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Bankers can normally be relied upon in a crisis to say something really stupid - generally because they are too full of themselves to realise what is happening in the world about them. But even by this unedifying standard, the comments from Charles Prince, the now ousted boss of Citigroup, take a lot of beating.
Asked in the early summer if he thought economic conditions were becoming so insanely speculative that perhaps it was time for Citigroup to stop pouring petrol on the flames, Prince replied with a different metaphor. "As long as the music is playing you have to get up and dance," he said. "We are still dancing."
Well the music has certainly stopped now. A fortnight ago, Citi announced that it was writing off $6.5 billion of loans and its third-quarter profits had more than halved. Now, after an emergency board meeting over the weekend in New York, and leaks in advance that it would be Prince's last stand, the expectation is that the true picture to emerge in the coming weeks and months will be significantly more gruesome.
But for us on this side of the Atlantic, the important question is not the extent of Citi's losses so much as the knock-on effect. Who ultimately will pick up the tab for the banking debacle? Because that is the thing about banking: when they get it wrong, we suffer. Banks have such clout that they can infect the whole economy with their problems.
One bank on its own might not be so bad and were Citi the only sinner there would be less to worry about. But they all seem to have been at it, and indeed Prince is not the first casualty. Stan O' Neal, the boss of investment bank Merrill Lynch, lost his job in very similar circumstances only last week.
The core skill of banking is to lend only to people who intend to pay you back, not to people who promise to pay you a high rate of interest but who do so only because they have no intention of keeping their word. What Prince's comments show is that he had lost sight of this fundamental point. He and his fellow bankers had become so focused on the race that they had stopped looking where they were going. They were so busy looking at each other that they ran straight off a cliff.
So what happens now? Well, when banks lose money they get cautious and cut back on their lending to other people. They do this partly as a natural reaction to getting burnt, partly because they want to conserve their cash because they think there might be other past mistakes still to come to the surface. Either way they cut the flow of money into the economy and that, crudely speaking, means everyone else has less to spend.
There is less money for mortgages so people can't afford to pay the current high house prices, and sellers have to take a hit if they want to make a sale. There is less money for credit cards, which comes through in higher interest rates and monthly charges. There is less money for companies, so they cannot borrow to expand, back new ideas or create new jobs.
Less money spent in the shops in turn means there is less tax revenue for government as corporation tax and VAT revenues dwindle. That raises the spectre of public-spending cuts, tax increases or both, as the Government grapples with a sudden drop in its income. That is why banking crises are bad news and also why in this global economy where everything is interlinked, we all risk suffering the consequences.
But of course it may not happen. The credit crunch has been running now since early summer but the financial world remains totally split on how bad it could get. Optimists say that the world economy is strong and that it has sufficient momentum to shrug off the banking squeeze. It will slow, of course, but not come to a halt, and certainly not go into reverse. The important thing is not to panic. We all might have to watch the spending a little bit, but not so much that it will be particularly noticeable. There will still be turkey on the table at Christmas.
The other view is more or less the opposite. The only reason the optimists don't panic is that they don't understand what is going on. The banks and investing institutions have been so grossly reckless that they have lost untold billions, the full horror of which may take many more months to emerge, but when it does it will make everyone miserable and not a little frightened. Each bit of bad news will sap a bit more business confidence and the cumulative effect, month after month, will be to force companies to batten down the hatches.
On the personal side, where so much of the feel-good factor of recent times has been built on the back of rising property prices, the effect will be similar. The public mood will tank if house prices are widely seen to falter. Not only will there be no turkey this Christmas but the bailiffs will have repossessed the table.
So it could go either way but it really is just a matter of opinion and will continue to be so for some months yet. Economics does not provide clear answers because there are just too many variables - too many moving parts - in a forecast for there to be any certainty about the outcome.
The authorities - the Bank of England here, the Federal Reserve in the United States and the European Central Bank in Frankfurt - are as alive as anyone to the problems but appear to be as much at a loss as to what should be done. There is, however, an unreasonable weight of expectation on them and their ability to get the world through this when in fact the only tool they have at their disposal is lower interest rates, and past experience from the crises of 1987 and 1998 suggests that even it is two-edged. It buys time rather than solves the problem and that simply makes the mess bigger and more painful to deal with later on.
That is probably why the preferred policy option of most central bankers - and indeed politicians so far - seems to be to keep their fingers crossed and make a wish that it will all turn out right on the night.
Perhaps that is what we all should do.
Reader views (1)
Excellent article. Now I understand why Lloyds TSB have increased the rate of interest to 2.25% per month! I had thought that with a good payment record the rate would perhaps slightly increase following recent changes in base rate - but no, Lloyds TSB have tripled the rate - simply because they and other banks have recklessly been buying loans from Americans.
- Pascal, Barnet, 05/11/2007 15:35
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