We need decisive leader to see us safely through credit storm

Aug 26 2008 Agenda

Deputy leader of the Liberal Democrats Vince Cable takes the Labour Government to task over its handling of the economy.

The West Midlands so often leads the British economy, in good times and bad.

These are bad times. New home starts in the region fell by over 60 per cent in the second quarter over the same period in 2007.

The CBI also reports a severe decline in business confidence in the region with a large fall in orders for both the UK and export market.

There are obvious political repercussions. A year ago Gordon Brown could do no wrong. With a 10 point lead in the polls it seemed Brown was the perfect antidote to the Blair years.

Today it seems Brown can do no right. So what happened? Much has been made of Gordon Brown’s role in the election that never was last autumn, but I do not believe this can come close to explaining the predicament in which he now finds himself. Instead, as Clinton realised during the ’92 presidential election, “it’s the economy stupid”.

A reputation for competent economic management which Brown took a decade to build has been seriously undermined in less than a year.

The hubris which led him to proclaim the end of ‘boom and bust’ has been blown away as the economy, and particularly the housing market, progresses on that wearily familiar path from boom to bust. Food and energy prices have pushed inflation well above the target two per cent allowed under the Bank of England mandate for price stability.

Debt and mortgage repayments have become unaffordable for growing numbers, as is evident from the rise in recent actions for repossession.

A general lack of grip has been evident in the prolonged financial crisis; Northern Rock, bungled changes to capital gains tax and a forced U-turn over the 10p tax rate.

The Government’s response is that the UK is being buffeted by a world downturn not of our making.

They point instead to the credit crunch which started in America. It is certainly true that there has been a major shock from high world energy and food prices and from the collapse in confidence in the banking system, consequent upon the collapse in the US mortgage market. But the Government cannot be excused from overlooking for half a decade the imbalances in the UK economy built on massive personal debt and unsustainable house prices.

After the dot com crash at the turn of the century, Gordon Brown pumped billions into the economy through increased public sector spending.

The result of this was the UK coming out of the world downturn relatively unscathed and there was also the bonus of a catch-up in previously neglected public services. For the subsequent boom in living standards Brown was widely praised. But the success contained the seeds of future failure.

As people kept their money well away from a stock market which had burnt many fingers and which was still highly volatile, ever more money was pouring into property. People’s trust of putting their money into bricks and mortar as a safe way to guarantee a decent return meant that the housing market was no longer being governed simply by the supply and demand of houses which people wanted to live in.

Rather, a dangerous speculative bubble started to form in the housing market, as more and more people believed that investing in housing offered guaranteed returns.

So the price of property continued to climb.

Fuelling yearly double digit inflation of house prices was an unprecedented availability of cheap credit. Banks were happy to lend people up to five or six times their income for mortgages, twice the levels hitherto thought prudent, and some such as Northern Rock were happy to give people mortgages which were a third larger than the value of the house they were buying. All of these products were based on the notion that, as house prices were increasing quickly, these loans were of a low risk.

As a consequence British household debt spiralled to 160 per cent of earnings, twice the level in 1997 and without precedent historically. House prices increased to nine times average earnings, again double the level of a decade earlier and virtually the highest in the Western world.

Almost five years ago I asked Gordon Brown in Parliament “is it not the brutal truth, that the growth of the British economy is sustained by consumer spending pinned against record levels of personal debt, which is secured, if at all, against house prices that the Bank of England describes as well above equilibrium level?” He brushed the concern aside and ignored a warning too from the Governor of the Bank of England at about the same time.

Indeed, in the short term such inaction was in the Government’s interest. As people borrowed and spent ever more money, strong growth continued.

There was a feel good factor which was significant in helping the Government win the 2005 election.

But the boom was never sustainable.

When the bottom fell out of the US mortgage market and the credit crunch started, Britain was not, as the Government claimed, in an exceptionally strong position to cope with it but exceptionally vulnerable. And we face not just a financial and housing sector in crisis but rising world food and fuel prices.

What do we do now? Despite Gordon Brown’s rather vain attempts at the recent G8 conference to have us believe otherwise, there is little the UK Government can do to control world oil and food prices. Nor is it possible for the Government to prop up unsustainable prices in the housing market. A period of correction, even if very painful, will bring house prices back down to more sustainable levels and improve affordability for these not already on the housing ladder.

There are, however, areas where the Government can and should intervene. Firstly, as families struggle to meet rising bills and increasing mortgage costs it is critical that we avert a wave of repossessions. Under the Conservatives between 1992 and 1997 420,000 people lost their homes, not only aggravating the crash in the housing market because of distress selling, but a wave of homelessness.

The Government must legislate to ensure that repossession is only ever used as a last resort. At present the mortgage lenders have a perfectly sensible code of conduct to limit repossession, but it is voluntary and does not apply to the cowboys in the industry.

It should be binding. Before any bank can apply to repossess a home they should first be required to offer the mortgage holder independent financial advice. Following that the bank should offer a range of repayment possibilities, including shared equity and rental arrangements. Repossession must be an absolute last resort.

It is, however, inevitable that some people will lose their house, placing yet more strain on council house waiting lists, already at 1.7 million, with large numbers of new private properties unsellable. Councils and Housing Associations should be given the authority and financial freedom to buy these unsold properties to use for social housing.

The Government can also act to help households on low incomes, especially pensioners, who will be badly hit by the rising gas and electricity bills.

The full effect will be felt this coming winter which allows time to head off a big surge in fuel poverty. I don’t believe that there is any easy solution like a windfall tax, which would ultimately be paid by consumers, but nonetheless the Government can and should get tough with the energy companies. There has been a decline in meaningful competition in the industry which increasingly behaves in a monopolistic fashion.

And it has pocketed a large amount of money from the Government’s free allocation of permits under the European carbon trading scheme.

The Government is in a strong position to demand that the companies provide concessional terms – a social tariff – to low income users, many of whom use meters which cost more than direct debit. It should also demand an aggressive programme of energy conservation, getting the companies used to the idea that they will be rewarded for producing less, rather than more, energy.

The economy is in a worrying state. There are no easy answers. But there are things which can be done. They require decisive leadership, a quality which has been missing from the Government. If Gordon Brown is to survive now is the time for him to act.