It seems that most people were completely caught off guard by the financial crisis and had initially been completely confused over why it occurred. But more recently we have seen several theories being thrown around by politicians. I’ll just mention two quite basic theories and why I agree or disagree with them.
Theory 1: I like to call this theory the ‘Gordon Brown theory’ of why things went wrong. People in America borrowed too much and their bankers weren’t careful enough which caused a financial crisis and a credit crunch which means that British banks can’t lend because of the problems created in America.
Theory 2: I like to call this one ‘the theory that’s perhaps a bit closer to the truth’. It was given a brief mention by Stephen Nickell in this month’s Prospect magazine. He said that rather than British banks lending their money “unwisely” to foreign banks and doing dodgy dealings,
…in fact, British Bank lending was relatively prudent…The real mistake made by British banks was that their treasury departments took their reserves and invested them in assets which turned out to be unsafe, illiquid or more or less worthless. The consequence was that a lot of these reserves were lost. On top of this many domestic and foreign holders of capital…withdrew their deposits. With a lower level of reserves and lower deposits, the British banks had to cut their loans and continue to do so.
Evaluating the theories:
Well, let us deal first with the “Gordon Brown” theory. It’s clear from the outset that there are several views in here that it’s impossible to reconcile with reality. The first problem with this theory is that reality tells us that the British banks had as much to do with dodgy mortgages as the American banks. But furthermore, the supposition that British banks begs the question of why well balanced and well regulated institutions would suddenly collapse? Surely a ‘global credit crisis’ in a well regulated system would mean that the banks would have some small problems dealing with overseas markets, but would have no problems domestically. But our evidence clearly shows a bubble has burst in Britain as well as the US, so we can toss that theory aside.
Next we move on to the Steven Nickell theory. Now we have to bear in mind that he was on the Bank of England’s Monetary Policy Committee and therefore has a vested interest in saying that things were fine with the way banks were lending money. However his point about bank reserves is an interesting one to make, though it doesn’t explain away the whole problem. There is probably an element of overzealous lending coupled with bad regulation of bank reserves. However both were necessary in order to make a banking crisis possible.
So what’s the way out of this mess? Tighter regulation of lending seems to be a popular proposal. Tighter regulation of bonuses is even more popular. But in the end, just a little nudge by the regulator in the case of over lending and a tight regulation of reserve assets would be sufficient to stop something similar happening again.
While it’s popular to bash bankers at the moment, we must not forget that we have had good lives and have seen our standard of living rise as a result of the self-regulation of the city. We must learn from mistakes in this financial crisis and move on. Overkill on regulation will only make us poorer in the long run.
Posted by Will Stobart 
