by Peter Watt
What a relief, the world has been saved. Again.
In 2008 there was a financial crisis that many have described as being worse than that of the 1930s. Markets collapsed, banks failed and lives were ruined. In essence, and over many years, much of the western world had begun to believe in magic. Somehow we could all have really low taxes and really high spending by governments. We could have relatively low interest rates and unlimited access to borrowing. Individuals and governments indulged themselves as excess cash from the economies of the east poured into a market of gorging consumers. Credit cards, mortgages, car loans, government bonds – it didn’t matter as there was so much money to go around.
But it was all too good to be true and it couldn’t go on forever.
The complexity of the financial instruments used by money markets meant that for all intents and purposes regulators, corporate boards and indeed governments had no idea exactly who owed what to whom. And anyway at some point it would have to paid back. Fine, as long as economies were growing; but if they slowed down or stopped? And once the US mortgage market was rocked by increasing foreclosures from over extended borrowers the doubts really set in. House prices collapsed and money markets followed. Banks didn’t know whether they could pay what they owed, as they weren’t entirely sure what their loan portfolios were actually worth. And they didn’t know to what extent other banks were in the same position, so they stopped lending them money. Some banks collapsed and markets dived. At one stage it really did look as if we would have a financial Armageddon that could engulf us all. ATM’s would stop working, accounts would be frozen, commerce would slow and who knows what else?
But it didn’t happen and the world was saved. Governments stepped in and recapitalised the banks, basically saying “we won’t let you fail” and effectively underwrote all of their toxic, highly risky debt. Then governments began trying to stimulate their economies. Some cut taxes so that people and companies could spend more. Some got their central banks to start buying their own government bonds, so that effectively more cash was provided to financial institutions and interest rates could be kept low. Some did both, and slowly it worked. The situation stabilised and although economies slowed or even went into recession they didn’t collapse.
The consequence was that the exposure from decades of dodgy lending had been well and truly been soaked up by governments. But governments who relied on the tax receipts from growth faced reducing coffers. And they still needed ever more money, just to keep their enlarged state operations running. Pulling the plug simply was not an option, as it would lead to further ruin for the millions who relied on the states largesse. Deficits, and therefore overall levels of debt, increased for governments across the west. Banks, still hurting from their bad lending decisions of the past, saw government bonds as a relatively safe haven and kept lending. Relieved politicians largely avoided having to have really difficult conversations with voters about what they could expect their governments to do for them in the future.
But it was all too good to be true and couldn’t go on forever.
Governments started to peg back their spending, but it wasn’t easy. Their populations had become used to governments doing things for them and employing large numbers of them. Although cuts were made, the still depleted tax returns meant that borrowing was still needed. It was a rock-and-a-hard-place; cut hard, slow down economies and reduce tax-take further or cut slowly and worry lenders about how much you needed to borrow. Worse, many of the governments of smaller and less advanced economies in the Eurozone had told the odd porky-pie about how much they had borrowed. They had to, if they were to stay within the rules of membership of the Eurozone and keep their populations in the manner to which they had come to expect. But it began to cost more and more for them to borrow to fund their activities.
And slowly it dawned on financial institutions. Whilst they had been saved from their own excesses over sub-prime lending in the bail-outs, they had simply replaced it with someone else’s excess: an excess of sub-prime government bonds. The doubts crept back into bank board rooms across the world. Who has lent what to which government? What happens if a government fails? Will ATM’s stop working, accounts be frozen, commerce slow? Who knows?
But it didn’t happen, because the whipping boys of the Euro sovereign debt crisis, Greece, were this week finally reigned in. The banks agreed to write off some of their expensive debt, as it gave them a bit more certainty in terms of their overall exposure. And the Greeks were given billions in further cheap loans so that they didn’t go bust. In return they effectively had to give up any pretence of sovereignty and have to ask permission from the IMF and ECB to do almost anything.
The world though can breathe a sigh of relief, as once again it has been saved. Governments can keep on borrowing, albeit the rate of growth of their borrowing will slow. But at least an uncontrolled default by a member of the Eurozone and all of its unforeseen consequences has been avoided. Apart from in Greece, relieved politicians can once again largely avoid having to have really difficult conversations with voters about what they can expect their governments to do for them in the future.
But if we are honest, we all know that it is too good to be true and it can’t go on forever.