Too many bankers and not enough real wealth

It is an astonishing transformation from 12 months previously: for it is a year ago this week that the credit crunch broke on an unsuspecting world. Remember those balmy days? Gordon Brown had just moved into the Prime Minister's job and was hugely popular. Houses were soaring in price - but still being snapped up because lenders would cheerfully grant 100 per cent mortgages to multiples of five times income. Waves of immigrants were coming to work here.

The City drove the feel-good frenzy further with one mega deal after another - the bid for Sainsbury by the Qataris, which failed to come off, and the takeover of Dutch Bank ABN Amro by Royal Bank of Scotland, which did.

What a difference a year makes. House prices, the economy, the availability of mortgages, and Gordon Brown's ratings have all plummeted - and with them retail sales, house building and consumer and business confidence. Even the Poles are going home.

We now have to grapple with a damaging side effect of 15 years' uninterrupted growth: few people under the age of 40 can remember what to do when the economy slows. That is as true in Whitehall as in the rest of the economy. In the Treasury it's more trembling hands than stiff upper lip. Hence the flocks of headless chickens where leadership and government are supposed to be.

Twelve months ago only a few of us predicted that the crisis would last this long. Now that it has, even fewer see any sign of it ending soon. What is apparent, however, in a way which was not obvious back then, is that we have two separate challenges - and their combination makes the restoration of stability much harder to achieve.

The first is that now Asia is booming, there are not enough natural resources in the world to feed its appetite for economic growth. Supplies of basic commodities - the obvious ones such as copper and oil, and the less obvious but no less vital ones like phosphorus and food - are in such short supply that the prices have soared. Paying for these means we have significantly less to spend on the good things in life.

Short-term relief might come if China's growth slows so they buy a bit less. But in the longer term, with another two billion people coming into the world and Asia aspiring to western standards of living, prices can only go up. We will have to get used to much higher prices and spending much less on luxuries.

The second problem - and this is one which hits us hard - is that too much of the activity of the financial sector in recent years has had no underlying economic purpose other than to earn fees for bankers.

Reliance on financial services has at times made the UK economy look like a giant hedge fund and made us - both citizens and government - predisposed to spend the money without thinking too hard about where it came from or how it was being earned.

Had we looked more inquisitively we would have seen that the financial sector has grown bigger than the world economy needed it to be, and as a result was filling its days inventing ever more exotic products that it claimed made markets more efficient and added to economic growth but in fact contributed little to either.

Finance had become a machine to slice up and repackage old wealth for the fees it could earn, rather than a service to help others create new wealth. The consequences of that have now become apparent. When finance slows there is not enough to fall back on.

Economics has run ahead of politics across the world. Finance and markets and business have become global and respond to global pressures. Politics is still nation-based, local and unable properly to respond to the demands of the new world order. This is bad news because the actions of politicians - and it must be said the wishes of voters they represent - threaten to prolong the crisis.

Nowhere is this more obvious than in the seemingly endless succession of bank bailouts and rescues. The financial sector needs to go back to basics, renounce its addiction to gambling and rediscover its purpose as a facilitator of economic growth in others. But that means it will have to be smaller and less well paid. Getting back on that even keel means letting some of those banks go bust - but the politicians are too scared to do it.

It will happen in the end, though, because ultimately there is no alternative. The economy will slow further as banks withdraw finance from other productive parts of the economy, commercial property companies go bust, speculative office blocks stand empty, shopping malls get boarded up and individuals struggle to save more to relieve their debt burdens.

This is happening because much of what we thought of as prosperity was froth and it is now being blown away. What lies beneath will be sound enough but the glass will not look as full as it did 12 months ago.

But if the direction is clear enough, what no one can be sure of is the timing. Optimists say things could have bottomed out by Christmas, but we could still be dead in the water next spring.

A lot of other people think it will take till 2010 before the economy finds a firm foundation, largely because they think it will not be until then that the banks will have enough money and confidence to revive the mortgage market.

Either way, it is going to be a bit of a slog, with falling living standards, rising unemployment and a general feeling of malaise dragging on for months. Indeed it looks as if it could be a holiday in Bognor again next year. Pessimists should book now to beat the rush.