Paying the price for a boom built on debt

Yesterday, the Monetary Policy Committee made its trim and the banks and building societies shrugged. Some, including Nationwide, even went in the opposite direction, raising the charges on their fixed-rate products. The harsh reality confronting Bank governor Mervyn King and his worthies is that this isn't about tinkering with rates any more. They're stuck, like a football manager on the sidelines, having filled his players' heads with fancy tactics who can only watch in fear as his team get sucked into a dirty, clogging battle.

The giveaway to what is really occurring isn't the rate banks lend to us but the rate they charge each other. That Libor rate has not budged. It's 5.9 per cent or virtually one per cent above the official base rate. So the MPC says one thing and the market says another.

What the higher Libor rate represents is a giant distress flare from the banks that they're in trouble - not in the sense that most people understand it since, after all, they still make billions in profits, but it's a signal of turmoil. Their world, with its established order of doing things, has crashed down around them.

In a headlong rush to make even more money, they forgot their principles and threw caution to the wind. They traded in bundles of mortgages handed out to trailer-park America - to people they normally wouldn't let through their doors - and as the US economy has turned, they've come a cropper.

It was a mad time. They were lending to us like crazy, we were borrowing like there was no tomorrow - and meanwhile, their financial wizards in their investment banking arms were conjuring up new schemes for packaging together loans in the US and adding to their already bulging profits.

They, and we, were swept along in the euphoria. Property prices, driven by a buoyant City and rampant bonuses, soared. Spend, spend, spend and lend, lend, lend were the mantras.

Now, it's changed. Speak to any banker today and the language they bandied about freely only a few months ago has vanished. Then, the technical words they all used to explain what they were doing were "leverage" and " securitisation". Now, such words are forbidden.

Instead the chat is of a return to the old ways, of banks becoming risk-averse again. They don't want new customers, certainly not ones that may be dodgy, the sort that seek fixed deals. They've had their fingers burned big time in America and they're not going there again - the prospect of having to announce further write-downs fills the heads of bank chief executives with dread.

The great free-for-all has gone, the giant wave of cash that flowed over the UK has receded. But whereas in the past, battening down the hatches and everyone becoming a bit more cautious and having to save before they can borrow would be no bad thing, there is an awful fragility built into our current economy. During the last downturn, in 1992, Britain had a manufacturing base - or rather it had a much stronger one than the one that exists at present.

What's happened as the boom took hold is that we've grown dependent on property prices and the City for our wealth. We've borrowed and spent on the basis that values will continue to rise. And they have risen - to levels that bear no relation to reality (the IMF reckons our house prices are 30 per cent above what they should be). The financial services industry has become the country's biggest contributor - accounting for more than 30 per cent of GDP.

But the tap has been turned off - the banks aren't lending any more. We're already experiencing a stagnant market - very real falls in property prices are on their way. That, coupled with job cuts in the City, could spell disaster. Phrases we've not seen for ages, like negative equity and repossessions, could start to come to the fore.

While, to an extent, we only have ourselves to blame, there is a body that seems blind to what is occurring. This government has deluded itself - and us - with its claims about the underlying strength of the economy.

As house prices tumble, the City freezes and people can't borrow, the truth will emerge. Alistair Darling, and before him Gordon Brown, have done nothing to shore up our defences. Like the consumer on the high street, they've been spending too. For years now, it's been hard to square their vision of Britain with the one held by much of the rest of the world. While others, such as the IMF, have advised caution we've been treated to positively glowing Budget and party conference speeches.

The market says different. That's why the pound is so low against the euro. The market doesn't hold Britain in the same regard as Darling and Brown do.

Also guilty is the Bank of England. Even yesterday all it could muster was a paltry quarter of a per cent cut. The world is moving on without it. The usual monetary devices of a little bit off here and there, aren't up to the task. They tell us they've got inflation under control, yet we know prices are rising. Retailers are being clobbered with increased costs from China and elsewhere. Some they pass on to the shopper, some they don't. Oil is over $100 a barrel and not likely to drop back. Food is going through the roof - rice is up 70 per cent this year.

Not all the increases have hit us yet but they exist. The MPC, if it still has a meaningful purpose, needs to be bolder and more decisive. Rates should come down, dramatically - as the Federal Reserve has ensured they have in the US. Meanwhile, money needs to be pumped in quickly to unblock the supply line. They must find a way of making more cash available to banks - yes, on more generous terms, than previously. It isn't pretty but this isn't a pretty game - needs must and it's about time the Bank and the Chancellor realised as much.