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Financial Times: Stopping a crisis becoming a catastrophe

By Philip Stephens
Published: September 17 2007 23:17 | Last updated: September 17 2007 23:17

In the end fine economic judgments were swept aside by politics, calm deliberation by panic on the streets. Never mind that investors in Northern Rock, Britain’s fifth largest mortgage lender, had been assured their money was safe. The television images of thousands queuing to empty their bank accounts the length and breadth of Britain were too much for Gordon Brown’s government. Signs that the contagion was spreading to other leading banks risked a crisis turning into a catastrophe. Only a blanket guarantee would do.

Such was the judgment that led to the extraordinary announcement last night that the Treasury is ready, in effect, to stand behind depositors not just in Northern Rock but in every other British bank. Government ministers – notably Alistair Darling, the chancellor of the exchequer – presented the guarantee as a prudent safeguard against the risk of systemic breakdown. In truth, the panic that had brought down Northern Rock was fast spreading through the corridors of power in Whitehall. Gordon Brown’s government has built its reputation on economic competence. Stability was Labour’s trump card in the three general elections fought and won by Tony Blair. As chancellor through that decade Mr Brown could claim much of the credit. This week’s scenes of anxious voters emptying their bank accounts, redolent of Latin America 20-odd years ago, threatened to sweep it all away.

That, after all, is what happened to the Conservatives on September 16 1992 when a wave of financial speculation saw sterling ejected from the European exchange rate mechanism. The Treasury wasted billions in the pound’s defence. The then Tory government never recovered its reputation for sound economic management.

Now Mr Brown’s administration is haunted by the memory. It can hardly have escaped the present government’s notice that the latest turmoil has coincided almost to the day with the 15th anniversary of what became known as Black Wednesday.

The impact, to be fair, has been much more limited. There have been no emergency rises in interest rates this time. The prime minister has escaped public humiliation. Most voters have been as yet untouched. But the damage to the government’s reputation may be considerable – the reason perhaps why Mr Brown, less than three months in 10 Downing Street, has seemed reluctant these past few days to step out of the shadows.

How is it, voters might reasonably ask of the politicians, that an upheaval that began with some dodgy loans in the American mortgage market could bring one British bank to its knees and threaten the future of several others? Why, if London claims to be the world’s pre-eminent financial centre, did the regulatory system not work? Most people will not be much interested in complex explanations about the implications of the integration of global financial markets or about the balance of regulatory responsibilities in Britain between the government, the Bank of England and the Financial Services Authority. The buck has to stop somewhere; that may well be Downing Street.

The speed with which a squall became a hurricane leaves some of the big questions unanswered, even among the experts. Britain’s regulatory system, with responsibility split between the Bank of England and the FSA, and the government one step removed, looked fine on paper. Many saw it as a model for others. But during recent days, the big question has been where does responsibility lie? With the FSA, the Bank or the government? Sometimes it has seemed the real answer has been nowhere.

Mervyn King, the Bank governor, has played by the book. His refusal to bail out the banks when the credit squeeze began to bite set him apart from central bankers in the US and continental Europe. But it also carried the right message: commercial banks should not expect to be rescued by taxpayers from bad decisions. Likewise, shareholders in Northern Rock should have expected to pay the price for a business model that relied on limitless liquidity. But, as Mr King has discovered, being right can also sometimes carry costs.

Mr Brown must hope that by writing a blank cheque to worried depositors the government will restore trust in the financial system. It also seems likely that ministers will move swiftly to improve the protections afforded to bank depositors, borrowing, with perhaps a blush, from the American model. But even if calm is restored, the second round impact of the crisis is yet to be felt. Voters may soon find themselves paying more for their mortgages just as house prices begin to fall. Consumer confidence may slide further. The Conservatives and Liberal Democrats, though supportive of the emergency measures, will make political hay.

All of a sudden the political mood which a week or so ago was said to be tempting Mr Brown to call an early general election is altogether darker. Only the other day I heard one senior minister predict that if the prime minister went early he would romp to victory. Now, nothing seems quite so solid. Politics, as they say, has got interesting again.

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Copyright The Financial Times Limited 2007

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