The Legacy of the Crash

by Terrence Casey

  Conclusion

  In both economies, it was predominantly the small business sector that bore the immediate brunt of the credit dearth: a dearth that quickly brought in its wake layoffs, falling consumer demand and diminishing business confidence. In both countries, a crisis that had begun in one part of the economy rapidly became a crisis of the whole economy. As it did so, the value of financial assets dropped dramatically – hitting small savers as well as large ones, triggering (among other things) an entirely unexpected crisis of private pension provision for baby-boomers on both sides of the Atlantic. The parallel collapse of consumer demand hit the labor market equally potently: and as jobs were lost in both the US and UK, a housing crisis which had originally been rooted in subprime lending morphed into one rooted in large-scale involuntary unemployment. The generalized recession that each economy acquired so quickly and so unexpectedly then became one that neither economy could easily shed. Indeed and instead, the recession incrementally spread from the private sector into the public sector, as the capacity of local and state government to finance basic welfare services was systematically undermined by the falling tax revenues generated by private sector layoffs. In that way, in each economy, a crisis initially characterized by private debt became, ironically, a crisis characterized by public debt – one in which the public spending made necessary by bank collapse and its ramifications reached a volume that the revitalized banking system was increasingly unwilling or unable to finance.

  In such a climate the housing market did not recover rapidly in either the UK or the US. UK house prices did briefly revive in 2009 – reflecting perpetual house-supply limits and unusually low interest rates – but fell back again in 2010 and were forecast to fall further in 2011/12 (Stewart, 2011). Indeed, by December 2010 both house prices and house sales had been falling in the UK for six unbroken months, as demand for homes fell, underwriting standards tightened and first-time buyers in particular found entry into the housing market progressively more difficult. The American housing market was similarly flat, as the foreclosure crisis persisted. Foreclosures encompassed 5 million homes by December 2010 (one in ten mortgaged homes) as unemployment and lack of consumer confidence persisted and as banks moved to clear the backlog of homes they had come reluctantly to own. The number of US homes ‘underwater’ (with a bigger mortgage debt than their current value) did ease slightly in the third quarter of 2010, but still constituted at least a fifth of all US mortgaged homes (Coates, 2011). Major American banks entered 2011 with more than half a trillion dollars of second-lien mortgages on their books and still vulnerable to court-imposed damages for the inadequate paperwork associated with many of the original subprime mortgages.

  But the banking sector in both economies had in general moved back into good times by the end of 2010, to the immense irritation of many of the victims of the 2008 financial tsunami – not least those many small businesses still struggling to raise credit. The worst excesses of the banking system that fueled the growth and distribution of toxic assets were by 2011 under tighter regulation in both economies, major financial institutions were being fined (if only modestly) for the worst of their previous practices, and in the UK at least banks were facing an annual levy of £2.5 billion. Such changes did not, however, stop major Wall Street institutions from reporting record profits in 2010. They did not prevent the distribution of major bonuses to senior staff; and nor did they remove the exposure of major banks – particularly in the UK – to the possibility of sovereign debt default by weaker euro-zone economies. Indeed, it remains one major irony of the fallout from the 2008 financial crisis that institutions then thought too big to fail were the very ones which, for all the regulatory initiatives put into play, emerged by 2011 even bigger than before and even more susceptible to system-wide collapse. Add to that irony the other one – that the only sector of either economy that moved quickly from recession to growth (the financial sector) was the one whose bad practices had caused the recession in the first place – and you see why electorates in both the US and the UK still struggle to understand what has actually hit them. With both governments and governed trapped between high levels of debt (both public and private) and low levels of income (taxation revenues and wages), a new politics of austerity has come to dominate public policy on each side of the Atlantic. The opening lines of Charles Dickens’ A Tale of Two Cities therefore have a new and a tragic resonance. In Washington and in London, as politicians, business leaders, workers and voters struggle to return to the certainties and affluence of an earlier age, the end of the first decade of the new century has indeed proved to be for them both the best of times and the worst of times – with the danger remaining that the worst of times is still to come.

  Notes

  1. Actually three cities – Washington and New York, and London. London is the site of both governmental power and City institutions. In the US, the centers of government and finance are geographically separate, hence the importance of the ‘Washington–New York nexus’. The title is Dickens’ fault. A fuller version, with chronological appendix, is at www.davidcoates.net/publications/non-fiction/american-politics-and-society/.

  2. The tripartite members were the Financial Services Authority (FSA), the Bank of England and the Treasury. Each had a different responsibility: the FSA controlled micro-prudential (day-to-day) regulation of financial firms; the Bank of England monitored overall financial stability and set interest rates; and the Treasury maintained the overarching legal and institutional framework and controlled public funds.

  3. In the UK, mortgage markets that had been dominated by building societies faced an influx of banks and centralized lenders. The 1981 abolition of the Supplementary Special Deposit Scheme loosened credit controls and allowed banks to lend on a greater scale; and the 1986 Financial Services Act allowed centralized lenders to enter the UK market. These new actors had access to more funds through the wholesale markets and were better equipped to utilize securitization. Thus they were able to issue more mortgage loans, including to subprime lenders. For the details of the US story, see the FCIC report (2011, pp. 79, 88–92 and 101).

  References

  Cable, Vince (2009) The Storm (London: Atlantic Books).

  Coates, David (2010a) Answering Back (New York: Continuum Books).

  Coates, David (2010b) ‘US Senate Finally Passes Financial Reform’, www.davidcoates.net/2010/06/01/u-s-senate-finally-passes-financial-reform/.

  Coates, David (2011) ‘Obama and Housing – is Anybody Home?’, www.davidcoates.net/answering back/chapter 10.

  Financial Crisis Inquiry Commission (FCIC) (2011) Report (New York: Public Affairs).

  Giles, Chris (2010) ‘Daunted by deficits’, Financial Times, 23 June.

  Land, Jon (2010) ‘Shapps to Keep Labour’s Mortgage Help Schemes – For Now’, 24dash.com, posted 20 July.

  Skidelsky, Robert (2009) Keynes: The Return of the Master (London: Allen Lane). Schwartz, Hermann (2008) ‘Housing, Global Finance and American Hegemony: Building Conservative Politics One Brick at a Time’, Comparative European Politics, 6(3), September, pp. 262–84.

  Schwartz, Hermann, and Leonard Seabrooke (2008) ‘Varieties of Residential Capitalism in the International Political Economy: Old Welfare States and the New Politics of Housing’, Comparative European Politics, 6(3), September, 237–61.

  Stephens, Mark, and Deborah Quilgars (2008) ‘Sub-prime Mortgage Lending in the UK’, European Journal of Housing Policy, 8(2), 192–215.

  Stewart, Heather (2011) House Prices to Fall by 20%’, Guardian, 19 February. Winant, Gabriel (2008) ‘Private Sector Sparked Subprime Crisis: Fed’, Newser, 12 October.

  Zandi, Mark (2009) Financial Shock (Upper Saddle River, NJ: Pearson Education).

  5

  Fiscal Policy Responses to the Economic Crisis in the UK and the US

  Edward Ashbee

  Despite the many references to an ‘Anglo-Saxon model’ bringing countries such as the US, the UK, Australia and New Zealand together
there were, as the financial crisis unfolded, important economic policy differences between the US and the UK. In particular, discretionary fiscal policies took very different forms. While the formation of the Conservative-led Coalition government in Britain in May 2010 and its commitment to large-scale retrenchment made some of these differences very visible, there were policy cleavages between the two countries throughout the crisis period.

  This chapter considers the reasons for these differences. It assesses the part played by agency and contingency and the extent to which policy was shaped by the size of budget deficits and longer-run debt levels. However, the chapter emphasizes the causal importance of underlying economic variables and the institutional arrangements in pulling the US towards large-scale fiscal expansion and the UK towards relative restraint.

  Stimulus policies in the US and the UK

  Although there were regional variations, real house prices began to fall during 2005–06 in the US and towards the end of 2007 in the UK. Against this background, the consequences of credit expansion and overleveraging for the financial sector quickly became evident. Household names, most notably Bear Stearns and Lehman Brothers, collapsed. Merrill Lynch sold itself to the Bank of America. The US federal government took control of Fannie Mae and Freddie Mac. In Britain, there were long lines at branches of Northern Rock leading to the provision of government guarantees to savers and the eventual nationalization of the bank. In September 2008, in a deal said to have been brokered by Gordon Brown personally, LloydsTSB took over HBOS (Halifax Bank of Scotland) so as to avert its collapse (Skidelsky, 2009, p. 10).

  The ‘credit crunch’ (that took place as bank lending was sharply reduced) inevitably spilled over into the ‘real economy’. Consumer confidence tumbled and unemployment levels rose. Although Lord Young, policy adviser to David Cameron after the 2010 election and Trade and Industry Secretary during the Thatcher years, pointed out in comments that cost him his job that those with outstanding mortgages gained from the fall in interest rates, many households and firms were compelled to cut their spending plans.1 World trade flows contracted. On 29 September 2008, the Dow Jones Industrial Average lost 777 points, the index’s largest-ever one-day fall (Keeley and Love, p. 18). When the upswing came, it was, particularly in the UK, slow, anemic and at times barely perceptible. There was frequent talk of a ‘double dip’ recession particularly after publication of the figures showing negative growth in the last quarter of 2010.

  Faced by these developments, both the US and the UK exploited the possibilities offered by monetary policy. While interest rates had been raised in both countries during 2007, they were, by the beginning of 2009, at an unprecedented low.2 Indeed, the reduction of the Bank of England’s base rate to one percent in February 2009 was, as the Guardian noted, ‘the lowest level in its 315-year history’ (Seager, 2009). The term ‘quantitative easing’ entered political discourse as the Bank of England and the Federal Reserve purchased Treasury bonds on a large scale.

  For commentators such as Paul Krugman of the New York Times, the scale and extent of the crisis required more. The US would otherwise risk a ‘lost decade’ of low growth and high unemployment. The crisis, Krugman argued, demanded the proactive use of discretionary fiscal policy: ‘the Fed, having cut rates all the way to zero, has run out of ammunition to fight this slump’ (Krugman, 2009). Although only limited numbers backed calls for a fiscal stimulus on the scale that Krugman proposed (and his later calls for a second stimulus), his critique of monetary policy was widely shared at the end of 2008 and during the early months of 2009. Furthermore, as Gordon Brown noted, governments could not credibly seek export-led recoveries if other nations were cutting spending levels (Brown, 2010, p. 130). While the G20 had concerns about the impact of the borrowing that would be required on long-term government debt levels, it placed increasing emphasis upon the importance of proactive fiscal policy. In mid November 2008, the Washington, DC, G20 summit called for the use of ‘fiscal measures to stimulate domestic demand to rapid effect, as appropriate, while maintaining a policy framework conducive to fiscal sustainability’ (New York Times, 2008).

  Nonetheless, whereas the size of the package adopted in the UK was very modest indeed (totaling about £25 billion), the US package was (once the $787 billion American Recovery and Reinvestment Act (ARRA) had been passed in February 2009) the largest in the 30 countries surveyed by the Organization for Economic Co-operation and Development (OECD) in a March 2009 report (OECD Economic Outlook – Interim Report).3 Table 5.1 shows the differences as a proportion of each country’s 2008 gross domestic product (GDP).

  Table 5.1 Total projected size of stimulus packages (spending and tax measures) in the UK and US, 2008–10

  2008–10 total net effect on fiscal balance

  (as % of 2008 GDP)

  United Kingdom

  –1.4

  United States

  –5.6

  Weighted OECD average

  –3.4

  Source: Adapted from OECD (2009a, ch. 3, p. 110).

  The relative size of the stimulus packages adopted in the US and the UK is, however, only one consideration. If the time distribution of the stimulus is brought into the picture, there are further differences between the two countries. In the UK, the Brown government concentrated almost all its projected stimulus funding (93 percent) on 2009. Indeed, 2010 and the years that would follow were to be a period of fiscal tightening and retrenchment as earlier spending was recouped (OECD, 2009a, p. 110). Speaking of Alistair Darling, the Chancellor of the Exchequer, Robert Chote, then serving as Director of the Institute for Fiscal Studies (IFS) put it in succinct terms: ‘He will be pumping £16 billion of extra spending power into the economy next year and then taking all that out – plus a further £22 billion – just three years later’ (Chote, 2008).

  In contrast, US policy-makers based their projections on a longer time-frame and allocated over a third of overall stimulus spending (42 percent) to 2010 (OECD, 2009a, p. 110). Although President Obama spoke at the beginning of his period of office about deficit reduction, it only again became a top-line issue in the 2011 State of the Union Address that was delivered in the wake of the 2010 midterm elections and the Tea Party movement’s successes. In the address, Obama proposed that ‘we freeze annual domestic spending for the next five years. Now, this would reduce the budget deficit by more than $400 billion over the next decade, and will bring discretionary spending to the lowest share of our economy since Dwight Eisenhower was President’ (quoted in National Journal, 2011). Nonetheless, the President acknowledged that the cuts and savings that he sought shied away from specific proposals to address ‘entitlement’ spending (such as social security) and he matched his comments on the federal budget with calls for infrastructural projects, educational expansion, and a government commitment to innovation so as to boost American competitiveness. This was, he announced, ‘our generation’s Sputnik moment’ (quoted in ibid.).

  One further policy difference between the US and the UK should be noted. Whereas the US allocated (once the ARRA had been passed) more than 40 percent of the total stimulus on expenditure projects, the UK devoted almost all of its funding (beyond bringing forward some projects that had already been planned) to tax concessions (OECD, 2009a, p. 110).

  Three interconnected questions should be asked about the policy gap between the US and the UK. First, why did the US adopt a far larger fiscal stimulus (as a share of 2008 GDP) than the UK? Second, why did the UK commit itself to fiscal retrenchment in 2010 whereas the US allocated the largest share of stimulus funding to that year? Third, why did the UK reject spending projects whereas they constituted a sizeable proportion of the US total?4

  Political actors, agency and contingency

  At first sight, these questions can be answered by considering the political preferences of office holders and the results of particular elections. Insider accounts of Gordon Brown’s government suggest that there were tensions between Number Ten and Number Eleven
Downing Street. Gordon Brown himself is said to have hoped for a larger-scale stimulus package while Alistair Darling successfully sought more limited measures. Darling’s reluctance to commit himself to large-scale or sustained increases in public expenditure may have stemmed from his own immediate circumstances. He had only served as Chancellor since June 2007 (when Brown had succeeded to the premiership) and his period in office had been beset by difficulty. In October 2007, amidst much embarrassment, the Treasury lost the personal records it held on 25 million people and at the end of the summer of 2008, Darling’s early warnings about the economic problems that lay ahead were swiftly repudiated by the Prime Minister’s media team.

  It might be said that policy developments in the US also owed much to political instincts, personality, accumulated ‘political capital’, and the fears associated with the specificities of the crisis period. Barack Obama’s victory in the November 2008 presidential election, and the Democrats’ gains in the congressional contests were, at least in part, a function of the economic uncertainties that defined the closing months of 2008 and they inevitably led to a significant reordering of policy priorities. They opened the way for the Obama transition team, the incoming administration, and the Democrats’ congressional leadership to craft the $787 billion stimulus of the ARRA. Their thinking rested, at least in part, on the inclusion of ‘twofers’. They not only sought to boost spending levels but also hoped to begin a process of longer-run structural change through public investment.

  Nonetheless, it would be difficult to assert that agency-based variables are sufficient in themselves to explain the process of fiscal policy determination. It could hardly be said that fiscal expansion was an article of faith for either Obama or congressional Democrats. Indeed, throughout the 2008 election campaign, his campaign team had largely eschewed the economic radicalism that the conservative right ascribed to him. He had called for a ‘middle-class tax cut’ but also emphasized the importance of deficit reduction. Calls for a significant fiscal stimulus only moved center-stage during the weeks that followed the November election and the projected spending levels only began to approach $1 trillion towards the end of the year.