Artillery Row

Capitalism in a time of coronavirus

The economy has shrunk by a fifth – so why is there no credit crunch this time?

Spare a thought for Andrew Bailey. The chances are that unless you’re employed in the financial services sector you will not have done so these past six months. And that is telling. With impeccable timing, Mark Carney handed over the governorship of the Bank of England to Bailey on 16 March. Seven days later Britain went into lockdown, and the economy began its nosedive. Between April and June, a fifth of national GDP was wiped-out in the worst output plunge since records began.

So, it is significant that Mr Bailey has not been nightly on our television screens, nor that the noble edifice of the Bank of England’s headquarters has not had journalists and cameramen daily encamped at its entrance waiting to glimpse members of its Monetary Policy Committee looking glum whilst resolutely shielding their memoranda from prying lenses.

The governor’s absence from our screens is not down to any short-coming – the strain did not get to him; he is not recuperating at home where he can get the care he needs. Quite the contrary, he has remained at his desk and, judging by his performance on Wednesday before the House of Commons Treasury select committee, is in robust mental and physical condition.

At almost any previous time, a plunge in national output comparable to what has just shaken the UK could have triggered any number of compounding shocks – a run on the pound, a stock market crash, a “credit crunch”, a full-on banking collapse. None of these events has come to pass in Britain, and not just because other countries are suffering varying levels of contraction too so there is nowhere for capital to fly off to. Indeed, the near worldwide scale of the downturn should, in normal logic, have risked making matters worse.

Boris Johnson was quick to reassure anxious listeners that his government would not be dealing with the crisis through austerity measures and that there would be no return to the response that followed the financial crisis of 2008. Implementing that strategy fell to Rishi Sunak, whose tenure at the Treasury was not much longer than Bailey’s at the Bank of England. The furlough scheme, loan guarantees and ‘Eat Out to Help Out’ have been among those Treasury initiatives.

But what has made these measures possible has been the failure of history to repeat itself. Capitalism has not seized-up in 2020 as it did in 2008. There are many reasons for why this should be and many of them are not made in Britain. For instance, this time there has been no American sub-prime property implosion to trigger a credit crunch.

It is not easy to praise Donald Trump without immediately qualifying the evaluation with a ringing condemnation of the man. But his tenure in the White House alongside that at the Federal Reserve of Jerome Powell (with whom the President has a typically on/off relationship but whom Trump appointed to oversee monetary policy nonetheless), has coincided with a considerably more robust US economic performance than many sensibly orthodox analysts would have considered possible. Perhaps in the long run it will prove to have been unsustainable. But for the moment, let’s be honest, it is timely. New York may have been badly hit by the virus, but – not withstanding Thursday’s fall in tech stocks – Wall Street hasn’t really sneezed and the rest of the world is in better health in consequence.

Understandably, Andrew Bailey and four of his senior colleagues from the Bank of England who joined him for Wednesday’s Treasury Committee meeting, were keen to stress what part of Britain’s avoidance of a financial collapse was made at home. Their main take-away does not maximise bad news, so it has understandably not made the news. But a crisis averted should still be noted.

It is when we start to see more of Andrew Bailey that we should start to worry

Their analysis can be summarised as follows – what went wrong in 2007/08 is the reason why it has not gone wrong this time. This is not to say that mistaken responses were enacted twelve years ago, indeed the withdrawal of credit was inevitable in the circumstances, but that we are now in a new situation.

Contrary to the incantations of anti-capitalist activists, the financial sector did not just pocket taxpayer underwritten bonuses and carry on as normal whilst their customers went to the wall. Reforms did follow and they have made a measurable difference. These were not reforms instituted in Britain alone, but to which Britain is fully party. Particularly relevant is the implementation of the Basel Committee on Banking Supervision’s stipulations (Basel III).

According to the Bank of England’s interpretation, the lessons learned include greater reliance on stress-testing and insisting on banks having deeper capital buffers – a legal obligation to have an additional capital cushion beyond the minimum capital requirements. In consequence, overall capital held in British financial institutions is three times higher than it was in the run up to the 2007-08 crisis. For the proverbial rainy day, the umbrella was thus ready to be unfurled.

Covid-19 has brought a monsoon, albeit of uncertain duration. As Alex Brazier, a member of the Bank of England’s Financial Policy Committee focusing on stability and risk strategy assured the Treasury Committee, “we are completely serene” about British banks letting their capital buffers take a hit at the moment because “that’s exactly what [the buffers] are for”. The ability of banks to continue lending whilst their clients are struggling and objectively less credit-worthy “has been the essential foundation for everything else that has gone on because the lending schemes – whether that’s bounce-back loans on business interruption loans – would not have had much value if the banking system through which they are channelled was on its knees as it was ten years ago.” According to Brazier, “the banking system has been transformed over the last ten to fifteen years”.

Underlying profits and this year’s retention of dividend pay-outs have boosted the capital position of Britain’s major banks whose common equity tier 1 ratio has been running at 14.5 to 15 percent. An assumption that the Covid downturn will bring credit losses of about £60 billion would bring the banks’ capital ratios down perhaps 2.5 points. In Brazier’s estimation, a loss of that scale in 2007/08 “would have wiped out the capital of the baking system.” By contrast, it would take at least a doubling of that loss this time for the consequences to be serious.

Such a dire outcome would require not only a succession of further Covid-induced downturns but also some other shocks to the system. The Bank’s Financial Stability Report modelling for either a very modest EU-UK trade deal or a “no deal” (in other words, WTO rules) scenario which causes some disruption to trade when the Brexit transition period ends in the new year suggests that this would not equate to an especially grave shock, indeed the system could pretty much take it in its stride.

None of this should be taken to suggest that the British economy is well. A resilient housing market and household spending (which has already returned to close to its pre-virus levels) have to be balanced against the potential for significant unemployment particularly in the arts, entertainment, leisure and some hospitality and retail sectors when the furlough scheme ends in October and, more generally, worrying low investment levels which may prove to be among the longer-term consequences. Bailey and the other members of the Bank of England’s Monetary Policy Committee readily concede that there is still considerable room for variation in short-term predictions, with Covid inflicting a permanent scar of at least (and potentially more than) 1.5 percent to the British economy. But financial life and all that if funds will go on.

The powers of the state may be increasingly rapidly, but capitalism remains the unsung cart-horse of this crisis. It is when we start to see more of Andrew Bailey that we should start to worry.

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