Who saw the crash coming?

It was Mark Radcliffe (I think) who said of the Sex Pistols famous gig at Manchester’s Lesser Free Trade Hall, if everybody who says they were there really was there, they’d have had to hold it at Maine Road.

People like to say they were in the know and, more importantly, that they saw things changing before everyone else did. This applies as much to politics and economics as to music and fashion. Nowadays, it’s hard to find anyone who was in favour of invading Iraq, even though the opinion polls at the time said that the majority of people were. I wouldn’t be surprised if some of the people who were gung-ho for going in will now say that they marched against the war. Some might even have convinced themselves that they did.

And these days there’s no shortage of people who saw the recession coming. In newspapers, on blogs, in the pub and on Twitter, it’s not hard to find people who ‘knew it was going to happen all along’. After all, you only have to look at the signs. Bleedin’ obvious, wasn’t it?

These experts seem to have been remarkably quiet before 2009, though. From what I remember, not many people were talking about the prospect of a crash in the early 2000s. Most people assumed there would be a slowdown at some point but few predicted a severe recession. I recall a pub conversation with some City comp & ben chaps at the fag end of the 90s in which, after several pints, we agreed that ‘things couldn’t go on like this’. But things did. The economy kept growing, investment banking continued to boom and the sort of bonuses we thought were crazy in 1999 looked like beer money a few years later. The dot com crash caused a slowdown but the sky didn’t fall in. It’s a sign of the times that, what we called a mini recession back then, growth rates of 2.3 percent, we now call a recovery.

Earlier this week, I went to the launch of the OBR’s report Crisis and consolidation in the public financesIt’s a fascinating document and one which we’ll see quoted by all political parties in the run up to the election. I’ll write about some of the projections later but what’s new in this paper is the publication of figures from before the financial crisis.

Ten years ago, I couldn’t have written a blog like this because most of the information wasn’t in the public domain. It’s only really in the last five years or so that so much economic data has been freely accessible. The OBR’s report gives us some of the history of government spending before the financial crisis. I’m not getting into it today but at least now we can have a more informed discussion about whether, and by how much, it was ‘all Labour’s fault’.

What the report does show, though, is that even those who were supposed to have been in the know didn’t see the recession coming. Some forecasters thought the government was being over-optimistic about growth and tax receipts but this suggested the deficit was a bit on the high side, rather than heading for disaster. The tone of this quote from the OECD reflects the spirit of the time:

“In another four European Union countries (Italy, the United Kingdom, Greece and France) the projected deficit, while remaining below 3 per cent of GDP, is well beyond the safe budget margins which might reasonably be expected to ensure that the 3 per cent deficit limit would be respected in the face of a major cyclical downturn.” (OECD Economic Outlook, June 2007)

It’s saying that, if there’s a downturn, there’s a chance the UK’s deficit might go above 3 percent of GDP. As it turned out, two years later it was at 11 percent.

This chart shows what the OECD now thinks the UK’s structural deficit was in 2007 compared with what it said at the time.

Screen Shot 2014-09-11 at 10.17.01

So they now reckon it was about twice as bad as they told the government in 2007. Then again, look what they said about Greece.

Were our financial institutions any the wiser? Here’s what they told the Treasury in the run up to the 2008 budget.

Screen Shot 2014-09-11 at 10.21.16

A bit of a slow down, then. Growth rates a bit below those we have been used to recently. Perhaps another period similar to 2001 and 2002. Six months after the collapse of Northern Rock, even the most pessimistic didn’t predict anything close to what actually happened. As the OBR says:

Other official bodies were also relatively sanguine about the financial and economic outlook. The Bank of England said in its May 2008 Financial Stability Report:

“The most likely outcome for financial stability in the United Kingdom in the period ahead is that conditions improve gradually as measures are taken.”

And the International Monetary Fund said in its April 2008 World Economic Outlook:

“In the United Kingdom, growth is forecast to slow to 1.6 percent in 2008, as the lagged effects of the 2007 monetary tightening, a turning in the house price cycle, and the financial turbulence are projected to slow activity, despite monetary policy easing. Only a moderate recovery is foreseen for 2009.”

The IMF predicted a mild recession in the United States, with the rest of the G7 avoiding recession.

Another six months on, Alistair Darling made what looked like a throwaway remark in a Guardian Weekend interview.

The economic times we are facing “are arguably the worst they’ve been in 60 years,” he says bluntly. “And I think it’s going to be more profound and long-lasting than people thought.”

It was the late summer bank holiday. I remember reading it up at my parents’ house and saying, “Are you sure Alistair? What, worse than anything since the war? Come on…” By the time I got back to work, I’d forgotten about it.

I wasn’t the only one who was not convinced, though John Band’s “poo on a stick” piece dismissed the Chancellor’s comments with the most aplomb. Even among the government’s opponents, the reaction was curiously muted. Most of the reporting at the time seemed to focus on the reaction of Gordon Brown and whether the government was split, rather than on whether or not Alistair Darling was right.

A couple of weeks later I was in Canary Wharf when Lehman Brothers collapsed. That was when things started looking serious, though some people were still cracking jokes about it. This Telegraph timeline reminds us just how quickly things went bad afterwards. Just over half a year separates what now look like ridiculously optimistic growth forecasts from the catastrophe that followed. The fall was rapid and, for the most part, unforeseen.

Hindsight, though, is a wonderful thing. Very few people saw the recession coming and, even those who did, had no idea it would be so severe. Even a few months before the world’s economies tanked, experts were still talking about a slowdown and maybe the odd quarter of zero growth. The OBR’s report reminds us of the prevailing mood before the crash and that the disagreements were, on the whole, about the degree of slowdown, rather than whether or not there would be a recession.

What we got instead was a series of events that blew holes in all the major economies and from which we have still not yet recovered. The world changed in 2008, it’s just that very few of us realised it at the time.

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11 Responses to Who saw the crash coming?

  1. johnb78 says:

    Haha, epic skills. I also overestimated the 2010 Tory vote somewhat…

  2. Jim says:

    I sold my modest portfolio of shares in April 2007, because I considered the USA set for a housing market correction, and that would cause a recession there that spread to the UK. I remember there was some forward looking indicator that had predicted x out of the y last US recessions flashing red at the time, and I thought it was time to bail out. I also couldn’t believe the sort of articles that were appearing in the press at the time about in x years house prices are going to be y hundred thousand etc etc. It all seemed mad to me, and couldn’t possibly continue indefinitely (Steins Law etc) so there had to be a correction. I had no idea how bad it would be due to the over financialisation of everything , and the increased interconnectedness since the last recession, but I did call the top IMO.

  3. Dipper says:

    my own particular history on this … I worked since the mid 90’s for a city trading desk who generally thought the western world economy was hopelessly overborrowed and heading for a large crash, so we were predisposed to think the crash was coming, but by 2007 I had thought it would never happen and invested some of my dosh in a pension. I probably bought Jim’s share portfolio (above) so I didn’t see it coming.

    But on (I think) Aug 7th 2007 the world as we know it ended. It was as if a trap door had opened and people were falling through it. The panic and fear in the markets was palpable, and though the markets didn’t move exceptionally the cost of insurance went through the roof. I told my brother this was going to be a big recession and someone big would go bust. I had no idea so many banks would go bust.

    My view was and still is that banking was a messenger, and the message was that as a society we were living far beyond our means, our standard of living was maintained by borrowing, and the crash happened because there was no-one left to lend too. So the correction was going to be big, and strong, and it is still going.

    • P Hearn says:

      But fortunately, the Blair/Brown government had run such large budget surpluses during all the “boom” years that we could implement Keynesian remedies and bail out the banks without too much pain when the downturn came.

  4. John says:

    I was one of those who marched against the threatened invasion of Iraq. I went on the first, smaller, demonstration, where around a quarter of a million of us marched through London.
    The bigger demonstration – which saw the Liberal Democrats opportunistically change their position on the threatened invasion – saw an estimated 2,000,000 march through the streets of London, in which friends of mine participated.
    The outcome of the largest demonstration ever in UK history was that Tony Blair and his cabal simply ignored us all and went along with the lunatic Bush and the invasion of Iraq, with results that are still affecting us – negatively – today.
    With regard to the crash, I was in no position to do anything about it. However, I recall seeing a TV programme in which a former Las Vegas casino dealer was seen selling properties in the US using sub-prime mortgages [remember them?]. I knew then that it would end in tears.
    The crash was largely US-inspired. Again, it is a long story to explain it. It was a combination of repealing the Glass-Stegal Act of the 1930s and the arrangements by which local pressure groups and banks – with the active participation of US federal agencies – endeavoured to create a property-owning democracy in the US, targeting people who had no hope of servicing their debts and the credit agencies then bundling-up the mortgages into derivative products sold with AAA ratings which were wholly unrealistic. Once the mortgage defaults began to rack up, the whole house of cards unravelled and collapsed.
    To give him credit, once Gordon Brown had realised what was going on, he brought together the G20 leaders in order to formulate policies which would save the western banking system.
    That, plus the fact that senior bankers and business executives in the US went to Congress and largely demanded bail-outs, which they got, then bailed out the whole rotten system but also saw a continuation of policies which enriched the rich and penalised the poor in all our societies.
    We are all still living with this mess today and seeing quantitative easing and low interest rate policies as a result – all of which has a “through the looking glass” quality to them, even now.
    The mess is not over yet. Where it will all end, I just don’t know – but it won’t be good.

    • P Hearn says:

      Keen to promote home ownership (laudable though that might be), President Clinton’s National Homeownership Strategy relaxed old fashioned tests on a borrower’s ability to repay a mortgage. In other words, the “liar loan” was born.

      Clinton’s certainly not the sole cause of the financial crash, (Bush eagerly continued the lending programme), but it’s interesting that the roots of sub-prime lending were US government inspired.

    • Dipper says:

      thanks for sharing that John. Two points:

      re the cause of the boom, I recommend reading “All The Devils are Here” by Joe Nocera and Bethany Maclean. The picture that emerges is of a massive pyramid scheme which relied on new entrants to support it, so rather than Class-Stegal producing more mortgages as a by-product, I would suggest that this and other acts were undertaken specifically to allow the credit boom to continue.

      As for timing, markets are a battle between buyers and sellers. It is easy to be a seller and predict doom, but as Keynes said Markets can remain irrational longer than you or I can remain solvent. A good example is Spanish and Italian debt. There are lots of good reasons for thinking Spain and Italy are basically bust and there debt should be junk. Howver, thanks to the unyielding commitment and generosity of the German worker, it is currently high quality investment grade debt.

      • John says:

        My information is based on a publication “Fragile By Design – The Political Origins of Banking Crises & Scarce Credit” by Charles W. Calomiris – Professor of Financial Institutions at Columbia Business School – and Stephen H. Haber – Professor and Senior Fellow at Stanford University – Princeton University Press 2014. I found it technically complex but still understandable.
        Spain’s economy is nominally in recovery, though Italy is still depressed, though its size means it can still hang on to lower borrowing costs – like Spain – because it is generally backed by the European Central Bank.
        Spain is introducing economic reforms but Italy appears still mired in historic forces which will not yet allow it to modernise and update their economy.
        Many younger citizens of Spain and Italy have migrated to my country – Britain – where they presumably feel there are much better prospects, though – paradoxically – the availablity of reasonably priced housing is much less than where they have come from.

  5. Pingback: Was the crash really ‘all Labour’s fault’? – Flip Chart Fairy Tales | Vox Political

  6. guthrie says:

    Actuallyyyy, I reckoned we were in a housing boom in 2005. I bought a flat at the end of the year, because one needs a place to stay, and opted for a 2 year fixed interest rate mortgage, because I had this idea that the boom would peak in a year or so, and in another year the government would have cut interest rates to keep things going as we entered a recession of sorts. So after 2 years I’d standa a chance to re-mortgage at a lower rate, or at least benefit from them.
    Instead, the insane boom kept going for a a year longer, and then crashed much more than I expected, because, as a mere plebeian, I didn’t know about all the dodgy instruments of destruction the banks used to blow themselves up. All I knew at that stage was a smidgen of basic economics and some history, and yet even I knew we were in an unsustainable boom and that things would get messy.

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