The Great Financial Crisis

The following is a copy of a short essay I was required to write recently as part of a job application I made to a Business-to-Business media company as a trainee journalist.

The essay was required to be 500 words long and the only stated requirement was to "discuss the response of the British Government and regulatory authorities to the financial crisis". A pretty broad topic, and not many words to do it in. Here it is.

In late 2007 Northern Rock found itself struggling to raise money on capital markets. Defaults on sub-prime mortgages in the US had triggered a banking ‘credit crunch’ and banks which had specialised in mortgages found themselves unable to raise funds on capital markets. The government searched in vain for a private buyer before finally nationalised Northern Rock in February 2008. As credit tightened and liquidity decreased the Government moved to a Keynesian policy of active intervention to free up credit, consisting primarily of capital injection and asset guarantees.

The Government at first encouraged buy-outs, such as Lloyds TSB’s takeover of HBOS. The Bank of England, although its remit was supposedly limited to inflation targets, created a Special Liquidity Scheme to swap banks’ risky mortgage assets for billions of pounds of government debt. As banks refused to lend and share prices plummeted, private buyers stayed away and the Government was forced to nationalise banks such as Bradford and Bingley, taking on their debt. This process snowballed by October 2008 into the offer of unlimited guarantees to all British banks. The objective was to restore confidence, encourage lending and forestall a recession. Despite this the UK entered recession anyway.

In September 2007 the FSA imposed a belated ban on short-selling to relieve downward share price pressure. It also announced it would guarantee savings of up to £50,000 to try and reassure small savers. To boost lending the Bank of England made a succession of interest rate cuts until they reached the lowest rates ever seen in the UK. As the economy deteriorated the UK Government injected billions of pounds of taxpayers’ cash to bail out major banks in exchange for equity stakes. Confidence and lending had fallen so low that it was felt that only the most direct form of state intervention and control could restart lending. The Government had to hope, rather than guarantee, that taxpayers would eventually get their money back.

A second bank bail-out was launched in January this year, taking the total to almost £400 billion. The government also tried to tackle the problem by cutting VAT to encourage consumer spending; but (as German politicians pointed out) when weighed against the public’s instinct to save and continuing high street sales, the small VAT reduction had little effect. The government also unveiled plans to guarantee up to £20 billion of loans to firms.

The response of the Government and regulatory authorities has been incremental, reactive and often too little too late. The Chancellor’s recent reforms to vet the pay deals of bank executives, force banks to hold more capital and stop lending ‘overstretch’ by banks have not fundamentally altered the ‘tripartite’ regulatory structure between the Treasury, FSA and Bank of England. Nevertheless, the government has avoided a total banking collapse and this should be praised. The real cost, however, aside from huge debts, has been a collapse in the public’s trust.

498 words