Who’s to blame for the debacle at Northern Rock? We’ve had a go at answering this question in our cover story this week. We’ve considered everyone from America’s subprime mortgage borrowers to Margaret Thatcher, and we’ve tried really hard to be fair. For example, we would have quite enjoyed blaming Gordon Brown, but the truth is that, while he could have been more proactive in preventing recent disasters, the root causes of the credit bubble and crunch aren’t really his fault. Instead, we’ve had to point the finger at Alan Greenspan, for the very simple reason that it was his policy of keeping rates at absurdly low levels that really kicked off and maintained the credit bubble and injected moral hazard into the market. He intervened via interest rates to stop the market falling, but never to moderate its rises. By providing a constant supply of liquidity, he effectively encouraged investors to take as much risk as possible: faced with very low yields, and in this case often negative real yields, investors tend to be driven to seek out higher yields regardless of risk and of liquidity. Hence the weird idea that subprime mortgage-backed securities made good investments.
However, credit-crunch expert Edward Chancellor, who I talked to at the Independent Investor Conference this week, points out that we might also lay some blame for the former Fed chairman’s behaviour at the feet of modern public economics. Like Gordon Brown in the UK – remember it is Brown who sets the targets for our “independent” Bank of England – Greenspan focused on “price stability” above everything else. This resulted in an obsession with two ideas. First, that prices should not rise very much on an annual basis, and, second, that they should never, ever fall. Yet over the last decade there has been every reason why prices should have fallen across the board: the rise of the Chinese manufacturing boom has made most things cheaper, something that in an entirely rational world shouldn’t necessarily have been seen as a bad thing. But that’s how the central bankers saw it. And in their efforts to stave off the effects of £3 T-shirts, £1.99 dolls and five-for-a-pound pairs of socks flooding the market, they found the only path open to them was to cut rates to dangerously low levels.
The net result, whatever the optimists might tell you, is that we are now at the beginning of the end of the credit bubble. The Northern Rock debacle may have slid out of the headlines, but it was really nothing but a sideshow, or symptom, of the real problem: that everyone knows the days of easy money are over, and everyone is trying to position themselves accordingly. There is endless discussion in the City about whether this is a liquidity crisis or a solvency crisis, but as Edward Chancellor says, most real credit crunches start as liquidity crises and turn into solvency crises (would Northern Rock still be solvent if Darling hadn’t stepped in to solve its liquidity problems?). Odds are that this one will too.