There will be another crash – a brave government will intervene earlier to stop consumers

By Kitty Ussher MP

Bad news: there’s going to be another banking crisis. No, I don’t have any inside information, it’s just that there always is. Impossible to tell when it will happen but it is certain that we won’t spot the signs early enough and it will catch us unawares, leading to severe problems for individuals, families and firms, with those in low paid jobs particularly vulnerable. It will have a different cause to the one we have just experienced.

Otherwise we will have learnt nothing. So the next time a big economy like the US engages in a deregulatory spree leading to a house price bubble, and the banks think they can eliminate risk by the mass securitisation of ever-more-risky mortgages, presumably a collective warning bell will start to ring.

But at some point there will be other, new, developments in the economy that are just as dangerous and will not cause bells to ring until it is too late. So what can we do now, to convert the next crash, when it comes, into more of a soft landing?

The current crisis could have been avoided if either of the following things had happened: (a) the US regulatory authorities had prevented so many bad loans from being made in the first place, or (b) all bank bosses around the world were as good as the best in realising that the securitisation of these bad debts did not make them any less risky.

What was unfortunate for Britain was that our banks and consumers didn’t have the buffers to absorb the problem to a greater extent when it came. So banks had to try and raise more money in the middle of the crisis; those that were not strong enough had no choice but to go cap in hand to the government.

Consumers too had few reserves to fall back on, and so when faced in 2008 with the triple whammy of rising food and fuel prices, falling house prices (as lending dried up) and fears of job cuts they had a long way to go to retrench their own personal finances before they felt safe again. The result was a drastic fall in retail spending, that turned the fear of recession into reality.

Luckily for us and unlike consumers and banks, the government did have sufficient buffers with overall debt levels low by any standard, so it was able to spend to support the economy.

As we look to the future, there are plenty of proposals around about how to ensure that the banking capital is not found to be wanting again: we could require them to keep more capital the larger they are, or the higher their profits, for example.

But we need to help consumers to keep their buffers strong as well. Interest rates are no longer the tool that they were, as the Bank is now rightly focussed solely on its retail inflation target. And as we have seen it is possible to have inflation remain low even when there are other severe imbalances in the economy.

I remember as an economics student being thoroughly confused that John Major introduced Tessas and Peps in the middle of a recession. Surely now was the time to encourage people to spend, not save? Of course I now realise his timing was purely political. People had already decided to retrench their finances and so it was popular to give them a tax-efficient way of doing so.

To better protect ourselves against the next crisis, we should build on Major’s policies but correct his error of timing. The right time to encourage people to save is when they are spending too much, not when they’ve already decided to rein things in. The economic indicator to watch is the savings ratio – the proportion of our income that we save for a rainy day, rather than spending it now. By 2006 the savings ratio had fallen below 3%, the lowest at any time since the 1950s.

If this starts to happen again, the government should sound an early warning. If interest rates are not rising fast enough (for whatever reason) then large yet temporary additional tax breaks should be given to encourage saving, with particular emphasis on low earners. At the same time the regulatory authorities should consider short-term restrictions on the marketing of high-cost credit.

At the extreme, if the savings ratio falls below a pre-announced level, even if the economic weather is otherwise calm, the government should send a sufficiently strong note of caution that it dampens retail confidence and spooks the financial markets. It would take a brave government to do it. But done early enough it would put us in a far stronger position to withstand the next real crisis, whenever it comes.