Let the markets rule during the credit crunch

Apr 23 2008 by Bill Gleeson, Liverpool Daily Post

THE Government has decided to intervene to alleviate the effects of the credit crunch by injecting £50bn into the global money markets.

The Government has acted this way because banks and building societies need the extra funds so they can in turn lend them to consumers for home buying or other spending or to businesses for investment.

The banks’ usual source of what is in effect “wholesale” cash has dwindled as the world’s financial institutions have all but stopped lending to each other.

The reason the banks have stopped lending to each other is that they don’t trust one another to be good for the money. They are worried that the next Bear Stearns, the big US investment bank which all but collapsed earlier this year, is just round the corner.

But is the Government wise to step in where banks are refusing to? After all, when it comes to assessing credit risk, there can be nobody who does it better than the banks. So, why then is the Government prepared to take risks with taxpayers money?

But there is an even bigger reason for the Government to stay out of the money markets. Government intervention distorts the market.

The world’s financial markets have for at least a decade been flush with cash. China’s savings, for example, from its huge trade surpluses have been reinvested back into the western financial system, making money plentifully available and pushing interest rates down.

As a result, banks and building societies and their equivalents in the US have been awash with cash that they have struggled to place with borrowers.

Once they saturated the normal market of good borrowers, those with good credit histories, they still had plenty of cash left over. Rather than just sit on it, the banks lent the money to those they would not normally lend it to.

That was fine while interest rates were low, but once they started to rise, the high-risk borrowers started to default. And so the chickens have come home to roost.

It is inevitable there will now be some pain as the banks own up to the extent of their mistakes, but what we don’t need is panic measures that will only serve to reflate the money markets when a period of calm and sober reflection is needed.

We need to adjust to markets operating at lower levels of liquidity. Money ought to be less available than it was five years ago. It will be good for everybody if it means banks refocus on the fundamentals of good business practice and don’t dish out the dosh to those that are not good for it, be they would-be home buyers or businesses.

One such business that probably wouldn’t get the cash today is Knowsley retailer Ethel Austin. When the Austin family sold it to the management team in 2002, tens of millions of pounds of bank debt was raised to finance an over-ambitious expansion plan.

What real hope could there ever have been that a provincial chain of small, tatty stores located away from prime locations could ever double in size by branching out to parts of the country where it was never heard of before?

It is time to lay-off the markets and let them recover and find a new equilibrium without the distortion of government intervention.

This could be hugely socially beneficial if it means there is less debt around in the future. As well as fewer people getting into trouble, less debt would cause house prices to fall, chasing greedy investors out of the homes market and making houses more affordable for people to buy to live in.