Poor Mervyn King. The man is the head of the Bank of England. He was just trying to do the right thing. When the credit crisis began this summer he, alone among central bankers, stood firm. No bailouts, said he. If we rescue reckless lenders and imprudent speculators, he opined, it could “sow the seeds of a future financial crisis”.
But integrity in a central banker is like honesty in a politician or chastity in a prostitute – the quality is completely at odds with his profession. Economists talk about the “moral hazard” of allowing investors to do the wrong thing and get away with it. But the hazard is greatest for central bankers themselves. Not since Paul Volcker has any central banker been able to stand up straight. Instead, they bow to pressure – from politicians, the public, the media, and the squirrelly economics profession itself. This has led to what some economists refer to as an “asymetrical response” from the financial authorities. When the going is good…they are reluctant to tighten up on credit. But when the going is not so good…they ease up quickly.
Mr. King resisted pressure for a few weeks. Then, when the tabloids began running photos of depositors lining up to get their money back from troubled mortgage lender Northern Rock (LON:NRK), he buckled. He turned to the cameras and offered to help out. “You need money?” he almost said. “Just come see me.”
“I’ve seen this movie before,” said Angelo Mozilo, boss of Countrywide Financial, “and it always ends in some form of recession.”
Does it? Real estate prices have gone down before – sometimes sharply – in the United States. But the declines were always confined to certain regions. Now, for the first time ever, real estate prices are falling nationwide.
If they fall 10% or more – as Alan Greenspan suggests – it will take more than US$2 trillion out of the nation’s wealth. Of course, it was never real wealth anyway…as we pointed out many times. It was just ‘on paper.’
Still, many Americans spent the money anyway…borrowing against the inflated value of their own homes in order to get cash. Now, the value may disappear. But the debt will still be there. What happens next depends on what prefix you put before the ‘flation.’ If it is ‘in’ interest rates tend to rise…then, the cost of servicing the debt pushes the hapless debtor into the poorhouse. If it is ‘de’ …then he loses his job…his house falls in value, along with his stocks…and he is out of luck. Either way…the result is a slump (eventually).
Markets and Money