Joseph Ward attempts to shed some light on the events which led up to the 2008 economic crash. Should Labour get the blame?
Let’s cut to the esoteric truth. Throughout the election period, David Cameron constantly recounted – almost like a demagogue – that we couldn’t let Labour send us back to square one. Meanwhile, Ed Miliband would squirm about in the most furtive manner and fail to defend Labour’s economic record. The Conservatives blamed Labour and Labour blamed the banks. The truth of course is far more complex.
Back in the late 1990s and early 2000s, the housing market boomed. At the end of 1996, the average house price in the UK was £110,400 however, by the end of 2007, the average house price was £367,700, according to Nationwide. Why is this important? The answer is: mortgaged-backed securities. Mortgaged-backed securities are a large collection of normal people’s mortgages that investors buy from banks, sold as a single asset, similar to a stock/share. Because of the typically high interest rate that the housing market has, these were seen as investments that would yield a high profit with very little risk. Investors were especially confident in these economic ventures since the rate of people defaulting on their mortgage was falling and even if a few people did default on their mortgage, the value of houses was rising so much that they could just sell the house and make a profit on its resale.
With hindsight, this obviously sounds rather ominous. However, at the time, credit agencies were lauding these investments because they appeared to be so safe. The truth is: if they continued to be regulated in the same manner, they always would’ve been. As demand for these assets rose and as their value sky-rocketed, money lenders and banks began to loosen their standards on mortgages and give them to people with more questionable credit scores. This made buying a house easier due to the availability of loans to people who were seen as riskier investments – or using the correct jargon: subprime mortgages. The problem became that risky loans, which would quickly become unaffordable, were given out to the masses which meant the housing bubble would eventually collapse.
It did. Home owners began defaulting on their loans and hundreds of thousands of homes began to appear in the market – which greatly impacted the market. The seller’s market quickly transformed into a buyer’s market – which is the basic principle that the larger the quantity, the lower the price because of the large amount of variety. Since the value of homes decreased, the value of the aforementioned mortgage-backed securities followed suit and, suddenly, investors began to panic and started to sell the shares rapidly at an ever-falling price.
When purchasing a mortgaged-backed security, investors also often bought credit default swaps which were a form of specialised insurance in case anything went wrong. The problem with the insurance business is that the general assumption is that everything won’t always go wrong. Banks didn’t have the money to pay-out insurance and the economic problems were so interlinked that they fell on a catastrophic scale.
Major banks, such as Lehmann Brothers, closed and many others began to fall into ruin. Global stock markets crashed, the British FTSE 100 recorded its largest points fall in its own history and credit froze and people were unable to make every-day purchases. This led to universal panic. People didn’t understand what had gone on and were so afraid that they ran to banks such as Northern Rock to try and withdraw as much of their money as they could which meant that banks were losing even more money. Most western governments were afraid of what would happen and so bailed out the banks in order to keep them afloat, and thus avoided the worst case scenario of the financial crisis. What this did do is turn Labour’s small deficit into one of a much larger and more considerable size. While the budget deficit did not cause the crash, the absence of reserves certainly didn’t help, according to the economist Tevjan Pettinger.
Brown actually “defined the character of the worldwide financial rescue effort,” according to leading economist Paul Krugman, by investing £50bn into the banks, along with supply short-term loans and encouraging inter-bank lending to get the flow of money moving again.
However, politics resumed and the Conservatives, who had backed Labour’s budgets, were quick to point the finger blaming Brown’s mishandling of the situation during his tenure as chancellor. The Labour Party’s leadership team’s economic credibility was thrown into question and new leader Ed Miliband wanted to disassociate himself from the premiership of Blair and Brown and destroy the notion of “Red Ed.”
When seeing the full picture, it is hard to see how one could pin the blame on Labour’s handling of the economic crisis. Gordon Brown’s legacy has been tainted and Labour’s economic credibility has been discredited ever since. It’s hard to see how the truth has been so misconstrued but ultimately, this is more evidence that people and macroeconomics have never been further apart.