A major financial panic is a horrible experience of risk and uncertainty at any time and for anyone. There is no doubt that the 2008 crash is a disaster, comparable to the Great Depression of 1929 to 1933. I have lived through great national crises but have not experienced a global economic panic on this scale before.
A financial panic is by its nature almost always unexpected; it happens because people have assumed the economy was so stable that they could take risks of expenditure and debt. That is true for individuals, businesses, banks, regulators and governments.
When individuals have taken on debts they cannot repay, when businesses are trading beyond their resources, when banks have lent too much to overstretched borrowers and a government faces a rising budget deficit, the stage for the crisis has been set.
It then takes only a trigger event for the underlying shortage of credit to become apparent. Everyone needs money at once, and nobody wants to lend money. In the current case, the trigger was the rising defaults on American mortgage debt, but if that had not been the trigger, something else would have been.
In the pre-crisis period it can be impossible to change the public mood. People want to think debt is a good thing. Before the 1929 crash on Wall Street there was a Cassandra in New York, a statistician called Roger Babson. On September 5, 1929, he said that ‘more people are borrowing and speculating today than ever in our history. Sooner or later a crash is coming and it may be terrific’. Nobody took any notice of him until it was too late.
Quite a few financial commentators, both in London and New York, took the Babson view in the run-up to the 2008 crisis. The warnings have proved equally true; they may have helped individuals, but they had little influence on policy or events. In this panic, the great engine of the global economy entered the crisis at full throttle.
After the 1929 crash and the bank closures of the early Thirties, there was a major debate among economists about the causes of the Depression and the best way to make sure that a similar catastrophe would never occur again.
The controversy over economic policy involved the Cambridge school, led by Maynard Keynes, the Chicago school, led by Milton Friedman, and the emigre Austrian school, led by Frederick von Hayek. It was one of the most brilliant intellectual discussions of the 20th Century and an education in itself for many who were not economists but wanted to understand these issues.
The irony has been that people came to believe that the world had now been given the answers, and that adhering to the Keynesian policy of ‘demand management’ would protect us from a global depression in the future. We should be more than grateful for the outstanding work of these leading economists.
Undoubtedly, they have contributed to the world’s ability to deal with the present crisis. Hardly anyone now thinks that the right thing to do is to introduce tariffs in order to protect home markets, a policy adopted by the United States in the period of President Herbert Hoover (from 1929 to 1933) and by Britain when Neville Chamberlain was Chancellor of the Exchequer (from 1931 to 1937).
Few people now think governments can stabilise a deflated economy by deflating still further. Both Keynes and Friedman stressed the need to avoid a contraction of the money supply. Keynes stressed the need for government intervention. In fact, most governments do follow Keynesian policies in a recession, though they rightly worry about the longer-term inflationary effect of too generous increases in money supply.
If one looks at the phases of the present financial crisis, one can see how the infection spread from one sector of the world economy to another. Probably the present crisis was in seed at the time of the financial panic of 1987. Certainly there were inflated asset values in the United States by the late Nineties — these were the ‘bubbles’. The most dangerous bubble proved to be that of the American housing market, which was imitated in Britain in recent years.
Both in America and in Britain, regulation was weak and the authorities failed to recognise the risks the banks were taking. Alan Greenspan, then the chairman of the Federal Reserve Board, seemed to think it was his duty to pour money into the market to prevent even a minor fall in share prices. He had a pathological fear of allowing the stock market to correct itself.
In the early months of 2007, it became apparent that American mortgages that had been packaged and sold to other banks were subject to default. A year ago, the problem of the housing market was the focus of the crisis; in the past month the crisis has spread further to Dow Jones companies and derivatives; inter-bank lending had dried up. Obviously, stabilisation will not be reached quickly or easily. What are the grounds for optimism, if any?
First, there is evidence that the world’s governments will go to great lengths to provide funds for their leading banks. These banks should survive. Second, stock market values have already reached levels at which companies that survive look attractive to investors. Third, we shall have a new American President elected next month, with the authority of a new mandate.
Fourth, Asia is financially much healthier than the West. Fifth, man is a resilient animal — the world has seen many crashes, crises and disasters in the past few hundred years.
David Hume, the greatest of Scottish philosophers, dropped a line to Adam Smith, the greatest of economists, in the middle of the Scottish banking crisis of 1772. He saw a silver lining to the crash.
‘On the whole, I believe that the check given to our exorbitant and ill-grounded credit will prove of advantage in the long run, as it will reduce people to more solid and less sanguine projects.’ Crashes are good for us — that seems unlikely, but there is probably something in it. With Hume there usually is.
Lord William Rees-Mogg is a former editor of the Times. This column first appeared
in the Mail on Sunday