain’s economic bust when they should be blaming themselves.
“People say to me, ‘it was the banks’. I say, ‘hang on, the banks had to lend to someone’. People feel in a sense that someone else is responsible for the decisions they made. Of course, if banks don’t offer credit, people can’t take it. [But] there were two consenting adults in all these transactions, a borrower and a lender, and they may both have made wrong calls. Some people are unwilling to accept responsibility for the consequences of their own choices.”
Mr Hammond, who was part of David Cameron’s economic team in opposition, also suggested that it is the public’s desire to pay down huge debt levels now that is holding back the economy.
I’m skeptical about this for two reasons. First, and most important, the UK’s banking crisis was not a consequence of bad loans made to British households or companies. Second, it is far from clear that UK households were disastrously overly indebted in the years preceding the crisis.
Let’s deal with the banks first.
Ben Broadbent, the former Goldman Sachs economist who now sits as an external member of the Bank of England’s Monetary Policy Committee, last month gave a speech in which he showed our largest banks got into trouble in 2008 because of their bad loans made to the rest of the world, not their UK lending.
This chart demonstrates the point:
75% of the banks’ losses were from their non-UK lending books. As Broadbent points out, the major UK banks were hit 15 times harder by losses on non-UK mortgages than duff UK home loans.
There’s no question that UK banks became perilously overextended in the years after the turn of the millennium. Their total assets reached 350% of our annual GDP, almost doubling over a decade. But let’s be clear: this massive expansion of lending was not a consequence of loans to British households. Much of it was lending to other banks (both here in the UK and abroad) as their casino trading arms engaged in an orgy of socially useless speculation.
This chart, again from Mr Broadbent’s speech, shows that lending to the British non-financial sector remained pretty constant as a share of GDP over the decade, at around 80%:
So what can we draw from this? Britain’s largest banks went bust, helping to plunge the UK into the deepest slump since the 1930s, because they overextended themselves. But bad loans made to British households were a minor part of their total losses. The banks did not go bust because ordinary Britons borrowed too much.
Now let’s address the idea that – even if it didn’t cause the banking bust – British households borrowed too much in the boom years and that these debt levels are now weighing down on our economy, stifling recovery.
This has become conventional wisdom. Proponents point to graphs such as these (courtesy of Fact Check), showing that debt as a share of household disposable income in the UK rose to 170%, much higher than in other advanced countries:
Case closed? Not necessarily. Ben Broadbent has some very interesting things to say on this area in his speech too.
He pointed out that the majority of the extra debt incurred by British households was mortgage debt, as this shows:
Secured lending here is mainly mortgage borrowing.
And when one considers mortgage debt one also needs to consider the other side of the balance sheet: housing values, which exploded over the decade.
When one factors in rising house values, the net financial position of UK households during the last decade looks much less alarming:
As Broadbent points out, UK households’ net financial wealth was no lower in 2008 than it was in 1992.
Ah, but didn’t we have a massive housing bubble? Hasn’t much of the value of those “assets” been wiped out, proving that we did borrow too much after all? The answer to that is that we don’t know yet.
House prices have fallen from the pre-crisis peak by around 15%. But that is nothing like the collapse witnessed in bust housing markets such as the US and Spain, where values are down by something close to 50%:
House prices may be on their way down again here in the UK, and this will cause further problems for the banks, but this is by no means certain. In the past I’ve argued that the only way is down for the market, with prices still well above historic income to value ratios. But now I’m beginning to think that there’s such a shortage of housing supply in this country that values could well remain elevated, despite the weak economy.
Reasonable people can take different views on this subject.
It is also reasonable to point out that unsecured lending – credit card debt – rose in the years running up to the recession and that this is likely to be weighing on consumer spending now as people seek to pay off debt:
But be wary of those who confidently assert that our present economy malaise is a consequence of high household debt levels. And certainly don’t accept for a moment that British banks fell over in 2008 because they lent too much to us.