The Financial Crisis: Between a (Northern) Rock and Hard Place

With Labour taking criticism for its handling of Northern Rock, so far only the Lib Dem's Vince Cable has come out this well, arguing for nationalisation much earlier given the amount of tax payers support going in.

To be fair to Labour, they probably couldn't have avoided nationalising the Rock, but they could probably have stopped pussy-footing about much earlier and simply got on with it rather than worrying too much about what the shareholders were saying (as if their shares were worth anything at all without the Bank of England lifeline).

I don't really see the Tories having done much differently given their aversion to public intervention and public ownership generally. Also, let's not forget that a key reason for the mess is actually too much financial deregulation (going right back to the days of Thatcher). The FSA itself admitted it hadn't done enough...

Until a year ago, the big UK banks' profits were so high and the fat-cats' payouts so great, that a few of us were calling for a windfall tax on the banks. That could well have raised cash which could be used now to sort out some of the problems we're now seeing.

The banks overextended themselves in the US and to an extent here, in a spree of reckless lending, assuming that the orgy of low interest rates, low prices and a consumption binge were here to stay and that the salami-sliced syndicated debts would spread the risk around the world to the point where they needn't worry about defaults.

Well, they were wrong. Big time. At some point the low-inflationary benefits of globalisation and cheap Chinese goods began to fade out and high prices for oil and raw materials kicked in. When the Fed started to ratchet up interest rates to constrain inflation, the debt mountain in the US weighed most heavily on the weakest members of society. Defaults took off, house prices collapsed and the globalised financial sausage machine seized up...

All of this isn't that strange. It's well known that financial systems need to be regulated to avoid them getting into such a mess. It's a particular example of the Galbraithian argument that social democratic governments saved the market from its own worst excesses, and thereby probably saved the Market system itself.

The market is a good tool but a bad master, and the financial markets in particular have had too much 'freedom' to pursue reckless lending strategies. Here we need sensible re-regulation to avoid such excesses again. Such regulation was a key part of the Roosevelt New Deal after the 1930s crisis and recession.

In a sense then, Labour now has the perfect opportunity to show its social democratic credentials and come up with a package of measures to revamp the financial system to avoid this getting any worse and to prevent it happening again.

So far, they have seemed curiously afraid of acting... but hopefully that will change after the PM meets US bankers next week after his chin-wag with top British bankers this week. Said bankers may warn against an over-reaction, but that's a rather meaningless tautological statement. By definition we don't want an 'overreaction', but we still do need a proportionate and intelligent reaction to stop this fiasco happening again. It's just that they might not like it; but then who cares if Brown has to upset a few bankers? He might even pick up a few votes.

Given that Gordon (allegedly) recently told some rebellious backbenchers to 'write down their ideas and send them in', I thought I'd have a go as well... In so doing, I suggest that points 1 to 3 are necessary but not sufficient, and more imaginative ideas are needed to build a stable financial system that supports an industrial and economic system in a more robust long-term way and that benefits a wider set of people...

1. Stimulate the economy through interest rate cuts if necessary (that's a decision for the Bank of England of course) and fiscal measures if needed...although given the constraints on the budget deficit, see point 8 below on the need for a more progressive tax system.

2. Provide liquidity for the system, in return for government shares in banks and pressure and/or legislation for banks to make rights issues to raise capital.

3. Re-regulate the financial system, implementing in full the Basle-based Financial Stability Forum's recent ideas that include: (i) banks fully and promptly disclosing their exposure to risk and write-downs, and giving a fair value for complicated and illiquid products; (ii) the need for better accounting standards and a strengthening of risk-management processes, backed up by tougher supervision by regulators; (iii) more stringent capital requirements to limit reckless lending when credit bubbles may be blowing up. (In the US, the role of the agencies that were supposed to assess credit risk also needs to looked at; where were they when the sub-prime bubble was ballooning?)

4. Find ways of providing alternative long-term investment for regional economic development and social-housing. Given that Gordon likes the US so much, maybe he could have a look at their municipal bond schemes which have financed much housing building in a way outside the crazy sub-prime fiasco? As former Birmingham City Cllr John Clancy used to say, we need 'Brummie Bonds to fund long term investment in Brummie industry and business' as well as our roads (instead of an expensive PFI deal).

5. Don't be afraid of nationalisation. As Will Hutton pointed out in a fascinating Radio 4 documentary a week ago, it wasn't so bad afterall, and can sometimes work very well. Indeed, we wouldn't have a successful Rolls-Royce aero-engines business in the UK today if nationalisation hadn't saved it in the 70s. Why rush to privatise Northern Rock? Why not run it as a state bank, providing competition to the - not as efficient as we once thought - private sector banks who are already jacking up mortgage rates in the absence of Rock competition? The government could sell Rock services (such as current accounts and savings accounts) through the Post Office branch network, as in the days of Girobank before that was sold off. This might also help some Post Offices stay open... which is no bad thing either given the lifeline they provide to many communities.

6. Use a new industrial policy to build an alternative economy that isn't dependent on another consumer spending binge driven by the advertising and marketing decisions of big-business, paid for by households constantly re-mortgaging, but instead built around investment in high-tech networks of advanced manufacturing and related services.

7. Throw some sand in the wheels of the stock market takeover machine to reduce the endless waste of money blown on takeovers that don't work. This can instead be channeled into long-term organic grown, also freeing up management time from defending themselves against takeover. This could genuinely help overcome short-termism, something that Labour was keen on tackling back in '97, but on which it backtracked under pressure from the big corporations.

8. Start making the case for progressive taxation. That needs to be done sooner rather than later. The government was right to suggest taxing Non-Doms but didn't do a very good case of presenting their argument. With the housing market falling and the least well off struggling with higher fuel and food bills (the abolition of the 10p tax rate was a real mistake for Labour) maybe redistribution from the top 1% super-rich (yes those very same top bankers in the City) to the poorest is an argument waiting to be made. Indeed as Larry Elliott of The Guardain points out, it could actually help the economy. Those on low incomes getting an extra 2 or 3 pounds a week in tax cuts will go out and spend it, whereas the City super-rich would otherwise sit on their 2-3 million extra a year.

Brown quite rightly had a good reputation as a Chancellor. He understands a lot more about how this crisis is playing out than most people. He now has a good chance to show us what he's going to about it.

This, I think, is a defining moment of his Premiership and a chance for him to set the policy debate for the next few years. After all, he has two years to go before the next election.