Can credit controls counter the crunch?
David Smith's excellent Economic Outlook article in the Sunday Times the other week made for depressing reading. It is certainly fair to say that the current credit crunch, and all the doom and gloom that comes with it, is a direct result of banks overlending in the good times and over tightening in the bad times. Who wasn't being deluged with credit card offers on an almost daily basis until about six months ago?
I heard the other day that my friend's daughter was given a 120% mortgage because she promised to make some home improvements. It's not that long ago that the mortgage lenders would only lend you 2.5 times the principal earner's salary plus the full salary of the secondary earner if there was one. And then what happened? Until recently it was not unheard of for banks to lend you five times both salaries. Little wonder that the house price boom continued a lot longer than expected and is now likely to crash.
For those readers over 35 some of this will all sound familiar. The recession of '89-90 was not the same as the current crisis but it was certainly exacerbated by the banks. During the late '80's boom they were lending money like it was just confetti and then with the first cold whiff of recession they slammed on the brakes, throwing thousands of small firms out of business and thousands of home owners out of their homes. Back then it would be fair to say they only contributed to the problem. This time around they are the problem.
During the early '90s, policy makers were apt to say this irresponsible lending by the banks must not be allowed to happen again. But did they learn the lessons? As we can see to our cost, no they didn't.
So let me return to David Smith's depressing column. It was depressing because he listed all the possible ways of dealing with this crisis and then explained why they will not work. The most interesting of these centred on credit controls. The reason he gave for this not being an option was that people would say we are returning to the '70s. It is on this that I take issue with him.
Up until the 1980s there were very strict credit controls in place. Minimum payments on credit cards were at 15%. Mortgage lending was rationed. You couldn't usually get a mortgage unless you had been a saver with the particular lender for at least a year. And if you didn't have a 10% deposit - forget it. There were also all sorts of other complicated and unnecessary restrictions at the time and of course there were also exchange controls.
No one in their right mind would wish to turn the clock back to those times, however just because there were credit controls back then is not in itself a good enough reason for not considering them in the future. In the current climate one would not want to do anything that would dampen down lending even further. But this crisis like all others will pass. Experience shows us that banks do not learn the lessons of history. Left to their own devices you can be sure that the cycle of irresponsible lending will reoccur and people will get themselves too heavily indebted only to be severely punished by the same banks that induced them into the folly of overlending in the first place. Surely therefore it's time for some gentle form of credit controls?
Mathematicians better than I could work out the details but perhaps a restriction on the amount of money lenders may lend against properties or salaries? Or at the very least, in boom times, requiring credit card companies to collect a minimum payment of 15% or even 10% to dampen down consumer spending, relaxing this again in the lean times to assist people in trouble. Arguably we get this anyway in that the Bank of England raises interest rates to have the same effect. The problem here is that interest rate rises hurt everyone, including industry, and people just sink even further into debt. Nudging people towards more responsible borrowing has the same effect on depressing inflation whilst not storing up problems of excessive debt for the future.
As for house prices, who has been helped by the crazy boom in house prices? Not the first-time buyers. Not anyone wishing to trade up. Not anyone currently paying a mortgage that's about 30%* higher than it should be. Had mortgage funds been a little more difficult to come by in the last 15 years house prices would not have boomed so badly and we would not be facing this catastrophic credit crunch situation now.
Alas, those who ignore the lessons of history are condemned to repeat the mistakes of the past. Who knows what damage this current crisis will have? But there will be pain. All to be forgotten in a few years and the same old cycle can repeat itself again.
* The International Monetary Fund believes that UK house prices are 30% overvalued. Ouch!