Home > Economics, Finance and money > Guest post: Avoiding a Lehman 2 and a Second Great Depression – David Lilley

Guest post: Avoiding a Lehman 2 and a Second Great Depression – David Lilley

I’m afraid a second Great Depression is a possibility.

The only doctor that can cure the problem is the G20.

The debt situation is far bigger than 1929 when many US citizens jumped on the stock bubble with credit. But many would be less than 10% unlike the many that jumped on the worldwide property bubble.

We cannot unilaterally change our interest rate without consequences affecting FOREX, capital movements and balance of trade. The US can.

The US is like the sun and the rest of us are like planets. If the US gets hot or cold the rest of us get hot or cold.

We have just witnessed a bubble busting, the tech bubble of 2001. We couldn’t possibly walk right into another, but we did.

The tech bubble burst thanks to tiny calculations showing that the emperor had no clothes and 90% of the new Internet companies disappeared overnight. It cost the US 2m jobs and Alan Greenspan took advantage of the US’s reserve currency status to reduce interest rates every 6 weeks 11 times in a row.

I’m not looking at any references. This is all from memory. I follow these things like a hawk.

Easy money put on 7m new US jobs.

When the US reduces interest rates we, and others, can follow and we did. We went down to 3.5% and it occurred to me that that was ¼ of the base rate when I bought here. Therefore, another person could get 4 times his mortgage for the same cost as his 1991 mortgage and that is what happened here and across the world.

The UK house price rose to 9.3 times average income when the norm is 3. US house prices went to 6.

We first heard the term sub-prime mortgagee in 2007. But the fact is that since Carter the NINJAs basically had to be given a mortgage and if he didn’t get one he could get legal assistance from Barack Obama, the solicitor, to get his right to a mortgage. The banks found a way of selling on sub-prime mortgages as securitized bonds (mortgages are securitized loans as the lender has his name on the title and can reposess the asset and sell it if the mortgagee fails to pay). The rip-roaring Northern Rock was giving 125% loans but it was selling them on and was outstanding in the building society market with a great business model for many years.

Securitized bonds paid as much as 18% and there was massive appetite for them. The more sub-prime the better the bond paid and house prices just went up and up and up (as bubbles do). US banks were actively seeking NINJAs and Northern Rock was reaping them in with its 125% deals. In the US you got a three-year easy start to draw you in. These bonds were triple A and when you think that interest rates in Japan were 0% for seven years you can see where the appetite came from. Foreigners held 80% of US treasuries. They were AAA and paid 4% when your bank paid 0%. Buyers of Mortgaged Backed Securities (MBS) looked no further than the 18% and the word “securitized”.

So my point is that the US, with its reserve currency status, had a licence to reduce interest rates and it paid them well, putting on 7m extra jobs and expanding GDP. The cost of Medicare and Medicaid increased 10 fold in twenty years and Bush signed the cheques. The cost of Iraq was small fry by comparison. The US debt ceiling was increased with a nod some twenty times and no one was bothered.

That is what was happening to the world economy. The sun was getting hot and we all benefited from the low interest rates.

But back home we were wanting in parliamentary debate and scrutiny. This is what parliament does. The massive Labour majority of 1997 led to a situation where it was not necessary for Labour MPs to attend debate but only to attend for the vote. Typically few or no Labour backbenchers attended a Finance Bill debate. Try keeping Ken Clarke, John Redwood or Peter Lilley away when money was on the table. But Labour MPs, who actually thought that Gordon Brown was a super economist (when he only studied modern history), never received or contributed to debate and scrutiny.

Labour (when we talk about labour we are only talking about the handful of middle class privately educated politics, philosophy and economics graduates, PPEs, who traditionally take all the top jobs) (prior to 1965 every member of a conservative cabinet had a PPE from Oxford, you need a PPE to govern) jumped on the easy money decade. They borrowed £30-£40bn every year since 2003, grabbed £15bn pa from pension funds (forcing employers to scrap their defined benefit schemes or fund the missing £15bn from profits which in turn takes £15bn from investment in UK wealth creation), drove people into property as the FTSE suffered the loss of £15bn pa, ran up an off-balance sheet debt of £300bn in PFI, allowed mortgage debt to sky-rocket to £1.2tr, allowed £400bn of home equity release and allowed banks to multiply their lending reserve by as much as 30 times deposits.

The result is that today we have personal debt of 1.06 x GDP, corporate debt of 1.26 x GDP and sovereign debt of 89% of GDP. All affordable when interest rates are low but all having to be paid back.

Debt is where you go when you cannot make ends meet. It is bringing forward future earnings. It is like earning £100 per week and taking a one-week sub and telling everyone you are on £200 per week.

GDP is measured in three ways that all give the same answer. It is basically the summation of all transactions. It peaked at £1.5tr in 2007, as did personal debt (£1.2tr of which was mortgages).

Nevermind Gordon Brown’s claim of 53 quarters of growth and the best chancellor ever. Just looking at a simple model; personal debt rising from 0 to equal to GDP between 1997 and 2007, and assuming it is linear, it takes real GDP from +3% to –7%. We were spending money and providing jobs that derived from home equity release, PFI, mortgages and personal, corporate and sovereign loans.

30,000 extra doctors, 90,000 extra nurses, 80,000 teaching assistants and 118 brand new schools in 2007. It all sounded great. A doubling in the spend on pupils pa and a tripling of NHS spend but all based on borrowing and not what we can afford but passed off as the latter.

The illusion was first broken when the Daily Mail ran the story that 90% of all the new jobs that Labour boasted about went to migrants who came here from 2004 onwards to get paid 6 times what they could get back home for the same work. The £ fell and the Zloty rose and many went home but we still have 1.35m doing work that Brits will not do because they are much better off on benefits. Then it transpires that many of the 5.2m Brits on benefits are basically unemployable and industry will always choose a migrant over a Brit because the Brit is less educated, less presentable and has a lower work ethic.

I broke the story that to halve the deficit in four years also meant to increase the national debt in five years. I put it on lots of financial sites prior to the election. Obama first used the phrase and I thought it was good news until I realised that he would be halving the deficit and not the debt. Labour picked up on it and even made it law and I knew it was a persuasive mantra.

You only had to add a few numbers together to understand that halving the deficit in four years meant doubling the debt in five. Debt was £700bn. Add £178bn, £130bn, £110bn, £89bn and a further year and you doubled the debt. I posted it on Jeff Randall’s Telegraph column and the following day was budget day. He never mentioned the budget on his Sky news show when every other channel was budget, budget, and budget. He just repeated that debt was different to deficit and the debt would double in five years. The Treasury Secretary, Steven Timms, was a guest and Jeff asked him what would happen to debt and Steve didn’t know. Jeff pointed out that it would double and that it was in the budget document that Steven had just written.

We are paying £43bn pa in debt service charges and this will grow to £63bn at the end of the coalition term. But we will miss this target, as it is so difficult to get the structural deficit down to 0 in a five year term.

Please ask yourself what you think about halving the deficit in four years? It does mean paying £120b pa in debt servicing in four years time, equal to the cost of the NHS.

The NHS costs £120b pa out of a total government spend of £700b pa of which £400b goes on benefits and pensions. Does any one really think that paying the cost of the NHS in debt service charges is a good idea?

The numbers are the key to understanding the problem and understanding a problem is the key to solving it.

Management is what we need.

Spending money on the most vulnerable in society was hard to control and ended up multiplying the poor and diverting money from the most vulnerable in society.

We introduced IB (incapacity benefit) for a target audience of 175,000 but soon there were 20 times that number claiming that they couldn’t work a day in their lives due to incapacity. Including 200,000 teenagers.

We went easy on single mums and their numbers grew by three fold in the last twenty years. Often due to LAT’s (live apparts). Those who choose to recover the lost income of the female when a child occurs by claiming to live apart and get everything funded by the state (or as I put it, by their neighbour).

We have to swallow some facts about Labour’s Britain that are not well aired by the media.

-The BBC delighted in telling us that the kids would go back to 118 brand new schools in September 2007 but omitted to tell us that even the primary school children would have to pay the PFI (generally 17% pa over 20 years) as it would load their council tax in years to come.

-600,000 LAT’s all getting all their home bills paid by the taxpayer.

-a career choice for 3.5m, less 175,000, was to graduate from JSA (job seeker’s allowance) to IB for the extra money and to save Labour the embarrassment of high unemployment figures. The most common illness being depression.

-1.35m guest workers doing the work we refuse to do.

-14,000 children excluded from school who will never learn to read and write.

-the average cost of a truant was £2m some 15 years ago. Yet we have more truancy today than ever
-15% leave school with no qualifications despite a doubling of the spend on schooling.

-public sector workers get 43% greater remuneration than private sector workers doing the same work when their 7% extra wages, lower hours, longer holidays, earlier retirement and better pensions are accounted for. The reason being that for 13 years the union (Labour) has sat in the employer’s chair.

-only 64% of working age men work, one in four children live in a home without a father (2m children), 5.2 m of working age do not work, one in four households of working age has no worker.

This list is endless.

I have not mentioned all the assaults on employers. We are beginning to realise that we quite like employers as they provide employment. That is what it says on the can. If you kill an employer you lose the tax they provide and the rest of us have to pick up the tab for benefits necessary to fund the workers that he funded before you hit him with CGL (climate change levy), NMW (national minimum wage) and increased employer NI and UBR (uniform business rates).

None of the Labour stimulus went to employers.

Going forward.

Before going forward let us please get the problem properly identified. There is no point in trying to solve the wrong problem.

Do we all agree that the above is the correct characterisation of the problem?

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  1. September 9, 2011 at 8:27 am

    Thanks David for taking the time and effort to write a clear and comprehensive post.

    The extent of debt escalation in the UK is clearly apparent. However, there is a risk that many people could construe the policy failings of the Labour Gvt since 1997 as that of a socialist / big state spending spree. This characterisation would only tell half the story.

    If one were to assess the majority of economic policies implemented by Labour, they successively pursued de-regulation of financial services. First the tri-partite BoE, Treasury and FSA ensured limited scope for each, and the responsibility for supervision to fall between the cracks. Second, the agencies far from being encouraged to investigate fraud, malfeasance and systemic risk levels were repeatedly undermined from doing their regulatory duty. See for instance this:

    http://www.bbc.co.uk/blogs/newsnight/paulmason/2008/10/hellzappopin_at_the_fsa.html

    (Unfortunately, I do not share Paul Mason’s optimism that “light touch” regulation has ended.)

    The inherently pro-business (and more importantly pro-finance) stance of the Labour Gvt suggests that they actually operated as Neo-liberal / Free market / Laissez-Faire / Anarcho-Capitalist wolves in sheeps clothing. It was under Blair & Brown that universal banking was permitted, the asset base of banks rapidly rose (https://forensicstatistician.files.wordpress.com/2011/09/uk_banking_sector.jpg) and some bright spark decided to sell a large proportion of the nation’s Gold reserves:

    http://www.telegraph.co.uk/finance/personalfinance/investing/gold/7511589/Explain-why-you-sold-Britains-gold-Gordon-Brown-told.html

    This mirrors the Neo-liberal policies employed in the US during the Clinton era. The extent of de-regulation under Greenspan, Rubin and Summers is very well documented here:

    http://www.pbs.org/wgbh/pages/frontline/warning/etc/synopsis.html

    And the intellectual ties between the two Governments is not to be underestimated:

    http://www.economist.com/node/105528

    This crisis started as a banking crisis, and as the R&R analysis shows is typically precipitated by financial de-regulation:

    https://forensicstatistician.wordpress.com/2011/08/05/banks-victims-or-perpetrators/

    Government debt crises and sovereign / currency crises are merely extended (but not necceasrily unintended?) consequences of banking crises that couldn’t be suffiently defused.

  2. September 20, 2011 at 12:40 pm

    Money always was warfare. It is easy when your country can also destroy the world? These people are DANGEROUS. Many believe that God’s work is being done and that soon there will be a Rapture to whisk them away ……

    Check how many tsunami attacks are coming …… not all from USA?

  3. September 30, 2011 at 7:22 am

    If I understand it right your diagnosis of the causes are as follows:

    – Low interest rates (facilitating easy money) – most non-mainstream economists and commentators would agree with you on this

    – Poor lending standards and excessive Loan to Value mortgages (primarily facilitated through Securitisation) – I fully agree with this and my 10 page submission to the ICB clearly argued this case – They have ignored the main thrust of my argument but seem satisfied in their Ring Fencing proposals (see my Potemkin Firewalls for a response on this)

    – US Gvt spending getting out of hand – as you state, they can get away with this because they are the world reserve currency (Prof Michael Hudson is perhaps the leading proponent of this argument and he is shunned by mainstream media)

    – UK Gvt massaged GDP by excessive borrowing – yes, the whole country lived off our credit card and beyond its means – but does the borrower have to accept full responsibility or is the lender just as complicit / culpable?

  4. David Lilley
    October 16, 2011 at 10:47 pm

    Dear Naill,

    Please see attachment. If you wish to comment you may do so on
    http://www.forensicstatistician.com.

    New subject.

    World 5.

    Your wife may be more interested in this.

    If I were to teach history I would begin with World 1-Kant’s Big Bang,
    the introduction of matter. Then Darwin’s World 2-life (different to
    matter). Then World 3-Descartes Mind, the ability to reflect, grass
    doesn’t have it. Then World 4-Popper’s Objective Knowledge. He
    introduced the Falsifiability Criterion some 80 years ago but it took
    him some 40 years to introduce “Objective Knowledge” as World 4.

    World 4 is the stuff that has passed the Falsifiability Criteria and
    we can put it on the shelf marked Truth or Objective Knowledge. It is
    true because it “corresponds with the facts” (Tarski’s definition of
    Truth). Popper explains World 4 in his book Objective Knowledge.

    So if we have Worlds 1, 2, 3 and 4, all discovered in retrospect this
    leads to two possibilities.

    1. Will there be other discoveries, World 5, 6 ….

    2. Is the Second Law of Thermodynamics wrong, things do not build
    themselves but rather built things fall down. Worlds 1, 2, 3 etc
    suggest building.

    I introduce the idea of World 5, the PLC.

    Please give it some thought. I pass it to you.

    World 4 is OK. We have been putting stuff on the Truth shelf for some
    2,000 years at a pace; Newton’s Optics, Lamb’s Hydrodynamics, Mill’s
    Socioeconomics (these examples are given because they are still
    textbook today, hundreds of years latter).

    World 5 is bigger than World 4 because it puts World 4 to use and has
    done since the Industrial Revolution.

    As an aside. It is poignent to the understanding of the significance
    of World 4 and World 5 to agree that China can simply buy all the
    World 4 from Rover by simply buying all the intellectual property and
    therefore doesn’t need to go through its own industrial revolution.

    The big thing happening in the world today is World 5 and not the
    Eurozone debt crisis or loss of Empire.

    We can and should learn lessons from history. We don’t, for example,
    wish to see another Great Depression. But one of the biggest shakers
    of the modern world, Steve Jobs, knew nothing of history and only
    wished to be a part of World 5.

    PLCs hire the best brains with World 4 knowledge in every discipline
    from banking to IM. These are some of the biggest companies in the
    FTSE 100. The FTSE 100 earn 66, 70 or 75% of their income abroad. We
    are so lucky. 36% of Britsih males of working age don’t need to work
    and we can still manage. If only Portugal or Greece could muster this
    amount of World 5.

    Maybe some of your students are in the Wall Street protests. If only
    they knew about World 5, ipads, new wonder drugs, banking innovations
    etc. We should be telling them about World 5.

    I hope that you, or your wife, can find something to sleep on in the above.

  5. David Lilley
    October 16, 2011 at 11:05 pm

    My post always begin with emails to my relatives. I am trying to get one of my sons off Chomski and the Real News. Chomski should be off Chomski by now. He has changed the world twice. He should get on to World 5.

    My text above is an email to Naill Ferguson and his new wife.

    I hope it hits the button.

  6. October 17, 2011 at 8:40 am

    Hi David

    You have raised a number of points, which I will tackle in turn. Not only would it be helpful to gain your feedback on these point but it would be good to hear your reply to the points I made in the first comment (above).

    It is interesting to hear your thesis of the mutiple worlds again. Certainly the world has appeared to fight the 2nd law of thermodynamics. But this should not be concluded by suspecting that mankind (whether by virtue of our superior knowledge – World 4 – or by the “wonders” of the PLC – world 5) can create perpetual motion machines!

    http://en.wikipedia.org/wiki/Second_law_of_thermodynamics#Perpetual_motion_of_the_second_kind

    If you read Schrödinger’s “What is life” you will understand that living organisms only achieve the apparent fight against entropy by feeding off condensed sources of external energy.

    “Schrödinger explains that living matter evades the decay to thermodynamical equilibrium by feeding on negative entropy.”

    So we have plants taking energy from the sun, animals taking energy from plants, and mankind taking eneregy from the plants, animals, wind, and (in the last 200 years) decayed organic matter. Without this “negative entropy” at man’s disposal we would be as nought. To believe otherwise is to mistake the real world for the garden of eden (to paraphrase Georgescu-Roegen).

    If you genuinely believe in the power of scientific enquiry, you would appreciate the work of nobel Chemist Frederick Soddy. Here he is in 1921 writing about the role of energy, the origins of wealth, and the true nature of money:
    http://habitat.aq.upm.es/boletin/n37/afsod.en.html
    Soddy didn’t need Popper to reach his conclusions.

    You say that “Maybe some of your students are in the Wall Street protests. If only
    they knew about World 5, ipads, new wonder drugs, banking innovations
    etc.”

    Do you know what these protests are about? And might these people actually be aware of iPads and “wonder” drugs and banking innovations? They are protesting because inspite of such “wonders” as you profess, they don’t appear to have any prospects for themselves, they are in debt, without jobs, and appear to have been sold out to elite interests who seem hell bent on applying austerity to the 99%.

    Indeed perhaps thety are protesting BECAUSE of such innovations. The iPad is manufactuered in China, wonder drugs are the purvey of big profits Pharma, and banking innovations seem to have created more toxic debt than the world knows what to do with!

    Crony Capitalism has created a very unnequal society. Banking “innovations” have merely disguised problems, and / or shifted problems from the private sector to the public sector. Meanwhile CEOs of failed institutions have lined their pockets. Rewards for failure is not the mantra of Capitalism – surely!

    I have studied modern banking and have written a critique here:

    https://forensicstatistician.wordpress.com/2011/05/25/how-a-bank-works-modern-miracle-or-just-a-mirage/

    As with the banks, rampant PLCs may be as much to blame for our problems are they are our saviours.

    For instance, do you think there is a relationship between the dominance of the PLC, and the now ballooning debt crises in the developed world?

    http://www.economist.com/content/global_debt_clock

    Surely the most “recknecked” Capitalist countries are also the ones mired in sovereign debt woes (debt that was foisted onto sovereign balance sheets by PLCs!)

  7. October 17, 2011 at 8:43 am

    David

    In answer to your short comment above.

    What is your concern about Chomsky and the Real News Network (TRNN)? Surely many young people are disillusioned with mainstream media as it appears to be little more than a mouth piece for the Kleptocratic elite.

    Why are Chomsky’s criticisms not valid? And have you watched much of TRNN, in order to to arrive at an informed opinion of the topics covered and journalistic quality?

  8. David Lilley
    October 18, 2011 at 8:53 pm

    Mervin King’s speech, Liverpool, 18th October 2011.

    Mervin, one of the most respected of the world’s central bankers, spoke out today:

    1. Defending why he spent 95% of the previous £200b of QE helping Gordon Brown rise money at a time when the Gilt market might have failed to buy UK Gilts as our credit rating was “on watch for a downgrade”.

    2. Explaining why he couldn’t have directed that money to people who could have used it far better for the benefit of the economy and jobs.

    3. Explaining, better than my explanation, the origins of the financial crisis.

    4. Explaining why the MPC couldn’t have done the credit easing for SMEs that the Treasury has just proposed to do themselves.

    5. Explaining that the big fix that will come on Friday is only a sticking plaster, providing liquidity to the European Stability Fund and thence to European banks rather than addressing the real problems of insolvency in these banks and some of their sovereigns.

    6. Explaining that Germany, for example, would help the world redress trade imbalances if it wasn’t in the Euro And Greece could address its insolvency if it were not in the Euro. They would both be able to address balance of trade issues and competitiveness in the world better if they would re-appoint good old restorative sovereign currency fluctuations back into the equation.

    He also explained that, of course, we have to do the immediate fire fighting despite the fact that this unfortunately also contributes to the bigger long-term problem by further contributing to debt.

    On the same day it is reported that Mercosy (Angela and Nicolas) will adopt Tim Geitner’s proposal to leverage the European Stability Fund from 440b Euro to nearer 2t Euro.

  9. David Lilley
    October 18, 2011 at 9:10 pm

    Harkeye,

    I will get back to you but in the meantime I have posted my comments on Mervin King’s excellent speech today.

    When Mervin and the German Finance Minister are breaking ranks before Friday’s G20 it will be interesting to see what happens.

    New subject.

    When Marx was dismissing World 4 by saying “its not about understanding the world it is about changing the world” he might also have given a cheer for World 5.

  10. October 24, 2011 at 9:28 am

    I have written a Song about the 99%. Looking at the Statist constructs of the 19th and 20th century expecting to find their builders had the answers for the 21st Century strikes me as a little optimistic. Corporatisation of Government and Business is really not the way Anarchist Thinkers Like Chomsky and Greiber perhaps Systems folk Like Beer and free thinkers Like Watts all can assist us in showing some concern and then applying some imagination. Watts was very good on Ego and Self interest interfering with spiritual honesty. Great Men like Robert Owen also have a lot to teach us about human motivation and teamwork.

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